Governors' Biofuels Coalition

President Donald Trump announced in late August that his administration would be unveiling a “giant package” on biofuels to support the U.S. farming sector. This announcement, combined with the news that Mr. Trump was personally mediating between the U.S. biofuels and refining sectors in an attempt to develop a proposal that both sides found acceptable, has caused a substantial amount of volatility in the share prices of major biofuel producers such as Green Plains, Inc. (GPRE), Pacific Ethanol(PEIX), Renewable Energy Group (REGI), and REX American Resources (REX) over the subsequent five weeks (see figure). Expectations had been diminished after it become clear over the last week that the mediation had failed to overcome opposition by the U.S. refining sector to any mandated increase to U.S. biofuels demand. Even then, though, this recent volatility made the relative lack of a reaction by those same companies’ share prices to last Friday’s unveiling of the plan all the more notable.

Data by YCharts

The plan’s details continue to be scarce despite the fact that it still needs to undergo a lengthy public review process prior to the plan’s final release by November 30. The U.S. Environmental Protection Agency [EPA], which oversees the revised Renewable Fuel Standard [RFS2] blending mandate that the plan would modify, simply noted that the plan would “ensure that more than 15 billion gallons of conventional ethanol be blended into the nation’s fuel supply beginning in 2020.” (Conventional ethanol refers to corn ethanol, as opposed to the cane ethanol, biomass-based diesel fuels, and renewable natural gas that are the other major contributors to the mandate.) It appears that the specific volume will be determined in part by the number of volumes that were waived over the previous three years via EPA awards of small refinery exemptions [SRE], although the calculation methodology was not made public.

The good news for biofuels producers in the announcement is that the EPA’s comments suggest that responsibility for blending of the waived volumes will now be reallocated to those refiners that don’t receive SREs, as is required by law. As I noted in September, these waivers have historically reduced the mandated blending volumes by a substantial fraction, so any reallocation will result in higher biofuel demand moving forward.

The use of reallocation in future blending volume calculations is the extent of the good news for biofuels producers, however. The EPA’s statement that “more than 15 billion gallons” of corn ethanol must be blended in 2020 under the plan is intentionally vague given the statement’s stark legal complications. The Energy Independence and Security Act of 2007, which created the RFS2, implicitly capped corn ethanol blending at 15 billion gallons per year. This cap has long been interpreted by government officials, legal authorities, and market participants as being permanent due to the will of Congress. Here is how the EPA explained its decision just last June to maintain the 15 billion gallon cap for corn ethanol (which it refers to as “conventional renewable fuel”):

It is unclear how the EPA expects to justify this break with a precedent that has existed throughout the RFS2’s existence. Prof. Scott Irwin at the University of Illinois Urbana-Champaign recently suggested that any blending beyond 15 billion gallons of corn ethanol in 2020 would take the form of reallocated volumes rather than an actual increase to the blending volume. While more than 15 billion gallons of corn ethanol would be nominally blended in 2020 and beyond, then, the excess would only offset the volume that was waived in the previous three years. Or, put another way, the EPA would simply be repaying, without interest, volumes that it had “borrowed” through the award of SRE waivers in earlier years. This would not violate the cap in the same way that the repayment of the principal on a zero-interest loan would not constitute income from a creditor’s perspective.

Further complicating matters is the fact that former fossil fuel lobbyist and current EPA Administrator Andrew Wheeler testified to Congress just last month that the SRE waivers were not reducing demand for ethanol:

While Mr. Wheeler’s conclusion is debatable, he will ultimately be responsible for implementing any rulemaking that will result from Mr. Trump’s intervention in the RFS2. Any increase to the mandated corn ethanol blending volume in 2020 will represent a tacit recognition by the EPA of the very demand destruction that Mr. Wheeler so recently denied was occurring, with the volumetric increase being equal to the volume of demand destruction. Given that “beyond 15 billion gallons” could mean anything from 15.01 billion gallons (the EPA’s past published volumes have utilized two significant figures) to 16 billion gallons or more, the ambiguity of the EPA’s announced plan can be interpreted as a sign that it intends to require an increase that is on the lower end of the possible range.

This interpretation is supported by the behavior of Renewable Identification Number [RIN] prices in recent weeks. RINs are the tradable compliance commodities that obligated blenders (i.e., refiners) use to demonstrate the fulfillment of their required blending volumes. Other things being equal, a stronger mandate results in higher RIN prices than does a weaker mandate. D6 RINs, which are primarily utilized for corn ethanol, ended last week only a few pennies above their 5-year lows, and well below the levels seen prior to the expansion of the SRE allocations that occurred after Mr. Trump took office (see figure). The market does not expect the EPA to increase biofuel blending by any meaningful amount, let alone to the extent that Mr. Trump suggested in late August.

Source: EcoEngineers (2019).

Last Friday’s announcement has the hallmarks of something drafted by a White House that is eager to broadcast a win amidst a barrage of negative news coverage rather than of a plan that is likely to provide meaningful support to a long-struggling U.S. biofuels sector. Unfortunately for investors in U.S. biofuels producers, this means that little relief is in sight despite the flurry of pronouncements that have been made about Mr. Trump’s plan in recent weeks. At best Mr. Trump’s plan will offset some of the damage that has been done by the EPA’s expanded SRE allocations. At worst, given the plan’s continued lack of details less than two months before it must be finalized, none of the proposed changes will actually be implemented until 2021 at the earliest.

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.

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