The biggest change to U.S. biofuels policy in the last year was the expiration of most biofuels tax credits, subsidies, and tariffs at the end of 2011. Among the expired programs are the Volumetric Ethanol Excise Tax Credit (VEETC), multiple biodiesel tax credits, and the tariff on imported ethanol. The revised Renewable Fuel Standard (RFS2) is still in force, however, making it the primary government mechanism for supporting U.S. biofuel production and consumption. Few investors have a clear understanding of the RFS2's inner workings due to both its complex structure and a lack of full government enforcement in recent years. The purpose of this article is to give readers a full understanding of the RFS2 and its ability to affect biofuel profitability, which is substantial.
The RFS2, which is overseen by the US Environmental Protection Agency (EPA), mandates minimum usage requirements for different categories of biofuels, starting at a total of 9 billion gallons per year ((NYSE:BGY)) in 2008 and rising to 36 bgy in 2022. The biofuels categories are both separate and nested, with four broad categories: (1) total renewable fuels, (2) advanced biofuels, (3) biomass-based diesel, and (4) cellulosic biofuels. Each category has its own volumetric requirement and these will change in relation to one another over time; while most of the mandate can be met by any renewable fuel early on, the total renewable fuels category is permanently capped in 2015 and by 2022 the cellulosic biofuel category is responsible for a plurality of the mandate.
The definitions for the biofuels categories encompass both the type of biofuel and the biomass feedstock. Total renewable fuels must be sourced from renewable biomass that in turn meets certain land use restrictions. Each category of biofuels must also meet a certain lifecycle greenhouse gas (GHG) reduction threshold relative to its hydrocarbon-based counterpart. The total renewable fuels category must meet a 20% reduction threshold. Under the EPA's current analysis most biofuels, including corn ethanol, fall under this category. The second category is advanced biofuels, which must meet a 50% reduction threshold. Corn ethanol is explicitly excluded from this category regardless of its actual lifecycle GHG reductions. Sugarcane ethanol, on the other hand, can be included, as can cellulosic biofuels and biomass-based diesel. The biomass-based diesel category also requires a 50% reduction threshold and includes both biodiesel (i.e., ester biomass-based diesel) and renewable diesel (i.e., non-ester biomass-based diesel). The final category is cellulosic biofuel, which covers biofuels that are derived from lignocellulosic feedstock and meet a 60% reduction threshold.
The RFS2 impacts the economic feasibility of biofuel production by attributing a credit value to each gallon of biofuel produced in the form of 38-character Renewable Identification Numbers (RINs). A RIN is attached to a gallon of biofuel when it is produced and detached when it is sold to a blender, which uses RINs to demonstrate its compliance with the RFS2. A blender that has already met its mandated biofuels usage can sell its excess RINs to another blender or bank them for future use. The RIN value increases when biofuels demand exceeds supply and can represent an important source of income to biofuel producers, as RINs for biomass-based diesel fuel reached $1.60/gal in August 2011 . The RIN values are designed to ensure that biofuel production for each category (e.g., cellulosic biofuels) is profitable, or at the very least not a lossmaker, so long as production falls short of the mandated volume in a given year. Initially this means that no qualifying producers will lose money, and those with the lowest costs will enjoy the high profit margins. The RIN value will decrease as production closes with the mandated volumes, however, until only those pathways that are able to compete with petroleum-based transportation fuels on an unsubsidized basis remain. This is to ensure that the RFS2 does not become an inflexible subsidy such as the VEETC, which paid a predetermined amount of money to ethanol producers for every gallon of ethanol produced, regardless of their profitability.
