The White House Continues To Drive The Outlook For Biofuels Producers

Source: By Tristan R. Brown, Seeking Alpha • Posted: Monday, June 25, 2018

  • Three major policy developments by the White House have had a large impact on U.S. biofuel producers over the past week.
  • The EPA was initially reported to be on the verge of effectively reducing the U.S. volumetric biofuels mandate before making a surprise direction reversal several days later.
  • The White House has also caused trade tensions with China to escalate this week, prompting soybean and corn prices to decline sharply.
  • The EPA is expected to make its formal announcement on the biofuels mandate soon, but uncertainty around America’s trading relationships continues to grow.

Three major developments in the last week have once again illustrated just how much the outlook for U.S. biofuels producers is being driven by the whims of the White House at present. The share prices of the affected companies, including The Andersons (ANDE), Green Plains, Inc. (GPRE), FutureFuel (FF), Pacific Ethanol (PEIX), Renewable Energy Group (REGI), and REX American Resources (REX) have demonstrated strong volatility in response, albeit in a variety of directions (see figure).

Last Friday, Reuters reported that the U.S. Environmental Protection Agency [EPA], which oversees the country’s revised Renewable Fuel Standard [RFS2] biofuels blending mandate, had decided to effectively reduce the volumetric mandate below its statutory levels. As I explained back in May, the EPA has been awarding “hardship waivers” to an unprecedentedly-large number of refiners that effectively reduce the volume of biofuel that they must blend prior to retail. Congress established annual blending volumes for the entire refining sector when it created the mandate, however, and by law, the waivers cannot affect this larger number. In other words, any volumes that are waived for some refiners must be reallocated among other (generally larger) refiners so that the total blending volume remains unchanged regardless of how many individual waivers are distributed.

The hardship waivers have been a last resort for EPA Administrator Scott Pruitt, who earned a reputation as an advocate for the refining sector and opponent of the biofuels sector in his previous job as Oklahoma’s attorney general. Earlier efforts by former Trump administration officials such as activist investor Carl Icahn to alleviate refiners’ compliance costs under the mandate came to naught, leaving Mr. Pruitt with few options other than the waivers for achieving this goal. While never likely to pass judicial muster, a steady stream of reports that Mr. Pruitt would use the waivers to reduce the national blending volume by as much as 10% had the desired effect of causing the prices of blending credits, or Renewable Identification Numbers [RIN], to collapse in the first several months of 2018 (see figure).

The report by Reuters that Mr. Pruitt intended to reduce the national blending mandate by the amount of the waivers despite a clear statutory precedent otherwise quickly prompted a sharp response from ardent biofuels supporter Senator Chuck Grassley (R-IA):

Mr. Grassley had previously threatened to call for Mr. Pruitt’s resignation if the EPA administrator violated the Congressional statute by reducing the blending mandate via hardship waivers. The sector quickly found itself caught up in larger developments, though, as the trade war that has been brewing between the U.S. and China this year reached new heights this week. China has targeted soybean imports for tariffs in response to the imposition of large tariffs on Chinese goods being sent to the U.S. Soybean prices plunged into what agricultural economist Scott Irwin has called “disaster territory” after the latest round of tariffs were announced earlier this week:

Corn prices quickly followed suit given the corn-soybean rotation system that is used by most farmers in the Midwest U.S.:

This price action has been very good news for corn ethanol producers and biodiesel producers given that the corn and soya crops are already in the ground. While the overall impact of the broader tariff war has been muted for the former due to China’s decision to also impose tariffs on its ethanol imports, biodiesel producers have largely benefited from the breakdown in trade relations, especially since it has coincided with a rising diesel fuel price (see figure). Biodiesel operating margins as measured by Iowa State University have moved to highs not seen since late 2016 in response.

Yesterday saw the third major development of the last week when Reuters reported that the EPA is reversing its earlier reported decision and will no longer use the waivers to reduce the national biofuel blending volume. Showing just how sensitive to headlines the RIN market has become, RIN prices responded with a 22% single-day jump on what was essentially a report that the EPA will do as federal law requires it to do.

Not everyone is convinced that the EPA’s official announcement regarding the volume reallocation will benefit biofuel producers. Reuters quoted a director at the American Petroleum Institute as saying that “Our view is reallocating volumes would obviously conflict with public and private statements on the issue.” The good news for investors is that the EPA’s formal decision is expected to be made as early as this Friday, reducing some uncertainty after several months of rumors regarding the effect of the waivers and nearly two years of efforts by the mandate’s opponents to weaken it.

The ultimate outlook for biofuel producers from the revived tariff exchanges is harder to discern due to the steady escalation that has occurred since the beginning of May. According to one recent estimate, China’s recent tariff actions will reduce U.S. soybean exports by almost 70%. Moreover, this reduction could become larger still given that Mexico, which is currently involved in a tetchy NAFTA renegotiation with the U.S., is the latter’s second largest soybean export destination (and also the largest destination for U.S. soybean meal and soybean oil). Germany, Spain, and the Netherlands are all in the Top 10 by export destination at a time when trade tensions are also rising between the U.S. and European Union. China has targeted its tariffs on products from battleground states such as those in the Midwest in a tactic that will likely be adopted by America’s other spurned trade partners. Volatility in the biofuels sector does not look to dissipate anytime soon.