Ethanol's 'Blend Wall' Has A Silver Lining For Biodiesel And Renewable Diesel Firms

Includes: FUE, REGI
by: Robert Wagner

Recently, there has been a lot of press about the ethanol "blend wall." EPA regulations combined with lower corn prices have created an economic condition that will likely result in the over production of ethanol. The ethanol surplus will have multiple economic impacts. The intended goal is to have the price of E85 gasoline fall in price hopefully making is more attractive to consumers.

The arrival of the blend wall changed this equation, at least temporarily. The jump in RIN prices has occurred even as gasoline prices have increased and corn prices have decreased (see figure), which would normally result in lower RIN prices. RIN prices have increased by 2700% because ethanol consumption is capped by the blend wall to a level that is below both production capacity and the volumetric mandate for 2013. RIN prices will therefore increase until they are high enough to incentivize the consumption of the missing gallons (400 million in 2013, rising to 1.2 billion in 2014). This would most likely happen in one of two ways: (1) via the RIN value being used to discount the market price of ethanol to make it more attractive than gasoline

Anyone who reads my article knows that I absolutely hate these command and control centrally planned social engineering programs. That being said, things are what they are, and when all is said and done, I'm a pragmatist. Facts are, whether or not I like these programs, they exist, and my responsibility is to provide objective financial and economic analysis. As much as I hate to admit is, there is a silver lining to this ethanol "boondoogle." That isn't my chosen description, I use it because it seem to be a favorite of politicians and progressive magazines when they describe the program.

The benefit that I see to investors beyond the M&A possibilities being created, is that a byproduct of ethanol is a waste called inedible corn oil (ICO). Why is creating more waste a benefit? Because that waste is a feedstock for multi-feedstock biodiesel and renewable hydrotreated diesel firms. These firms take ICO and can make FAME biodiesel and a "drop-in" "neat qualified" renewable diesel fuel, depending on whether it is a biodiesel or hydtotreating process.

During 2012, 84% of our feedstocks were comprised
of inedible corn oil, used cooking oil and inedible
animal fats with the remainder coming from refined vegetable oil.
We have increased the use of these feedstocks because
they are lower cost than refined vegetable oils.

Depending on the process, it takes between 7.6 and 8.2 lbs of ICO to make a gallon of "blended" renewable diesel and/or FAME biodiesel. This following quote is from a recent Renewable Energy Group's (NASDAQ:REGI) 10-Q highlighting the range of feedstocks and lbs/gal it uses at its facilities.

Soybean oil (crude) prices are based on the monthly average of the daily closing sale price of the nearby soybean oil contract as reported by CBOT (Based on 7.5 pounds per gallons).
(1) Used cooking oil prices are based on the monthly average of the daily low sales price of Missouri River yellow grease as reported by The Jacobsen (Based on 8.5 pounds per gallon).
(2) Inedible corn oil prices are reported as the monthly average of the daily distillers' corn oil market values delivered to Illinois as reported by The Jacobsen (Based on 8.2 pounds per gallon). (3) Choice white grease prices are based on the monthly
average of the daily low prices of Missouri River choice white grease as reported by The Jacobsen (Based on 8.0 pounds per gallon).

Because each feedstock varies by the number of lbs required to make a gallon of biodiesel, the feedstocks vary in price. Soybean oil is usually the highest, followed by choice white grease, followed by ICO and the lowest cost feedstock is usually used cooking oil, or what is referred to as "yellow grease."

Soy Oil White G ICO Yellow G
lbs/gal 7.5 8 8.2 8.5
$0.01/lb 42.11 40.4 39.5 34.5
$/Gal $ 3.16 $ 3.23 $ 3.24 $ 2.93
SME $4.95
FAME $4.90 $4.90 $4.90
Gross Margin $1.79 $1.67 $1.66 $1.97

This "substitutability" of feedstocks creates an arbitrage opportunity for the multi-feedstock firms, where they can exploit the price differences so the margins remain relatively close. Soy bean oil, however, competes with food so it is the least predictable, but can be hedged directly. The other feedstocks are difficult to hedge. Soybean oil also makes a lower cloud point diesel called SME so it usually sells at a premium, especially in the cold months, so there is a seasonality to the margins and feedstock prices.

Because ethanol is likely to be overproduced this year, there should also be an over supply of ICO. This is happening right when biodiesel plants are cranking up the production of FAME because of the warmer weather. This should help moderate the increase in the price of ICO that usually occurs as demand for ICO increases. ICO, however, is a substitute for soy oil, white grease and yellow grease, all of which should have their prices impacted by the greater supply of ICO.

In conclusion, the ethanol "blend wall" and the over supply of ethanol that is likely to result should be beneficial to the bio and renewable diesel industry. It will likely encourage "obligated parties" to buy more bio and renewable diesel, support RIN prices and most of all, produce an additional supply of feedstock for the bio and renewable diesel firms. This should not only translate into lower feedstock prices, but also higher margins. All these factors are combining to make 2013 a very good year for biofuels, but be careful, the market is rapidly becoming aware of these developments.

Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Disclosure: I am long SYNM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.