US Biodiesel Market Slows amid Demand Uncertainty

Article by Brian L. Milne, Energy Editor, Product Manager with Schneider Electric

Following progressively higher output of biomass-based diesel in the United States during the first six months of 2016, producers dialed back their yield in July to a three-month low and shrunk the year-on-year increase in monthly output to 5.9% from a double-digit growth rate realized each month during the first half of the year.

Biomass-based diesel production meeting the US Environmental Protection Agency’s requirements in satisfying the Renewable Fuel Standard in July totaled 204.0 million gallons, 11.3 million gallons more than in July 2015, with output for the first seven months of 2016 reaching 1.27 billion gallons, 280.6 million gallons or 28.4% above the production rate for the comparable year-ago period.

biodiesel production

An expanding demand mandate under the RFS, which requires an increasing volume of renewable fuels to be used instead of petroleum-based fuel, continues to underpin the biodiesel market and drove the sharp production gains seen so far this year. Biomass-based diesel is one of several renewable categories to satisfy the RFS alongside ethanol and cellulosic and advanced biofuels, with 1.9 billion gallons of biomass-based diesel required this year under the mandate and 2.0 billion gallons in 2017.

The National Biodiesel Board, the trade organization for the US biodiesel industry, indicates the United States used 2.1 billion gallons of biodiesel in 2015.

However, trading activity is stuck in a low drive, with extended term agreements not getting done while only a smattering of deals in the spot market are transacted. The majority of business continues at the rack level, much of which is already blended with ultra-low sulfur diesel fuel at the wholesale distribution point.

Two issues cloud the near-term horizon for US biofuel traders, marketers and producers, which include a lack of demand growth for distillate fuels–ULSD and heating oil, and the end-year expiration of a tax credit paid to blenders of biodiesel.

Data from the US Energy Information Administration shows implied demand for distillate fuel cumulatively in 2016 through August 19 196,000 bpd or 5.0% lower than during the corresponding timeline in 2015, although distillate supplied to market pulled to parity with year ago during the most recent four weeks of available data. Of that demand, 31.9% were generated by exports, eroding the benefit for US biodiesel blenders.

Distillate demand in the United States continues to emanate from industrial and commercial activity for diesel and winter cold for heating oil grades. A warm 2015-2016 winter sharply reduced demand for heating oil early in the year and remains an unknown for the fourth quarter, while US economic growth hasn’t been above a 2.0% annualized growth rate since the second quarter 2015 when it reached 2.6%.

The most recent reading from the US Commerce Department’s Bureau of Economic Analysis shows a 1.1% annualized growth rate for the U.S. economy in the most recent second quarter and a 0.8% expansion in the first quarter. That followed a 0.9% year-on-year expansion in the US economy during the final three months of 2015.

There is growth in freight movements by truck this year compared with 2015, but it has been slow and inconsistent. The American Trucking Associations’ advanced seasonally adjusted For-Hire Truck Tonnage Index fell 2.1% to 134.3 in July, and the index has declined for the fourth month out of the past five, with July’s reading the lowest since October 2015. In February, the index reached an all-time high of 144, with ATA, the largest national trade association for the trucking industry, starting the index in the 1970s.

“This prolonged softness is consistent with a supply chain that is clearing
out elevated inventories,” said ATA Chief Economist Bob Costello. “Looking ahead, expect a softer and uneven truck freight environment until the inventory correction is complete. With moderate economic growth expected, truck freight will improve the further along the inventory cycle we progress.”

Trucking, which serves as a barometer of the US economy, represents nearly 70% of tonnage carried by all modes of domestic freight transportation in the United States.

US industrial production rose for the second consecutive month in July, reaching its highest point since October 2015, according to the Federal Reserve Bank of St. Louis in their FRED economic data series. In March, output dropped to a better-than two-year low.

industrial output

The biodiesel industry is again confronted with an upcoming December 31 expiration of a US$1.00 per gallon credit paid to blenders of biomass-based diesel into petroleum-based diesel. The credit was approved for this year in December 2015 when it was also made retroactive for all of 2015.

The approaching expiration of the credit recreates a familiar scenario for the biodiesel industry. The credit has either expired and been reinstated or extended within weeks of an expiry several times in recent years, creating uncertainty for the market. The credit is critical in bridging the price gap between biodiesel and ULSD, and not knowing whether it will be extended into 2017 freezes out long-term deal activity.

There continues to be a legislative push to move the credit recipient from the blender’s level to the producer, with proponents including US Senator Chuck Grassley, R-Iowa, and US Senator Marian D. Cantwell, D-Washington, arguing the credit at the blender’s level invites biodiesel imports.

The two senators introduced legislation in July that extends the tax subsidy through 2019, and converts it from a blender’s tax incentive to a domestic production credit. The proposal would “appropriately reform this incentive by applying it only to domestic biodiesel production, ending a growing practice where foreign producers are taking advantage of our tax system. Our tax law should not be incentivizing foreign fuel, and this bill fixes that loophole so that we’re stimulating jobs and economic development here at home.”

