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With a monster tax credit and high government biofuel production mandates, 2013 was an amazing year for biodiesel producers as money was falling out of the sky for them. Renewable Energy Group (NASDAQ:REGI) is the biggest biodiesel producer and so had the greatest success. REGI shareholders should enjoy their fun while it lasted. 2014 will be just the opposite, with no tax credit, decreased government mandates, and an oversupply of biodiesel on the market. I expect the company will do poorly in 2014 with losing quarters and negative EBITDA. REGI will likely drift down to where it was in 2012, also when there was no tax credit, to around $5-$7 per share.
Blenders Tax Credit Expiry
As explained in this article, the Blenders Tax Credit (BTC) expires on December 31, 2013. This tax credit is huge, a $1.00 credit for every gallon of biodiesel produced. This is split 50/50 between the biodiesel blender and producer (which is REGI). In 2013, REGI's EBITDA margins were 50-60 cents per gallon of biodiesel produced. Take away the 50 cents from the tax credit, and that's 50 cents the company will lose immediately.
It's a good thing for the energy industry in general for this tax credit to go away. It is extreme and has helped to cause an oversupply of biodiesel. Foreign producers shipped biodiesel to the U.S. just to get the tax credit. They didn't care about fulfilling the government mandate, the tax credit alone is powerful enough.
It is possible that the tax credit will get reinstated. I don't think this is likely because it caused a lot of issues. As long as the mandate is in place, the biodiesel will have to be produced. The tax credit makes it more profitable for the producers and blenders, but the Obama Administration is under pressure to make a lot of budget cuts, and he hasn't shown the support for biofuels as he has in the past.
The Obama Administration Comes Down On Biofuels For 2014
Because of such a fiasco in the biofuels industry in 2013, for the first time the Obama Administration is reducing the amount of biofuels required to be mixed with petroleum.
In the beginning of 2013, Obama was a huge champion of biofuels. The tax credit was not only introduced for 2013, but also reinstated for 2012. This was a huge boon for biodiesel producers like REGI. REGI not only got the tax credit for 2013, but received the tax credit for its production in 2012. That's why its PE is about 2.5 right now, it includes the 2012 tax credit. Without that, the PE would be about 6.
The EPA then had fuel mandates that ended up being too high. In 2013, for ethanol, 13.8 billion gallons are required, which ended up being .8 billion gallons too much. This is because there is what's called the "blend wall" with ethanol. The oil industry said ethanol can't make up more than 10% of the mix between petroleum and ethanol for cars to handle it. And since only 130 billion gallons of gasoline will be used in the U.S. in 2013, then only 13 billion gallons of ethanol is needed. The 800 million gallons difference is huge.
As retaliation for this erroneous ethanol requirement, the oil industry's top lobby group, the America Petroleum Institute, launched an aggressive campaign urging repeal of the Renewable Fuel Standard. It spread the message on the TV, radio, and online about how ethanol is bad for the environment, for cars, and causes higher food prices. It spent a fortune on this campaign. The Renewable Fuels Association, the ethanol industry's lobbying arm, tried to fight back, but its advertising budget is miniscule compared to the oil industry's.
These events caused the Obama Administration to make a 180 degree turn in its attitude towards biofuels. The ethanol mandate was going to be 14.4 billion gallons for 2014, but it got changed to 13 billion gallons, actually lower than what is required in 2013. The biodiesel mandate stays the same in 2014 at 1.28 billion gallons.
It's likely that the Obama Administration will not reinstate the Blenders Tax Credit. It isn't needed anyways, as long as the mandate is there. The tax credit ends up making the supply/demand equilibrium unbalanced.
Oversupply Of Biodiesel
The ethanol too high mandate and blend wall forced oil companies to use biodiesel instead of ethanol. The EPA allowed this substitution. To measure how much biofuel is being used, the EPA uses a compliance measurement called the RIN (renewable identification number). Whenever a gallon of the biofuel is produced, a RIN is recorded with the EPA, and whoever buys that gallon gets that particular RIN. For ethanol, a D6 RIN is recorded, for biodiesel, a D4 RIN is recorded. The D4 RIN can be used in the place of the D6 RIN, but not the other way around. Since there is a blend wall of 10% ethanol, then the 800 million gallons over-requirement of ethanol couldn't be used. Since there is no blend wall with biodiesel then biodiesel was bought in the place of the ethanol, and the D4 RIN was often used in the place of the D6 RIN. This caused an oversupply of biodiesel, and also caused the RIN to balloon to very high prices.
Right now, the RIN is small, only $0.30. It will get a little higher after the tax credit expires, but not much. This small RIN price shows that there is little demand for biodiesel since there is already so much out there. RINs can last for one year before they expire, so this represents demand in 2014 as well.
Syntroleum Acquisition - A Sign Of Desperation?
On December 17th, REGI announced an agreement to purchase Syntroleum (NASDAQ:SYNM) using all stock. This doesn't look to be a very logical business decision. There are no synergies between the two. SYNM makes renewable diesel which is superior to biodiesel but is very hard to make. It's a completely different process than making biodiesel. Why would REGI do a better job running the plant than SYNM? SYNM has the one plant located in Louisiana, while REGI's plants are primarily in Iowa. SYNM has a 50% ownership of the plant company, Dynamic Fuels, and Tyson Foods (NYSE:TSN) has the other 50%.
In a time where biodiesel producers are minting money, with the tax credit and RIN prices at all-time highs, the plant was closed. Why should the plant get opened now, in a much worse environment for the biodiesel industry? It would cost at least $20 million to get it up and running. The plant has been closed all year so a new staff would need to be hired. A month's worth of feedstock would need to be bought up front, which would cost about $10 million. Then parts might need to be bought or machinery replaced. It's a big risk.
It seems like the acquisition is a "story creation" move by REGI. Since REGI management knows it's going to have a really rough 2014, it needs to create a story to keep shareholders interested. It uses all stock since it knows its stock is overvalued, otherwise it use at least some of its $135 million of cash. SYNM is happy to take the deal, otherwise it would probably go to zero. It's a stranded asset.
With the EPA biofuels mandate decreasing, REGI is in a stagnant, or even declining, industry. On top of this, with the tax credit expiring, an oversupply of biodiesel and low RIN prices, there is no incentive to produce a lot for 2014. With lower production, REGI will have to idle many of its plants. As the first quarter is slow for the biodiesel industry anyways, coupled with all the other problems REGI is facing, look for a swift downward movement in the share price after the first quarter results are revealed.
Disclosure: I am short REGI. 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.