The EPA Gets One Right on Biofuels

 | Nov 18, 2013 | 1:30 PM EST  | Comments
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I rarely have positive comments on changes in government policies, especially over the last few years. However, we must give credit where credit is due. I must applaud a proposed change within the ethanol and biofuel space. This change, if approved, will have impacts across a variety of industries.

The Environmental Protection Agency has submitted a proposal for public comment on changing current renewable fuel mandates. If this proposal comes to pass -- and there will be considerable opposition by those who benefit from the current mandate -- it will have significant impacts, as it would demand 3 billion fewer gallons of biofuel to be mandated in 2014 than what the original 2007 law stipulated.

On the margins, this should moderate corn prices. This would be good for livestock producers, given corn's role in feedstocks. This should also lower food prices for consumers in a variety of food categories.  For agricultural giants such as Archer Daniels Midland (ADM), it should be a mixed blessing. Lower mandated biofuel volumes would damage some of its renewable fuel projects, but lower corn prices would help other parts of its business.

Obviously, this would be a major blow for ethanol producers such as Green Plains Renewable Energy (GPRE) and Renewable Energy Group (REGI), which will probably protest the new lower mandate vociferously. Any investor in this sector should keep a watchful eye on the progress of this proposal.

If this proposal comes to fruition, one of the biggest winners would be the refining sector. Refiners have rapidly hit a "blend wall," thanks to falling gasoline demand as well as increased biofuel mandates. As a result, the costs of buying renewable fuel credits, in order to comply with the mandate, have gone parabolic. This has been a major earnings hit to many refining entities.

On any relaxation of biofuel mandates that causes the cost of these credits to come down, one of the main beneficiaries would be PBF Energy (PBF), which has seen these credit costs skyrocket this year.

The company is one of the largest independent petroleum refiners and suppliers of unbranded transportation fuels, heating oil, petrochemical feedstocks, lubricants and other petroleum products in the U.S., despite just coming public in late in 2012. PBF Energy owns three refineries in the eastern part of the U.S. and has a combined throughput capacity of about 540,000 barrels a day.

The other recent positive for the company is that the spread between West Texas Intermediate and Brent crude has widened considerably since reaching parity this summer. This is positive for the company's profit margins. Although PBF's stock is up some 25% over the last month to a little over $28 a share, it should still have upside. It sells for less than 6x 2012's earnings and pays a 4.2% dividend, and it went for over $40 a share earlier in the year.

In my personal opinion, it would have better for the country's long-term energy future to ditch the biofuel mandate completely, as using food for fuel has myriad negative impacts. It would be more efficient to more fully embrace our rapidly expanding natural gas production into our transportation infrastructure. However, this is a good first step. In the near term, this move will have consequences across a variety of firms that astute investors should be aware of.

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