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No Relief For The Struggling U.S. Biofuels Sector From The EPA

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Includes: ANDE, GPRE, PEIX, REGI
by: Tristan R. Brown
Tristan R. Brown
Alternative energy, long/short equity, commodities, energy
Summary

The full details of President Trump's promised "giant package" for the U.S. biofuels sector were released by the EPA last week via a supplemental proposed rulemaking.

Rather than increase the 2020 blending mandate by up to 1 billion gallons, as Mr. Trump had announced, next year's actual blending volume will remain mostly unchanged from before.

U.S. biofuel producers' share prices continued to underperform the S&P 500 in response to the EPA's announcement, continuing October's overall price decline.

Last week's development virtually guarantees that relief for the U.S. biofuels sector will not come from Washington D.C. until after the 2020 presidential election at the earliest.

Recent commodity price movements in response to extreme weather in the Northern Plains have also been unfavorable for U.S. biofuel producers.

The U.S. Environmental Protection Agency [EPA] released the long-awaited "supplemental notice" last week that contained its plan for the implementation of President Donald Trump's promised "giant package" for the ag and biofuel sectors. Mr. Trump had predicted on Twitter last August that "The Farmers [sic] are going to be so happy when they see what we are doing for Ethanol [sic]", but the actual reaction has been decidedly unhappy. The share prices of major independent biofuel producers such as The Andersons (ANDE), Green Plains, Inc. (GPRE), Pacific Ethanol (PEIX), and Renewable Energy Group (REGI) all underperformed the S&P 500 in the wake of the supplemental notice's official release (see figure), adding to losses that had already been steadily mounting through October to date.

ChartData by YCharts

The backlash was immediate. Iowa Governor Kim Reynolds noted the discrepancy between what Mr. Trump had pledged in repeated pronouncements since August and the supplemental notice's actual contents:

The National Biodiesel Board expressed skepticism that the EPA's latest rulemaking will result in compliance with its existing blending requirements, let alone the increases that Mr. Trump has recently promised:

Most importantly, the Renewable Fuels Association noted that the EPA's latest rulemaking, which proposes to utilize a new methodology for calculating annual biofuel blending volumes under the U.S. revised Renewable Fuel Standard, would not only cause next year's increase to corn ethanol blending to fall far short of the almost billion gallons that Mr. Trump had said just over a week ago would occur ("That's a lot of gallons... so they should like me out in Iowa and all of the different places, huh?"), but it could also actually reduce the annual blending volume by up to 600 million gallons below the statutory volume of 15 billion gallons:

To recap, Mr. Trump announced in mid-August that he would increase the mandated future blending volumes for biofuels, potentially reversing the reductions to demand that has been caused by his administration's expansion of its small refinery exemption (aka "hardship") [SRE] waiver allocations since he took office. He personally mediated negotiations between the biofuels and refinery sectors that ultimately collapsed when the two sides were unable to reach an agreement. Mr. Trump then continued to pledge a major increase above the statutory biofuels blending requirement for 2020, only to have his administration officially announce last week a plan that would once again see the statutory requirement missed in direct violation of the Energy Independence and Security Act of 2007. Or, as University of Illinois Urbana-Champaign agricultural economist Scott Irwin succinctly put it:

That biofuel producers' share prices did not decline more sharply in response to the EPA's proposed rulemaking is due to the fact that Mr. Trump faced steep administrative hurdles to any increase to the corn ethanol mandate beyond 15 billion gallons, such as those that I described earlier this month. Rational expectations were low among agricultural economists and many industry observers as a result. Hearing the world's most important policymaker make very public pledges of support multiple times still had a bullish impact on market sentiment, however. Furthermore, there was some hope in the sector that, even if the administrative hurdles could not be overcome, Mr. Trump's upcoming re-election concerns might prompt him to limit his administration's demand-eroding allocations of SRE waivers in response to the so-called "Grassley Rule" (named after Iowa's Senator Chuck Grassley). The poor performance of biofuel producers' share prices in October to date can be attributed to the industry-wide realization that the events of the last two months will ultimately not increase U.S. demand for biofuels despite Mr. Trump's proclamations.

The EPA's latest rulemaking now enters a public comment period. While this requirement nominally opens the door to future revisions following the recent backlash from the biofuels sector, major changes are unlikely to occur at this point. The final rulemaking for 2020 is due out by the end of November, leaving the EPA with very little time to overhaul its latest proposed rulemaking even if it had the desire to do so. More practically, it is unlikely that such a desire even exists, despite Mr. Trump's stated support for the biofuels sector. EPA Administrator (and former fossil fuel lobbyist) Andrew Wheeler testified to Congress in September that he does not believe that any demand destruction has occurred for ethanol in response to the EPA's increased SRE waiver allocations (he was notably quiet on the subject of biomass-based diesel demand destruction). Following that logic, then, Mr. Wheeler is unlikely to recognize any need to increase the blending volume in 2020 in order to offset past demand destruction that he considers to have been non-existent.

Last week's development came as U.S. biofuel producers were already grappling with the latest deterioration in their operating conditions. Recent poor weather conditions, including blizzards, in the Northern Plains have caused corn and soybean prices to increase over the last month on both an absolute basis and relative to refined fuel prices (see figure). This has, in turn, been a new source of drag on operating margins that have already been at multi-year lows throughout 2019 for both ethanol and biodiesel.

ChartData by YCharts

Last week's announcement by the EPA confirms my forecast, as detailed here on Seeking Alpha in a series of articles over the last two months, that Mr. Trump's August pledge would ultimately do little to improve biofuel producers' production margins and overall operating conditions. The EPA's latest rulemaking complicates the formula that is used to calculate biofuel blending volumes for 2020 compared to the one that was released in July but does little to increase demand. This will remain the case so long as the EPA continues to potentially violate federal law by refusing to reallocate the blending volumes that are waived through its SRE allocations. In the meantime, investors in the U.S. biofuels sector will need to wait until after the 2020 presidential election at the earliest (the mandate's 2021 volumes are scheduled to be finalized at the end of November 2020) before they can expect any relief to come from Washington D.C.

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.