According to the NBB, biodiesel and renewable diesel imports into the United States totaled 670 million gallons in 2015, accounting for nearly a third of the US biodiesel market.

Soy methyl ester B100 spot biodiesel prices rallied in early August off summer lows registered in early July, pushed higher by climbing ULSD futures traded on the New York Mercantile Exchange. Spot prices trade in an index to the ULSD contract, with NYMEX oil futures rallying in August on speculationmembers of the Organization of the Petroleum Exporting Countries would reach an agreement in late September that regulates their production in an effort to stabilize the global oil market.

The market for Renewable Identification Numbers, the credits used by obligated parties that include oil refiners, blenders and importers to show compliance with the RFS is also heating up–with biomass-based D4 RINs holding above $1.00 for much of July and August.

D4 RINs are lent upside price support from concern over a RIN shortage in the coming years, with obligated parties allowed to carry over as much as 20% of their current year Renewable Volume Obligation into a new year. This RIN banking is exacerbated by the ethanol blend wall, which refers to the 10% maximum concentration point for ethanol in gasoline allowed in all vehicles on US roads. Ethanol has reached this blending point limit, and the RFS demand mandate is set to increase in 2017 and beyond, and is seen pushing RIN values sharply higher in the months ahead.

ULSDspot prices

Short Squeeze Rallies Gasoline in August

Fuel Marketer Intelligence: Supply Chain Dynamics to Retail Fuel Prices | Brian L. Milne, Energy Editor, Product Manager with Schneider Electric

August marked the second highest market participation rate for the Reformulated Blendstock for Oxygenate Blending futures contract traded on the New York Mercantile Exchange on record, with a sleepy oversupplied gasoline market enlivened by speculation of upcoming coordinated action by the Organization of the Petroleum Exporting Countries to boost global oil prices.

Data on futures positions from the Commodity Futures Trading Commission shows noncommercial traders, also known as speculators since they are not using the futures contract to hedge an underlying physical position, reduced a net-long position in RBOB futures in late July to the lowest point in more than a year. A long position is taken on expectation for prices to move higher, so the liquidation of these contracts by speculators indicates a bearish sentiment for the US gasoline market.

As discussed in our previous blog, Summer Hope Dashed as Gasoline Supply Swamps Market, the gasoline market was under price pressure in July on bloated inventory and despite peak seasonal demand, with demand on pace to set a record high this year. The long liquidation in July as evidenced in CFTC’s Commitment of Trader’s reports left the market vulnerable for a price rally.

The bearish sentiment for gasoline futures in ending July was appropriate given the market’s fundamental disposition. Despite record high summer demand, gasoline inventory had increased for three consecutive weeks through July 22 to reach a nearly three-month high of 241.5 million bbl, sitting 25.3 million bbl or 11.7% above the five-year average, data from the Energy Information Administration shows.

As the August RBOB futures contract expired on July 29, the market was also confronting the seasonal change that occurs in September, with gasoline demand consistently lower in September compared with August. Hope that low retail prices would spur enough demand to shrink the oversupplied market was evaporating, and speculators were selling out of the market.

Nearest delivered RBOB futures fell to a $1.2760 gallon four-month low on July 29, but pared the loss to settle at $1.3210 gallon. Twenty trading days later, nearest delivered RBOB futures rallied to a $1.5257 gallon two-month high, spurred by belief OPEC members would agree to freeze their production when they met in late September in Algiers for informal talks on the sidelines of the International Energy Forum.

CFTC data shows noncommercial market participants increased their net-long RBOB futures position 30.8% from July 25 to August 22 to a 57,829 near two-month high. The CFTC also shows RBOB futures open interest, which measures the number of unliquidated, outstanding contracts on a given day, surging above 400,000 in mid-August. The prevailing high was reached in March during the preseason rally.

Speculation for an OPEC agreement was fraying in late August following comments from Iraq, Iran and Saudi Arabia, not to mention that OPEC production was at an eight-year high in July and Saudi output reached a record high. Iraq indicated it would cooperate in the September talks, but continues to ramp up output, and Iran restated its goal of securing market share lost during years of Western sanctions on its exports, planning to ramp up production another 200,000 bpd. The Saudis said they don’t have a production target, with their output set by customer demand.

Weekly data from the EIA showing US commercial crude oil supply increased to a 525.9 million bbl two-month high on August 26 and US dollar strength joined the market’s diminishing expectations for meaningful action to be taken by OPEC to press NYMEX RBOB futures to its third consecutive session loss on August 31. The September RBOB contract expired down 3.61cts at $1.4122 gallon, although nearest delivered RBOB futures ended August 9.12cts or 6.9% higher.

October RBOB futures settled at a 7.88cts discount to the now expired September contract on August 31, reflecting the seasonal transition to slower demand and higher Reid vapor pressure gasoline, which is easier and cheaper to produce than the summer grades. The market’s again in position to test the July low.

Yet, as the short squeeze in August demonstrated, speculation could again reverse the market. OPEC is still scheduled to discuss coordinated action to stabilize oil prices in Algiers September 26-28, and hurricane activity in the Atlantic Basin peaks in August and September.

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