U.S. Biodiesel Industry Again Waiting on Government Largesse

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

The higher cost of biodiesel compared with petroleum-based diesel fuel, especially in the third year of low global crude oil prices, requires a bridge to incentivize demand, and for several years the biodiesel industry in the United States has had those incentives amid multiple government programs.

Indeed, the US biodiesel industry ratcheted up production from 20 million gallons in 2003 to 2.1 billion gallons in 2015, according to the National Biodiesel Board, with an increasing amount of output, 24.5% of the 2015 total, renewable diesel. NBB, the industry’s national trade organization also reports 2.1 billion gallons of biodiesel was used in the United States in 2015.

production

The US biodiesel industry is an exceptional growth story, but also a challenging one that has seen a large number of bankruptcies, and frustrated traders too, when federal programs lapse or lack clear direction on how they will be implemented. These waiting games have pushed otherwise promising companies that lack protracted financial durability out of business or into distressed sales. Indeed, the industry continues to consolidate that defines its maturing status as much as it demonstrates the risk in government dependence.

In early November, and deep in the shadows of an extraordinarily contentious US presidential race, the US biodiesel industry awaits the finalized mandate for renewable fuel demand for 2017, and the renewal of a tax incentive to encourage blending. Even as clarity is sought on these two programs, a stream of news releases from the US Department of Justice highlights the fraud seemingly endemic in government programs, and so frequently twinned with unintended consequences.

The US Environmental Protection Agency appears to be on target in meeting its end of November deadline in issuing the volume obligation for renewable fuels under the Renewable Fuel Standard for 2017, having submitted their finalized Renewable Volume Obligation to the White House Office of Management and Budget in mid-October. OMB reviews such government diktats to ensure conformity with the administration’s goals and policies.

The law establishing the current mandate, which is known as RFS2, lists the volume of renewables obligated parties must use every year, which vary across several nested categories of renewables, and increase annually through 2022. However, the EPA, the administrator of the RFS, must review the market to ensure there will be enough supply to meet the mandate, and that pushing this supply into the market doesn’t cause serious harm to the economy or environment.

The legislated mandate for 2017 is that 24.0 billion gallons of renewables in five categories of varying quantities are used in lieu of petroleum-based products, although the EPA proposal released in the spring at 18.8 billion gallons is well below the target due to an inadequate supply of cellulosic fuels and limited space in the gasoline pool based on current fuel specifications, auto manufacturer restrictions and consumer choice.

Of that 18.8 billion gallons, biomass-based diesel fuel accounts for 2.0 billion gallons, with biodiesel also able to satisfy the advanced biofuel mandate proposed for 2017 at 1.68 billion gallons. Oil refiners and importers must meet their RVO, whether through blending or in buying a compliance credit in the market known as a Renewable Identification Number.

RINs vary in inherent value based on the renewable they were generated by, with D4 RINs satisfying the biomass-based diesel nested category trading over $1 gallon from late September through the full month of October. A finalized RVO above the proposal would likely trigger a higher RIN value in response in December, with RIN valuations seen climbing in 2017 as obligated parties struggle to squeeze more ethanol into the US gasoline pool.

The RIN is a critical component in a producer’s income stream. Since a RIN can be separated from the renewable as it moves through the supply chain and sold in an open market, speculators have done the math and have squeezed RIN prices higher, knowing the RIN market will continue to tighten.

There’s also been a considerable amount of fraud around the RIN program that have caused harm to obligated parties amid the EPA’s buyer beware policy. Doug Parker, president of E&W Strategies and a former Director of EPA’s Criminal Investigation Division who oversaw investigations into the Deepwater Horizon disaster and Volkswagen’s defeat device fraud case among others, said current RFS-related fraud cases reflect $271 million in documented fraud and another $71 million in seizures of illicit profits.

“In my experience this represents a fraction of the actual overall fraud impact, and significantly larger losses will be formally identified in upcoming court filings,” said Parker in a white paper issued early September commissioned by Valero Corporation.

RINs associated with the fraud will be retired, and parties that bought those RINs will be forced back into the market to reacquire a compliance credit, further tightening the RIN market.

A tax credit that pays $1 per gallon for blending biodiesel into a petroleum-based fuel known as the blender’s credit expires at year’s end, and has stymied forward term transactions for biodiesel because of the uncertainty in knowing whether the credit will be passed by the US Congress for another year or more. The tax credit has been allowed to expire four times over the past 10 years, and has been made retroactive at times, creating windfall profits, yet the uncertainty has challenged business planning and trading activity.

A bitterly divided Congress adds another layer of concern that the tax credit will again be extended, and in what form. The blender’s credit has been criticized since imports can also qualify for the tax subsidy with one estimate forecasting US biodiesel imports would reach 800 million gallons this year. There have been calls to move the credit from the blending level to producers.

A bill to extend the credit, H.R. 5994: Biodiesel and Renewable Diesel Incentive Extension Act of 2016, was assigned to a committee in mid-September that will consider sending it to the House or Senate for a vote. PredictGov gives the bill a 1% chance of being enacted.

Producers ramped up production in August and September, with EPA qualified biomass-based diesel output at 1.79 billion gallons for the first three quarters of 2016, which compares with 1.81 billion gallons for all of 2015 when you strip out renewable diesel. Renewable diesel uses the same feedstocks as biodiesel but employs a different technology.

Spot transactions for biodiesel remain limited early in the fourth quarter, but when completed are primarily transacted in a differential against the ULSD (ultra-low sulfur diesel fuel) futures contract that trades on the New York Mercantile Exchange. After a rally from September lows into October, ULSD futures were range bound until a selloff in closing out the month.

To learn more about Schneider Electric’s energy and commodity trading platform, DTN ProphetX click here.

spot-prices

ulsd-futures

 

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

RFS Drives US Biodiesel Production Surge

US biodiesel production surged during the first five months of 2016 compared with a year ago, with a climbing output rate driven by an increasing federal mandate to blend renewables into petroleum-based transportation fuels.

Biomass-based diesel fuel production in the United States, primarily biodiesel but also renewable diesel, has averaged more than 30% higher during the first five months of 2016 compared with a year ago based on data from the US Environmental Protection Agency. The higher level of supply availability coincides with clearer forward visibility for US biodiesel producers following the extension of a $1 gallon blender’s credit through this year and better clarity on blending targets under the Renewable Fuel Standard. Continue reading RFS Drives US Biodiesel Production Surge