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Trump's Biofuels Compromise Is Collapsing

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Includes: ANDE, BP, GPRE, MPC, PBF, PEIX, REX, VLO
by: Tristan R. Brown
Tristan R. Brown
Alternative energy, long/short equity, commodities, energy
Summary

President Donald Trump reportedly said that last week's negotiations between biofuel producers and refiners over the U.S. blending mandate were "more difficult than dealing with the Taliban."

Mr. Trump's frustration stems from the fact that the two sides remain far apart, with refiners wanting an effective negation of the increased blending volumes promised to biofuel producers.

The earlier rally by biofuel producers' share prices reversed itself last week on the news that the negotiations have continued to be unsuccessful.

Time is rapidly running out for a compromise to be agreed to by both sides even as Mr. Trump's re-election prospects continue to depend upon Corn Belt votes.

Investors should be wary of any rallies in the ethanol production sector that are not supported by underlying operating conditions.

What could possibly be more difficult than negotiating a peace plan with fundamentalist extremists in a hyperviolent country on the other side of the planet that has been riven by centuries of civil wars, invasions, and superpower proxy wars? Finding a compromise on the U.S. revised Renewable Fuel Standard [RFS2] that both refiners and biofuel producers are willing to agree to, apparently. Bloomberg reported late last week that President Donald Trump made an unfavorable comparison to his administration's recently-collapsed negotiations with the Taliban following a week of meetings with U.S. senators from major petroleum refining states:

President Donald Trump on Thursday expressed his rising frustration over trying to reach an accord between warring oil and biofuel interests by saying the negotiations were more difficult than dealing with the Taliban.

Trump made the observation during a White House meeting with oil-state senators who were trying to discourage the president from advancing a slate of changes meant to bolster corn-based ethanol and soybean-based biodiesel, according to people familiar with the matter who asked not be named describing a private conversation.

As I wrote last week, Mr. Trump had conditionally endorsed a compromise prior to the meetings with the refining-state senators that would have increased the mandated biofuels blending volume under the RFS2 by up to one billion gallons and, more importantly, also reallocated those volumes that have been waived via small refinery exemption [SRE] awards over the last three years to the rest of the refining sector. The result was a major rally by the share prices of ethanol producers such as The Andersons (ANDE), Green Plains, Inc. (GPRE), Pacific Ethanol (PEIX), and REX American Resources (REX) that outperformed the S&P 500 index on the prospect that the detrimental changes (from their perspective, at least) that the Trump administration has imposed on the RFS2 via its expanded SRE awards might be at least partially reversed.

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That optimism quickly dissipated last week as Mr. Trump's proposed compromise immediately ran into strong opposition from refiners and their supporters in Congress. BP (BP), Marathon Petroleum (MPC), PBF Energy (PBF), and Valero (VLO) in particular are not believed to have received SREs in the past, meaning that they would bear the burden of any reallocation of the waived volumes. This opposition to Mr. Trump's own proposal is what prompted his reference to his administration's earlier negotiations with the Taliban. The rally among biofuel producers that occurred in the first half of September was in turn partially reversed last week as those same biofuel producers' share prices underperformed the S&P 500 by a substantial margin (see figure), a move that was especially notable given that gasoline prices jumped by more than 10% following last weekend's drone strikes in Saudi Arabia.

D6 Renewable Identification Number [RIN] prices, which all of the biofuels that participate in the RFS2 are able to generate, had increased by 67% in the first half of September as ethanol producers' share prices rallied (see figure). (As a reminder, each RIN represents a gallon of biofuel that is produced under the RFS2; the RIN is then separated when that biofuel is blended for retail, at which point the RIN is used to demonstrate compliance with the blending mandate by refiners or sold to another entity for the same purpose.) The simultaneous increase to future mandated blending volumes and restoration of past waived volumes would have increased demand for RINs and, since RINs are traded on an open market, that market got ahead of the Trump administration's proposed policy changes.

Mr. Trump's negotiations appear to have broken down over the specific issue of RIN prices, of which D6 RINs are the most important category since they are the largest by volume. Bloomberg reports that the pro-refinery senators want the White House to allow the U.S. Environmental Protection Agency [EPA], which administers the blending mandate, to effectively create RINs that would be sold onto the market whenever RIN prices moved higher; this proposal sounds very similar to the cap on RIN prices that refiners advocated for in 2017 and 2018. (That cap, incidentally, would have likely reduced the mandated blending volumes by an amount roughly equal to what the Trump administration is proposing to increase it by in 2020.) While revenue generated under the refiners' proposal would be used to invest in ethanol blending infrastructure, the effective reduction to biofuels consumption that would result made it a deal-breaker with Secretary of Agriculture Sonny Perdue. Likewise, it does not appear that the refining sector will support any compromise that does not limit the ability of RIN prices to move higher in the future.

While the refining sector's opposition does not necessarily doom Mr. Trump's proposed compromise, it does reduce the likelihood that it will be implemented. It is telling that Mr. Trump, according to Bloomberg, "repeatedly told the [refining-state] senators 'I’m getting killed' over the [SREs]" given that (1) those senators mostly belong to his political party, and (2) the path to his re-election in 2020 almost certainly requires him to win the same Midwestern swing states in which the U.S. biofuels sector has the largest presence. Mr. Trump's need to shore up votes in the Corn Belt will become increasingly important moving forward given his poor head-to-head polling against Democratic primary candidate front-runners such as former Vice President Joe Biden and Senator Elizabeth Warren (Mr. Trump trails the former by 12% and the latter by 5% in the RealClearPolitics "Poll of Polls"). At the same time, however, it does not appear that he is ready to go against members of his own party such as Senator Ted Cruz and Senator Pat Toomey, both of whom have actively lobbied the White House on behalf of refineries.

Last week I wrote that Mr. Trump's proposed compromise would likely face strong opposition from the refining sector, and that sentiment appears to have been borne out by the results of the meetings between Mr. Trump and the pro-refinery senators. Mr. Trump is rapidly running out of time to take any steps to shore up in the RFS2 in time for 2020's November election, however. The EPA's final rulemaking on that year's blending volumes is due to be released this November, before which it must first go through a public notice period. At this point investors should be wary of any rally among ethanol producers in particular that is not supported by underlying operating conditions, as it is becoming increasingly unlikely with each passing day that Mr. Trump's proposal will ever be implemented.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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