Image Shown: A geographical overview of Renewable Energy Group’s operational “biorefineries” in the US and Germany. Image Source: Renewable Energy Group Inc – October 2020 IR Presentation
Executive Summary: Renewable Energy Group is an intriguing biofuel maker with operational “biorefineries” located across the US and in Europe (specifically Germany). The company’s operations are supported by an extensive distribution network that is primarily built upon supply agreements with third parties, though Renewable Energy Group opened its own branded fuel location in 2019 for the first time.
Shares of REGI have been on an upward tear of late, likely due to growing investor optimism towards green energy firms, in our view, as the new Biden administration in the US has made it clear that it would push for greater federal incentives to stimulate investment in domestic renewable energy industries. In Europe, the EU has imposed mandates and created incentives to stimulate investment in the biofuel space and non-EU members states, like Norway and the UK, have also implemented aggressive policies to support the biofuel industry.
During the first nine months of 2020, Renewable Energy Group’s financial performance posted a tremendous turnaround as the company focused on higher-margin products. The company’s balance sheet is pristine, though we caution that historically, Renewable Energy Group has leaned on equity issuances to fund its growth ambitions though more recently, the firm has started to focus on reducing its outstanding diluted share count (or at the very least, limiting its shareholder dilution).
We are impressed with Renewable Energy Group’s recent financial performance and are intrigued by its long-term outlook. However, we caution that the firm is highly exposed to exogenous forces. Government incentives, or lack thereof, from national government bodies (and to a lesser extent, from certain US state governments) will have an outsized impact on the trajectory of Renewable Energy Group’s growth story going forward. Investors are clearly optimistic, as shares of REGI have more than tripled over the past year. Please note Renewable Energy Group does not pay out a common dividend at this time.
By Callum Turcan
The biofuel producer Renewable Energy Group Inc (REGI) operates roughly a dozen “biorefineries” across the US and Europe. Shares of REGI have more than tripled during the past year as of this writing due primarily to expectations that the new Biden administration will provide the US biofuel industry with significant federal support, in our view, which comes on top of expectations that Europe will continue to aggressively support the industry going forward. In this article, we dig into the biofuel industry’s regulatory landscape, incentive structure, and Renewable Energy Group’s outlook.
Regulatory and Unit Economics Overview
Well over a decade ago, then-President Bush signed the Energy Policy Act of 2005 into law which created the Renewable Fuel Standard that mandated transportation fuels (such as gasoline and diesel) had to include a greater amount of biofuel. This mandate was expanded two years later when then-President Bush signed the Energy Independence and Security Act of 2007 into law. Every year since this mandate was enacted, an increasing amount of biofuel was required by law to be blended with traditional fossil fuel-based transportation fuels. The annual increases are slated to run through 2022, and by then the Renewable Fuel Standard mandate dictates the US needs to blend 36 billion gallons of biofuel per year with traditional transportation fuels. For reference, this is referred to as the Renewable Volume Obligation (‘RVO’) which is set by the US Environment Protection Agency (‘EPA’).
The Renewable Fuel Standard mandate is monitored through the Renewable Identification Numbers (‘RINs’) system. RINs are created when a domestic gallon of renewable fuel (such as biodiesel) is produced. Renewable fuels can be produced through “conventional” means (such as using corn or grain sorghum as a feedstock) or “advanced” means (using cellulosic and other feedstocks); please note there are several different classifications for biofuels. The Renewable Fuel Standard mandates that a certain amount of each type of biofuel (the four core groups are cellulosic biofuel, biomass-based diesel, advanced biofuel, and renewable fuel) needs to be produced each year domestically.
RINs can be sold to traditional refiners, refining operations that use fossil fuel to produce transportation fuels, to allow those refiners to comply with the Renewable Fuel Standard mandate. When a gallon of fossil fuel-based transportation fuel is produced domestically or imported, that creates a regulatory liability which needs to be offset either through the refiner producing a commensurate amount of its own biofuels domestically or by acquiring RINs from third parties. Generally speaking, most traditional refiners do not produce enough biofuels internally to comply with the Renewable Fuel Standard mandate.
Effectively, RINs increase the value of biofuels, which in theory, is supposed to stimulate domestic production of biofuels by enhancing the economics of biorefineries. There are other US government incentives to be aware of including state incentives, though one of the biggest is the biodiesel tax credit (‘BTC’). While the BTC expired at the end of 2017, it was extended until 2022 when the Further Consolidated Appropriations Act was signed into law in December 2019 by then-President Trump. Additionally, the biofuel industry received further federal support when the massive omnibus spending package for fiscal 2021 was signed into law by then-President Trump in December 2020, as that package extended key tax credits and other provisions that are beneficial to the industry.
In the upcoming graphic down below, Renewable Energy Group provides a breakdown of the unit economics of biofuel production in the US. There is the value generated from selling a product that is broadly equivalent to ultra-low sulfur diesel (‘ULSD’), where Renewable Energy Group would pocket the difference between its feedstock expenses and other operating costs versus the price received for the final product when sold (similar to “crack spreads” in the traditional refining industry). Also, there is the value generated from the creation of RINs through the domestic production of biofuels along with various state incentives, and then there is the BTC (along with any other tax credits).