Biofuel producer stocks have experienced one of the worst 4-months stretches in recent memory since May. The share prices of major independent producers such as Green Plains, Inc. (GPRE), Pacific Ethanol (PEIX), and Renewable Energy Group (REGI) have all declined by as much as 50% or more since May (see figure). The larger, integrated producer Valero Energy (VLO) has also underperformed its refining peers by a substantial margin.
The immediate cause of this turmoil has been the Trump administration’s August 9 decision, following months of waffling, to allow the U.S. Environmental Protection Agency [EPA] to retroactively grant 31 so-called “Small Refinery Exemptions” [SRE] to U.S. refiners for 2018 under the U.S. Renewable Fuel Standard [RFS2]. The RFS2’s mandate requires refiners to blend predetermined volumes of biofuels with their refined fuels prior to retail. It includes a mechanism that allows small refineries to be partially or fully exempted from participating in the mandate when doing so would cause them to incur economic hardship. (The SREs are also known as “hardship waivers” as a result.) The EPA has drastically reduced the volume of biofuels that refiners must blend under the Trump administration (see figure), even as many of the refiners that own the refineries that have received waivers have recorded bumper profits.
Small refinery exemptions granted per year, 2013-2018. Source: EPA (2019).
The large effective reduction to the mandated blending volumes has in turn caused Renewable Identification Number [RIN] prices to plummet (see figure). RINs are the tradable compliance commodities that refiners use to demonstrate their compliance with the blending mandate; each RIN is created when a corresponding gallon of biofuel is produced and separated from that gallon when the biofuel is blended for retail. Separated RINs can then either be submitted to the EPA to demonstrate partial compliance with the mandate or sold to another entity. D6 RIN prices, which represent the largest biofuel blending category of the RFS2, fell by 63% between late June and August as traders accounted for the reduced demand in the wake of the EPA’s most recent SRE allocation decision.
Daily average D4, D5, and D6 RIN prices. Source: EcoEngineers (2019).
The weakening of the blending mandate has occurred at a time when U.S. biofuel producers are already struggling with the effects of a multi-quarter low-margin operating environment that is in part the result of other actions taken by the Trump administration. Most immediately, it has coincided with the Trump administration’s ongoing trade war with China. The trade conflicts with that and other countries have greatly reduced demand for ethanol and co-product DDGS, hurting ethanol production margins. Likewise, a deteriorating global economic growth outlook has contributed to a 24% decline to U.S. gasoline prices since late April that has in turn put pressure on ethanol prices even as the latter’s premium relative to the former has increased modestly (see figure).
The result of this operating environment has been ethanol production margins in 2019 that have been near zero when excluding capital costs, or around -$0.20/gallon when including capital costs (see figure). The overall margin environment has been the worst that the industry has experienced since at least 2012, when a severe drought in the Midwest caused corn prices to rise sharply. The trade war and global economic growth outlook were already negatively affecting the U.S. ethanol sector even before the EPA released the latest round of SREs, prompting the CEO of Green Plains, Inc. to state in July that the U.S. ethanol industry was at a “breaking point.” The subsequent further weakening of the mandate has done nothing to improve conditions.
Corn ethanol production return over operating costs, 2013-2019. Source: CARD (2019).
President Trump’s 2016 election victory was largely attributable to votes from the Midwestern swing states. Mr. Trump, who is 15 months away from the election for a second term and faces a double-digit unfavorable rating in the polls, is sensitive to the fact that the path to a second election victory again requires the electoral votes of Corn Belt states. Cabinet meetings since the latest SRE announcement have focused on how to alleviate concerns in the Midwest over the state of the RFS2, culminating in the following announcement by Mr. Trump on August 29:
While details on this “giant” ethanol plan are scarce, Secretary of Agriculture Sonny Perdue recently stated that it will boost demand for biofuels, making it likely that the plan will take the form of an increase to future RFS2 blending volumes. At the same time, though, reports from the Cabinet meetings indicate that the SREs will not be rescinded. As Professor Scott Irwin of the University of Illinois Champaign-Urbana has accurately noted, this very much limits the Trump administration’s feasible options:
This situation will make it very difficult for the Trump administration to take any actions that are likely to provide long-term relief for ethanol producers. The increased SRE allocations have been the result of a multi-year lobbying campaign by executives at merchant refiners such as CVR Energy (CVI) and PBF Energy (PBF) and are unlikely to be reversed as a result. Legally the EPA is required to offset the impact of the waivers by increasing the blending requirements of those refineries that do not receive SREs, although it has failed to do so in recent years under pressure from larger refiners. Of the three affected entity types, then, the Trump administration cannot fulfill its commitments to merchant refiners, large refiners, and biofuel producers. Either it rescinds the waivers, which will upset merchant refiners and large refiners, or it offsets the waivers, which will upset large refiners (increasing the future blending volumes would have a similar impact as offsets).
This is not to say, of course, that biofuel producers’ share prices will not be affected by any future announcements by the Trump administration on the RFS2 and SREs. Mr. Trump’s August 29 tweet caused those share prices to immediately bounce by as much as 23%, for example. It is hard to see a path forward for the Trump administration that will result in a truly favorable plan for biofuel producers, however, given the constraints that it is currently operating under.
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.