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Editor’s Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Executive summary:

  • The Senate has introduced a bill which includes the blenders' tax credit or BTC.
  • The Bill extends the life of the BTC to 3 years.
  • The EPA is considering boosting the 2014 biodiesel RVO from 1.28 to 1.7 billion gallons or more.
  • How the BTC and RVO issues are resolved will have a significant impact on the biofuels industry.

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Things are beginning to look brighter for the biofuels industry. After the "blenders' tax credit" or BTC expired at the end of the year, margins in the biodiesel and renewable diesel industry collapsed. To this day, biodiesel made with soybean oil is still showing a negative margin.

As I write this, biodiesel operating margins for soybean oil based biodisel are negative according to Iowa State University

The regulatory environment totally dominates this industry, and what happens in Washington easily outweighs almost any other factor. The key issues facing this industry are: 1) the fate of the BTC and 2) the fate of the EPA's RFS2 mandates. How those issues get decided will have a monumental impact on the companies within those industries.

One of the biggest flaws in the government's administration of the biofuels industry is the overlapping regulatory/subsidy systems of the EPA's RFS2 and Congress' BTC. The overlapping and redundant systems create unbelievable confusion, uncertainty and disruptions in the industry. One of if not the greatest flaw is the on-again-off-again nature of the BTC. The BTC has been in place since 2005 and has expired and been reinstated 3 times. In 2012 it was restored in early 2013 and made retroactive to 2012, forcing the industry to produce at low to negative margins for half a year and gamble on the ultimate passage of the BTC. Most smaller firms simply can't afford to produce for 6 months as a loss hoping to get reimbursed by the IRS once all is said and done. From following the EPA's RFS2 and Congress' BTC, it becomes crystal clear that most politicians and bureaucrats in Washington have never run a business or studied free market economics.

The $1-per-gallon incentive covers biodiesel, renewable diesel - a similar diesel alternative made with a different technology - and renewable aviation fuel. First implemented in 2005, it expired on Dec. 31, 2013. It also was allowed to lapse in 2012 and 2010.

Fortunately, people in the real world have run real businesses and have studied economics, and they hire lobbyists to educate those in Washington. One of those lobbying groups is the National Biodiesel Board or NBB, and it looks like they are making progress. Just yesterday the Senate introduced a bill attempting to reinstate the BTC.

"On behalf of biodiesel producers across the country, we want to thank Sens. Cantwell and Grassley for their leadership on this issue," said NBB Vice President of Federal Affairs Anne Steckel. "The biodiesel tax incentive has expired three times over the past five years, and each time it has severely disrupted production. By comparison, we know that at least $4 billion in incentives encouraging domestic petroleum production are built into the tax code. We need that same kind of stability for younger, cleaner industries like biodiesel and renewable diesel to compete."

The introduction of the bill however isn't what got me excited. Everyone knew the bill was going to be introduced at some time. What got me excited are two things:

1) My understanding was that the BTC was going to be made part of a much larger comprehensive tax reform bill that wasn't due to be introduced until much later in the year if at all.

2) This bill addresses the greatest flaw in the BTC, its year-by-year expiration and passage.

The bill being introduced would extend the BTC's life to 3 years.

WASHINGTON - The National Biodiesel Board (NBB) called on Congress to move swiftly on tax legislation after Sens. Maria Cantwell, D-Wash., and Charles Grassley, R-Iowa, introduced a bill to extend the expired biodiesel tax incentive for three years.

That is huge to an industry that invests tens of millions on dollars into plants that may take years to build and many more to pay off. The uncertainty of the regulatory environment is a great hindrance to this industry. Giving the BTC a 3 year life greatly improves the stability and economics of this industry. Additionally, the 3 year life will take it to the end of the Obama administration and through 2 elections. Providing stability during that time is extremely important given that these issues are certain to become political issues.

The bill introduced Wednesday, S. 2021, would extend the tax incentive until 2017, providing the tax certainty the industry needs to gain access to capital and plan for production expansions and additional hiring.

