Biodiesel Economics 101: Understanding The Margins, Part 1

Includes: REGI, SYNM
by: Robert Wagner

I recently wrote an article titled "Early Signs Mixed for Biodiesel," which highlighted that a biodiesel company, BIOX (OTC:BXIOF), jumped after reporting a loss. I also wrote an article "Blender Tax Credit Isn't Helping Biodiesel Much" highlighting how the tax credit wasn't really helping biodiesel producers as much as one would have expected. I currently have an article in review titled "Signs Still Mixed for Biodiesel, but Economics are Improving," which highlighted a biodiesel company Renewable Energy Group (NASDAQ:REGI) whose stock initially dropped after reporting a profit. Then we have an advanced biofuels company Syntroleum (NASDAQ:SYNM), whose economics are similar to biodiesel, report in their recent 10-k that:

The plant was placed in stand-by mode after completion of a maintenance turnaround in December, 2012, primarily because of economic conditions. Although economic conditions have improved in 2013, the plant remains in stand-by mode as the Company and Tyson (NYSE:TSN) have not yet agreed upon the economic conditions required for plant start-up.

If the experts that run these firms have difficulty navigating these complex and ever changing markets, how can an individual investor ever hope to understand and value these stocks? This article is the first in what I hope to be a series that attempts to do just that, explain the complex and ever changing markets and economics that make up the biodiesel and advanced biofuels industry. Once the series is completed I will use the model to produce a weekly biodiesel margin report to make it easy for interested investors to follow the margin trends in this industry so they can make up their own minds about the economics and whether or not they justify their investment dollars.

To do that I will attempt to construct a production model so that an estimate for the gross and net margins can be calculated. I want to stress "estimate." The resulting estimates will be a good tool to use in tracking the trends in the industry and formulating estimates for earnings, however, for companies like REGI that have multiple plants a one size fits all estimate may not be appropriate when applied to any one single firm which may have a unique cost structure that differs from the defined model. If a firm only has one plant like SYNM or BX.TO, I will use the information provided by the company in the model.

To begin, we will start with the top line number; the revenues per gallon. Two of the sources I use for prices is Progressive Fuels Limited and Starfuels which has a nice e-mail report. The part we will be covering in this article is the table of biodiesel prices and how to construct an estimate for the advanced biofuel SYNM sells.

These are quotes for biodiesel. B100 is 100% biodiesel. B stands for biodiesel and the number that follows represents the % blend.

SME Prices

The first thing to notice is that there are various grades of B100 defined by their feedstock. SME stands for soy methyl ester and is made from 100% soybean oil, FAME is a generic term that stands for fatty acid methyl esters, but in this context, it is used for a B100 made from a mixture of feedstocks.

The second thing to notice is that SME sells at a premium to FAME. The spread is usually widest in the winter and narrows in the summer. The reason for this is that SME has a lower "cloud point" than FAME. Cloud point is like the game of golf, the lower the score the better. A lower cloud point means that the SME B100 "clouds" at a lower temperature than FAME B100, a critical issue when driving in colder climates and why the spread usually widens in winter.

The third thing to notice is that there are regional differences for the price of B100. Gulf Coast B100 SME is more expensive than Chicago B100 SME, Chicago B100 FAME is more expensive than Gulf Coast B100 Fame.

The fourth thing to notice is that the wholesale price of B100 is a whole lot higher than the wholesale price of ultra low sulfur diesel ULSD, which currently trades around $2.94/gallon. Baked into the $4.99 Gulf Coast SME price is 1) the price of Gulf Coast ULSD 2) 1.5x the price of a D4 RIN and 3) the portion of the $1.00 tax credit that is passed on from the blender to the producer.

Tax Credit Calc

Because we will be focused on REGI in this series, Chicago SME and Chicago FAME will be used in its margin calculation. REGI has the majority of its plants located in the Midwest (see page #6). Once again, I want to stress "estimate." By using Chicago SME and FAME, it isn't a perfect match for the Gulf and East Coast plants that they have. That is an inherent weakness of modeling. A small amount of glycerin is also produced in the manufacture of B100, so there is a slight blending that is needed to adjust the wholesale price of B100. Glycerin is about 10% of the production and I use $1.07/gal. I am currently looking for a source of daily quotes for glycerin, which has been driven lower by increased B100 production.

For example, in 2007, the refined glycerol's price was painfully low, approximately $0.30 per pound (compared to $0.70 before the expansion of biodiesel production) in the United States. Accordingly, the price of crude glycerol decreased from about $0.25 per pound to $0.05 per pound

That is the easy part, it is relatively easy to get a quote for B100 and adjust it for a 90/10 blend of fuel and glycerin. Calculating what SYNM makes per gallon isn't so easy. SYNM doesn't produce B100, they produce a blend of fuels. The majority is a "neat qualified" ULSD which they refer to as "just diesel." It is also referred to as a "drop-in" fuel which is nearly chemically identical to petroleum ULSD. Their ULSD qualifies for 1.7x D4 RINs and is categorized as a biomass-based diesel. The second largest part of the blend is naphtha, which qualifies for 1.7x D5 RINs, and is categorized as an advanced biofuel by the EPA. The last and smallest part of the blend is liquid petroleum gas (LPG) which doesn't currently qualify for RINs.

That isn't all, there is more. The blender tax credit passed at the end of the year, so SYNM gets $1.00 per gallon of ULSD that they produce. In the recent 10-k they state they also get $0.50 for their naphtha.

will receive the alternative fuels mixture credit of $0.50 per gallon for a portion of the renewable naphtha

Now, armed with that understanding we will construct a "blended" rate for SYNM's fuel.

SYNM's mixture is approximately 83% ULSD, 12% naphtha and 5% LPG. They also "capture" 98%/96%/79% of the market price for those fuels.

I get the quotes for Gulf Coast ULSD, naphtha and LPG from the EIA website. To get an estimate for naphtha I use Gulf Coast gasoline and subtract $0.70, for LPG I use Texas propane.

When we put all these factors together we can formulate an estimated "blended" rate for SYNM's fuel. Currently I calculate it to be $4.96, very close to the $4.99 price of Gulf Coast SME.

Blended Rate

In conclusion, this is the first in a series of articles intended to create a biodiesel model so that individual investors can better track the economics, market conditions and margins of the biodiesel and advanced biofuels industry. This initial article defined how to calculate the top line revenue for a gallon of fuel sold by REGI and SYNM. The next article will cover the main variable costs, namely the cost of feedstock, hydrogen, methanol and neutralizers.

Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and 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.