The recent fiscal cliff "solution" extended Bush-era tax cuts for 99% of American incomes. Along with the dozens of provisions weaved into the bill was one that generated relatively little media coverage: the extension of tax credits for renewable energy. This included important cost reductions for renewable fuels, namely first generation blendstocks such as ethanol and biodiesel. There may be a long line of critics lamenting government involvement in the biofuel industry, but it has proven to be one of the most successful – and important – partnerships of private industry and state in recent years. Don't believe me? The numbers don't lie.
Renewable Fuel Standard (RFS)
Despite their respective flaws, the Energy Policy Act of 2005 (RFS1) and Clean Energy Act of 2007 (RFS2) have been extremely successful in fostering markets for renewable fuels. The stability allowed first generation ethanol production to grow 257% from 2005 to 2011. In fact, more ethanol was produced in 2011 than in the 17 years from 1981 to 1997 combined.
Agricultural giant Archer Daniels Midland (NYSE:ADM), with the nation's leading grain distribution network, was a natural fit to capitalize on the government programs. Despite gradually scaling down its operations the company boasted 1.4 billion gallons of U.S. ethanol capacity in 2012, which represented 10.2% of the country's total and was second only to POET. The willingness of agricultural heavyweights to enter the ethanol market allowed the United States to offset nearly 9% of domestic gasoline consumption by volume in 2011. The 133.93 billion gallons of gasoline consumed contained 12.87 billion gallons of ethanol.
How was this possible, you ask? Renewable Identification Numbers (RINs).
Gotta play to RIN
RINs are certificates that are bought (fuel blenders/distributors) and sold (biorefineries) with each gallon of renewable fuel. They allow the EPA to ensure annual targets are met. The value of a RIN is determined by the unmet need of the RFS and the cost needed to allow producers to cover costs. When more RINs are being sought by distributors the prices increase, therefore creating an incentive for biorefineries to increase production. Ideally, RIN values reach equilibrium when supply meets demand. Unfortunately, it's not always so simple.
An oversupply of ethanol and biodiesel in 2012 caused a crash in RIN values. While smaller producers struggled, larger producers flourished with industry consolidation. Renewable Energy Group (NASDAQ:REGI), the country's largest biodiesel producer, has grown annual capacity to over 225 million gallons by scooping up assets at liquidation prices. It recently purchased two 15 million gallon per year (mmgy) multi-feedstock facilities in Texas and Georgia for just $7.4 million in cash and stock. That's less than $2 per gallon! With 150 mmgy of capacity currently under construction, REGI will have the ability to produce 375 million gallons of biodiesel in 2014 – or one in four gallons produced in the United States.
Missing: cellulosic ethanol
With first generation ethanol (corn) production capped at 15 billion gallons per year, focus is rapidly shifting to the next fuel in line for RFS nurturing: cellulosic ethanol. Years of setbacks have repeatedly drained enthusiasm for the fuel. Furthermore, with fuel blends and ethanol production already at the maximum 10% of gasoline consumption there is also a question of where all the cellulosic fuel will go.
Big time financiers have been a little quicker to react than our elected officials. BP (NYSE:BP) pulled the plug on a $350 million project in November. The move followed Royal Dutch Shell's (NYSE:RDS-A) targeted exit from pricey biocatalytic partnerships, such as those with cellulase enzyme producers Iogen and Codexis (NASDAQ:CDXS).
Despite claiming to wield market leading cellulase enzymes Codexis saw its share price drop over 63% last year, thanks to the lost partnership with Shell and a constant shuffling of management. With a new management team in place and reduced headcount the company now faces an uphill battle wrestling market share from enzyme leaders Genencor and Novozymes. Nonetheless, Codexis could play a big part in shaping the cellulosic ethanol industry. Once it arrives of course.
Can state aid combat the corporate exodus?
Perhaps the corporate exodus from biotech-oriented advanced biofuels bodes well for KiOR (NASDAQOTH:KIORQ), which recently commenced commercial operations at its first drop-in (not blends) cellulosic gasoline and diesel biorefinery. Although the facility will have a nameplate capacity of just 13 mmgy it utilizes thermocatalytic cracking technology that is well understood. The modular process allows for easy replication and scale-up – something the company is eying for the 2014 launch of a 40 mmgy facility in Natchez, Miss.
The company isn't producing cellulosic ethanol, but its fuels do qualify for all RFS waivers possible for advanced biofuels. As a result, KiOR expects their RINs to be worth up to a whopping $2.36 per gallon in 2013. Given a projected selling price of $2.88 per gallon the company could pocket a total of $5.24 per gallon of fuel sold this year.
More advanced fuels, such as those derived from algae or other biotechnology platforms, will have more difficult time getting to the market (they aren't even included in the most recent RFS legislation.) That hasn't stopped dozens of private algae ventures from staking claim to the fuel markets.
Although it is not an algae company in the traditional sense (large, outdoor farms), Solazyme (NASDAQ:TVIA) is developing a heterotrophic algae platform (indoor facilities) for producing renewable oils. The company offered algae-based SolaDieselBD, a drop-in diesel replacement, at select Bay Area stations of partner Propel last November. Despite the media coverage, the economics for producing fuels on the company's platform don't compare favorably to higher-value oil products such as cosmetics, specialty chemicals, and nutritional additives.
The blueprint has been drawn
The next time you complain about the government hand in the fuel market consider that without the RFS, the United States would need to import an additional 768 million barrels of oil every year. Support for advanced biofuels, which have many more scientific obstacles to hurdle than their predecessors, will bring about the loudest critics to date. Still, the groundwork has been laid to bring them to the market.