The other issue pending is the decision on the EPS's RFS2 Biofuels RVOs, or production targets.

In addition to the pending expiration of the tax incentive, the industry also is fighting a weak Renewable Fuel Standard proposal from the EPA, which recently proposed limiting biodiesel volumes under the RFS to 1.28 billion gallons for the next two years, a significant cut from last year's production of 1.8 billion gallons.

According to the NBB 2 billion gallon/yr capacity currently exists in the biodiesel industry, and 1.8 billion gallons were produced in 2013. The 2014 biodiesel RVO of 1.28 is a substantial cut below the capacity that already exists and production levels already reached.

In addition to the pending expiration of the tax incentive, the industry also is fighting a weak Renewable Fuel Standard proposal from the EPA, which recently proposed limiting biodiesel volumes under the RFS to 1.28 billion gallons for the next two years, a significant cut from last year's production of 1.8 billion gallons.

(click to enlarge)

While it is impossible to say how the EPA will decide the RVO issue, the NBB appears to have a pretty solid case. This is from a recent Wall Street Transcript of a Raymond James alternative energy analyst.

One of the issues on the policy front that investors will be watching this year is what happens in Washington with regard to the Renewable Fuel Standard. To be clear, there is not much push in Congress to change the RFS in any meaningful way. The bigger issue is whether the EPA will follow through with a haircut of its production targets to the extent that its original proposal suggested last fall. The biofuel industry is not happy about these proposed haircuts, but on the other hand the petroleum fuel industry doesn't think they go far enough, so we'll see which way the EPA goes. My guess is they will probably upsize the blending targets because I think they want to be receptive to the needs of the biofuel industry, but the biofuel industry is not likely to get everything that it wants either.

The other issue covered in that transcript is what I call the future of RFS2, the cellulosic biofuels. This industry have been really struggling to get off the ground and the EPA has had to issue waivers and cut the RVO for cellulosic fuels in the past. A permanent 3 year BTC would greatly improve the outlook for these companies.

One of the realities in recent years has been that it is taking longer than many industry players would have expected to scale up these emerging technologies, and to some extent, it's been an issue of just pure execution. In other words, lots of operational and technological hurdles need to be overcome as part of commercialization, and this is true for companies that use fermentation as a process as well as those that use a thermochemical process. Also, financing has been a source of difficulty, because the public markets have not been very receptive for these companies.

Despite that, by the end of 2014 there should be at least six industrial-scale cellulosic biofuel plants operating in North America, versus only two currently, so hopefully it triples in the next 12 months.

Companies that are likely to benefit from the BTC and boost in the RVO if they occur include:

Renewable Energy Group (NASDAQ:REGI)

Biox (OTC:BXIOF)

Syntroleum (NASDAQ:SYNM)

Oxford Catalyst/Velocys (OTCPK:OXFCF)

Valero (NYSE:VLO)

ADM (NYSE:ADM)

Ethanol producers like Green Plains Renewables (NASDAQ:GPRE) may also benefit from changes to the EPA's cut in the ethanol RVO if it were to happen.

In conclusion, while the introduction of the BTC bill doesn't mean it will pass anytime soon, it is certainly a step in the right direction. Not only does the bill move the timeline forward for its possible passage, it also includes a dynamic changing 3 year life. If the BTC is given a 3 year life it will be extremely beneficial for the biofuels industry, especially the emerging cellulosic companies. Continued pressure on the EPA to boost the biomass based diesel RVO may also result in another step in the right direction if the EPA decides to boost the 2014 RVO from 1.28 billion gallons to 1.7 or more. Only time will tell how these events get resolved. If steps keep going in the right direction the biofuels industry may be looking at a very energetic 2014.

Source: Future Of Biofuels Is Looking Brighter

Additional disclosure: I own calls on REGI.

Disclaimer: This article is not an investment recommendation or solicitation. 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. Past performance is no guarantee of future results. For my full disclaimer and disclosure, click here.