EPA Sets Renewable Fuel Standard

This week the US Department of Environmental Protection (EPA) issued volume requirements for the Renewable Fuel Standard (RFS) program for calendar years 2019 and 2020.  Set up pursuant to the Clean Air Act requires the EPA to set minimum standards for the blending of renewable fuels.  The standards are used by oil refiners and blenders to determine how much low- or no-carbon fuel must be added to their fossil fuel production. The program encompasses cellulosic, biofuel, biomass, and other renewable technologies. 

The 2019 and 2020 standards reflect small increases in volume requirements with the exception of conventional biofuel, which was kept flat at 15.0 billion gallons.  This category encompasses corn ethanol. 

Gallons	2018	2019	2020
Cellulosic biofuel	288 Million	381 Million	NA
Biomass diesel	2.1 Billion	2.1 Billion	2.43 Billion
Advanced biofuel	4.29 Billion	4.88 Billion	NA
Renewable fuel	19.29 Billion	19.88 Billion	NA
Conventional biofuel	15.0 Billion	15.0 Billion	NA
Proposed standard in italics

The EPA reports that transportation gasoline contains about 10% ethanol and diesel fuel contains about 5% biodiesel or renewable diesel.  Unfortunately, there have been shortfalls in advanced biofuel and renewable fuel volumes.  As a consequence, the 2019 volume requirements for cellulosic biofuel, advanced biofuel and renewable fuel were set below the statutory requirement at a level that is expected to be available in the year.  The ethanol mandate was kept at 15 .0 billion gallons, just short of the U.S. installed ethanol production capacity near 16.4 billion gallons per year at recent conversion rates near 2.91 gallons ethanol from a bushel of corn. 

The effect of the RFS program has been to deliver an element of certainty to investors and entrepreneurs through a stream of mandated demand.  In turn this has encouraged technology development and expansion of production capacity for a variety of renewable fuels, including ethanol, biofuel and renewable diesel.   

Company	Symbol	Product	Sales TTM	Operating Margin	ROE
Andersons	ANDE	Ethanol	$3.5 B	1.36%	5.46%
Archer-Daniels	ADM	Ethanol	$61.4 B	2.50%	9.22%
Darling Ingredients	DAR	Renewable diesel	$3.7 B	3.72%	9.86%
Gevo, Inc.	GEVO	Ethanol	$30.2 M	-69.95%	-30.62%
Green Plains	GPRE	Ethanol	$3.8 B	0.54%	6.01%
MGP Ingredients	MGPI	Ethanol	$348.2 M	12.03%	25.53%
Pacific Ethanol	PEIX	Ethanol	$1.7 B	-1.22%	-8.74%
Renewable Energy	REGI	Biofuel, biomass	$2.4 B	8.02%	21.35%
REX American	REX	Ethanol	$460.3 M	5.13%	12.00%

Shareholders can also expect an effect on sector valuation from the certainty in the standards.  There are a number of companies with publicly traded stocks that compete in the alternative fuels space.  On average the sector is trading closer to 52-week high prices than to 52-week low prices, suggesting the sector is riding a tide of positive sentiment.  In the days since the EPA announcement none of the stocks appear to have registered a significant reaction.  That might be because the announcement was already widely expected.

Company	Symbol	Price	Market Cap	52 Wk Hi-Low	Forward PE
Andersons	ANDE	$34.20	$966.1 M	$38.00 - $29.60	13.0
Archer-Daniels	ADM	$45.83	$25.6 B	$46.79 - $38.59	14.1
Darling Ingredients	DAR	$19.88	$3.2 B	$20.36 - $15.50	21.4
Gevo, Inc.	GEVO	$3.80	$6.3 M	$24.74 - $3.23	Neg
Green Plains	GPRE	$18.30	$757.3 M	$21.90 - $15.60	23.77
MGP Ingredients	MGPI	$88.81	$1.5 B	$99.99 - $49.58	35.52
Pacific Ethanol	PEIX	$2.60	$113.9 M	$7.50 - $2.40	8.12
Renewable Energy	REGI	$17.85	666.1 M	$18.45 - $9.50	10.50
REX American	REX	$80.97	$520.9 M	$102 - $70.48	11.95

What may be even more interesting is the impact of renewed and certain blending standards on the entire alternative transportation fuel market.  In addition to the public companies listed in the tables here, there are a number of private ethanol companies, including POET, LLC, Ringneck Energy and Fees, LLC, and farmers cooperative CHS, Inc.  

There is a particularly interesting dynamic shaping up in the ethanol sector.  Average profit margins reached $0.30 per gallon in 2017, well off record highs for the industry set in 2014 near $0.90 per gallon.  With such thin profit margins, the ethanol group is particularly sensitive to the blend standard.  In 2017, exports helped soak up ethanol supplies that exceeded the standards-based domestic demand.  So far in 2018, there over 688 million gallons of ethanol were shipped out of the U.S. in the first four months of 2018  -  43% more than last year at the same time.  Unfortunately, export demand may dry up with the imposition of tariffs by China and Brazil  -  two of the most important buyers of U.S. ethanol.  

The shifting dynamic in markets is coming along at a time when the ethanol sector is staging an expansion.  According to the Renewable Fuels Association, ethanol projects continue to dominate new investment in the biofuel sector.   For example, POET and Ringneck are both moving forward with construction on new plants in Ohio and South Dakota, respectively. 

The trends appear to be on a collision course  -  a certain cap on domestic demand, interruptions in foreign demand and the pressure of capacity expansion.  This may be the fertile ground for one of the periods of consolidation for which the ethanol sector has become well know.  Notably Green Plains just completed construction of new rail terminal capacity and may be casting about for production capacity to help fill rail cars.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.