Syntroleum Could Benefit From A Poor Soybean Crop

| About: Syntroleum Corporation (SYNM)
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The Midwest U.S. is currently experiencing the worst drought conditions since at least 1988 and possibly since the 1930s Dust Bowl. The corn crop has been devastated and the price of corn is attaining new highs as a result. Concerns over damage to the soybean crop and a potential substitution effect have caused soybean prices to mirror the recent increase in corn prices.

US Corn Farm Price Received Chart

This rise in soybean prices does not bode well for biodiesel producers. Soybean oil is transesterified to produce biodiesel, which is blended with petroleum-based diesel fuel for use in diesel engines. Much as corn ethanol producers incur losses when an increase in the price of corn is not matched by an increase in the price of gasoline, soybean biodiesel producers struggle when feedstock prices outpace diesel prices. While soybean prices have historically lagged behind diesel prices (see chart), a combination of the Midwestern drought and concerns over slowing global economic growth have caused soybean prices to recently outpace those of diesel.

US Soybean Farm Price Received Chart

Biodiesel producers are in theory capable of utilizing any lipid as feedstock. Most are located in close proximity to areas with intensive soybean production, however, making it difficult to switch to less expensive feedstocks during times of high soybean prices due to the feedstock transportation costs thereby incurred. While the percentage of total U.S. biodiesel production derived from soybeans has fallen in recent years, it is still responsible for a majority of production.

Soybean biodiesel producers are not as exposed to high feedstock costs as corn ethanol producers due to the revised Renewable Fuel Standard (RFS2), which incentivizes production via compliance commodity Renewable Identification Numbers (RINs). The purpose of RINs is to subsidize biofuel production by giving additional value to each gallon of biofuel produced until the volume required by the RFS2 mandate is met, at which point RIN value goes to zero so as to prevent runaway subsidization. RIN values ultimately operate as a function of both feedstock costs and output values: They increase when feedstock costs are high (to cover higher producer operating costs) and decrease when output values are high (to prevent windfall profits during periods of high diesel prices). (For more information on RIN values, see my previous article on the subject.)

While corn ethanol production is at mandated levels and corn ethanol RIN values barely cover transaction costs as a result (causing corn ethanol producers to incur substantial per gallon losses at present because of high feedstock costs), biodiesel production is in a separate RFS2 category: Biomass-based diesel. Production in this category has not yet met its mandated volume and RINs for biodiesel are still quite valuable as a result, although their value has fallen by nearly half since mid-September due to a combination of high diesel prices, low feedstock costs, and allegations of RIN fraud by the EPA. Barring a sharp increase in diesel prices, biomass-based diesel RIN values can be expected to increase in response to higher soybean prices resulting from drought conditions. While this will not produce a windfall for soybean biodiesel producers, it will insulate them from the poor operating conditions currently enveloping corn ethanol producers.

Renewable Diesel and Syntroleum

The biomass-based diesel category of the RFS2 covers both biodiesel and renewable diesel. While the two terms are sometimes used interchangeably, they refer to different pathways and fuels. Biodiesel is produced via lipids transesterification (i.e., reacting lipids with methanol to yield fatty acid methyl esters) and while the final product is similar to petroleum-based diesel, it does encounter problems with cold weather gelling and water contamination (albeit in small quantities). One means of avoiding these issues is by reacting the lipids with hydrogen (via hydroprocessing) rather than methanol. The hydrogen deoxygenates and depolymerizes the lipids into straight-chain paraffins in the diesel fuel range. These paraffins then undergo isomerization to produce branch-chain hydrocarbon molecules in the diesel and jet fuel ranges that are virtually identical to the petroleum-derived versions. In addition to producing diesel that is chemically identical to petroleum-based diesel, the ability of the pathway to yield jet fuel represents a major advantage over lipids tranesterification, as biodiesel cannot be used in jet engines.

The largest lipids hydroprocessing project in the U.S. at present is Dynamic Fuels, which is a joint venture between Syntroleum (NASDAQ:SYNM) and Tyson Foods (NYSE:TSN) located in Geismar, La. Syntroleum operates the project and reports income or losses from the project while Tyson Foods provides the primary feedstocks. The 75 million gallon per year project is notable for being the first commercial-scale advanced biofuels facility in the U.S. to become operational. In addition to producing renewable diesel and jet fuels, Dynamic Fuels differs from most biodiesel producers in that it utilizes a combination of corn oil, yellow grease, and beef tallow as feedstock, with the first two being responsible for a majority of input volume. The utilization of yellow grease in particular places the project at an advantage relative to soybean producers during periods of high soybean prices, as there has only been a weak correlation between soybean oil and yellow grease prices over the last year.

Sources: WSJ and USDA.

Furthermore, the correlation between soybean and yellow grease prices over the last year has been virtually non-existent.

Correlation between soybean and yellow grease cash prices, Aug. 5, 2011 to Aug. 10, 2012:

Sources: WSJ and USDA.

Soybean prices have increased over the least year while yellow grease prices have actually declined.

Percent change in soybean and yellow grease cash prices, Aug. 5, 2011 to Aug. 10, 2012:

Sources: WSJ and USDA.

Renewable diesel production is currently equal to only 5% of biodiesel production, so biomass-based diesel RIN values can be expected to rise in response to higher soybean prices so as to compensate soybean biodiesel producers for their increased feedstock costs. RIN values are the same for all biofuels within a RFS2 biofuel category, however (although the number of RINs that each gallon of biofuel qualifies for varies by fuel type, with most renewable diesel qualifying for 13% more RINs per gallon than biodiesel), so renewable diesel producers will benefit as this rising tide lifts all ships (or biomass-based diesel producers, as it were). Provided that yellow grease prices don't increase by as much as or more than soybean prices do in the coming months, Dynamic Fuels will benefit from higher biomass-based diesel RIN values without encountering the offsetting rise in feedstock costs experienced by soybean biodiesel producers.


Rising soybean prices could spur an increase in biomass-based diesel RIN values due to soybean's status as the primary biomass-based diesel feedstock in the U.S., assuming that diesel prices do not increase substantially as well. The Dynamic Fuels project qualifies for these RINs as the only operational commercial-scale renewable diesel project in the U.S. and will benefit from their increased value due to its use of yellow grease as a major feedstock component. Syntroleum, which reports any income or loss from the Dynamic Fuels project in its quarterly reports, will directly benefit from higher profit margins per gallon resulting from this increase in RIN value. Given the outsized influence of the Dynamic Fuels project on Syntroleum's earnings (Syntroleum reported six-month revenues of $100.3 million and $12.1 million for the Dynamic Fuels project and the company's other operations, respectively, in its Q2 2012 earnings), higher RIN values resulting from higher soybean prices will have a substantially positive impact on the company's earnings. Syntroleum is well-positioned to benefit from a poor soybean crop resulting from the current drought conditions in the Midwest as a result.

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