A hypothetical example is useful here. Previous research has calculated minimum selling prices (MSPs) for three different cellulosic biofuel pathways: (1) fast pyrolysis and hydroprocessing; (2) gasification and Fischer-Tropsch synthesis; and (3) cellulosic ethanol via enzymatic hydrolysis . The MSPs are listed on a gasoline-equivalent basis in Table 1, along with the Energy Information Agency's 20-year projected pre-tax gasoline price [3, 4].
|Pathway||MSP ($/gge)||Gasoline price ($/gal)|
Assuming for the sake of this example that these are the only three commercial-scale cellulosic biofuel pathways in the US (and they are not in reality), initial production is expected to fall far short of the mandated cellulosic biofuel volumes (indeed, the EPA waived the cellulosic biofuels mandate in 2010 and 2011 due to a lack of available capacity). The initial RIN value attributed to each gallon of cellulosic biofuel produced will therefore be the difference between the gasoline price ($2.86/gal) and the highest MSP ($5.00/gge), or $2.14/gge. This will result in per-unit profit margins of $3.00, $0.50, and $0.00/gge for producers employing fast pyrolysis, gasification, and cellulosic ethanol, respectively. While no cellulosic biofuel producer will lose money, those employing fast pyrolysis and gasification will be the most profitable. This will encourage their expansion until the two pathways are capable of meeting the mandated volumes on their own, at which point the RIN value will fall to the difference between gasification MSP ($4.50/gge) and gasoline ($2.86/gal), or $1.64/gge. Ultimately investors will focus on fast pyrolysis as the only one of the above pathways that is expected to compete with gasoline on an unsubsidized basis, resulting in the cellulosic biofuel RIN value falling to $0 (it cannot go negative).
Cellulosic biofuel RINs have no market value at present due to the lack of enforcement of the category's mandate by the EPA (they have instead been replaced by a temporary waiver credit worth $0.25/gal). This will change in the future as cellulosic biofuel commercialization occurs. While it is easy to assume that a rising tide will lift all ships and all cellulosic biofuel pathway profit margins will increase under the RFS2, investors (as opposed to traders) should be aware that some profitable pathways will become unprofitable over time due to a shrinking RIN value as total production approaches the mandated volume. A contemporary example is the recent idling of corn ethanol facilities due to falling profit margins; while RINs exist for corn ethanol, current production exceeds the conventional biofuels category mandate, causing RIN values to fall below the level at which corn ethanol production is profitable. This should be accounted for when deciding whether or not to invest in cellulosic biofuel companies such as BlueFire (OTCPK:BFRE), Codexis, (CDXS), Gevo (GEVO), KiOR (KIOR), and Rentech (RTK). Investors should therefore cross-reference the MSPs reported by cellulosic biofuel producers with those published in the open literature and by the government laboratories to determine which pathways are likely to derive the greatest benefit from the RFS2. For example, KiOR's S-1 states that the company can produce biobased gasoline and diesel fuel at commercial-scale on an unsubsidized basis for $1.80/gal, which is comparable to the MSPs for fast pyrolysis and hydroprocessing reported both in the open literature ($2.00/gal)  and by the national labs ($2.04/gal)  (note that KiOR employs a variant of fast pyrolysis called catalytic pyrolysis and while the two pathways are similar, they are not identical).
 McPhail, L., Westcott, P., Lutman, H. 2011. The Renewable Identification Number System and U.S. Biofuel Mandates. Economic Research Service, Washington, DC.
 Anex, R., Aden, A., Kazi, F., Fortman, J., et al. 2010. Techno-economic comparison of biomass-to-transportation fuels via pyrolysis, gasification, and biochemical pathways, Fuel (89): S29-S35.
 EIA 2011. Annual Energy Outlook 2011. Washington, DC.
 API 2011. State Motor Fuel Excise Tax Report. Washington, DC.
 Wright, M., Daugaard, D., Satrio, J., and Brown, R. 2010. Techno-economic analysis of biomass fast pyrolysis to transportation fuels, Fuel (89): S2-S10.
 Jones, S., Valkenburg, C., Walton, C., Elliott, D., et al. 2009. Production of gasoline and diesel from biomass via fast pyrolysis, hydrotreating, and hydrocracking: A design case. Pacific Northwest National Laboratory, Richland, WA.
Disclosure: I am long KIOR.