Oil and Gas

RFS Drives US Biodiesel Production Surge

US biodiesel production surged during the first five months of 2016 compared with a year ago, with a climbing output rate driven by an increasing federal mandate to blend renewables into petroleum-based transportation fuels.

Biomass-based diesel fuel production in the United States, primarily biodiesel but also renewable diesel, has averaged more than 30% higher during the first five months of 2016 compared with a year ago based on data from the US Environmental Protection Agency. The higher level of supply availability coincides with clearer forward visibility for US biodiesel producers following the extension of a $1 gallon blender’s credit through this year and better clarity on blending targets under the Renewable Fuel Standard.

Higher biodiesel output comes despite weak producer margins that were negative from December 2015 through early May. The weakness in the return has more to do with price pressure for New York Mercantile Exchange ULSD futures than with soybean oil prices, although Chicago of Board of Trade soybeans futures rallied to a 10-month high in April before sliding to a nearly six-month low in early July on favorable growing conditions.

NYMEX ULSD futures also rallied in May alongside NYMEX West Texas Intermediate crude futures on supply disruptions for oil sands in Canada amid widespread wildfires in Alberta and militant attacks targeting oil and gas infrastructure in Nigeria, with the North African nation a member of the Organization of the Petroleum Exporting Countries. NYMEX oil futures also benefited in the latter part of the second quarter from strong gasoline demand in the US, China and India.

Freight demand in the US remains lackluster, with freight primarily moved by trucks in the United States. Freight movement did increase for two consecutive months in the second quarter, up in April and May, according to the US Department of Transportation’s Bureau of Transportation Statistics.

US industrial production also improved late in the second quarter, with output climbing to a four-month high in June after mixed readings from March through May, data from the Federal Reserve Bank of St. Louis shows. Nonetheless, US industrial production is holding well below the output rate experienced in 2015, weighing on diesel demand.

In the United States, diesel demand is primarily consumed in commercial and industrial operations, and the soggy growth in these sectors of the economy has slowed consumption. US Energy Information Administration data shows distillate fuel supplied to market down 5.9% during the first six months of 2016 against the comparable year-ago period, and 1.6% lower than the five-year average. A weak 2015-2016 heating season compounded the declines.

Spot market trades for physical biodiesel remain limited, occurring in heated bouts of activity before again slowing to a crawl. Spot B100 values remain indexed against the NYMEX ULSD futures contract, and vary based on feedstock, location, delivery method, and whether a D4 renewable identification number is attached to the biodiesel.

Biomass-based diesel D4 RINs are credits submitted to the EPA by parties obligated under the RFS–oil refiners, blenders and importers–to show compliance with the federal mandate. This year, the RFS carve-out for biomass-based diesel has been proposed at 1.9 billion gallons, climbing to 2.0 billion gallons for 2017.

RINs, which are generated when a qualified renewable is produced or imported, can be separated from the renewable and sold in the open market, allowing obligated parties to purchase compliance credits. The RFS program also offers obligated parties flexibility in meeting their Renewable Volume Obligation by carrying over a maximum 20% of their required RINs into the following year.

Biomass-based diesel D4 RINs topped $1 in early July for the first time since January 2015 as demand for the credits heats up, with expectations for RIN values to continue to appreciate. The outlook calls for a tightening RIN market going forward as annual RFS demand mandates increase.

Total mandated RFS volume for this year is proposed by the EPA at 18.11 billion gallons, increasing to 18.8 billion gallons for 2017. Conventional biofuels are expected to satisfy 99% of this year’s mandate.

Biomass-based diesel is one of the five nested fuel categories under the RFS, with the largest category, renewable fuel, satisfied overwhelmingly by corn-based ethanol. Cellulosic biofuel and diesel and advanced biofuel are the other three nested categories, with renewables required to account for 10.1% of transportation fuels in 2016.

The 10.1% RVO is above the ethanol blend wall, referring to the 10% maximum ethanol blend in gasoline allowed universally in US vehicles. The EIA projects record gasoline demand in the United States this year at 9.29 million bpd, with a 10.1% blend ratio implying ethanol demand at 14.384 billion gallons in 2016, short the 14.5 billion gallons of conventional biofuels proposed by the EPA.

Renewable fuel D6 RINs also briefly cracked above $1 in early July, trading at roughly a nickel discount to a D4 RIN which is remarkable when you consider a D4 RIN is equal to two D6 RINs. The expected difficulty in reconciling the climbing mandate and the limited ability to blend at higher ethanol ratios is seen maintaining strong price support for D6 RINs that, in turn, underpin D4 RIN values.

Biodiesel is expected by some in the industry to compensate for the shortfall in ethanol blending volumes, with biodiesel also considered an advanced biofuel. Yet, the EIA also projects a 90,000 bpd decline in distillate fuel demand this year to 3.88 million bpd that likely limits biodiesel blending. EIA expects US distillate demand to increase by 80,000 bpd in 2017 to 3.96 million bpd.

Demand in California for biomass-based diesel fuel is expected to continue its sharp upward trajectory as the state advances on environmental goals, with California demand for biomass-based diesel surging from 14 million gallons in 2011 to 291 million gallons in 2015, according to the National Biodiesel Board. The trade group forecasts California’s demand for biomass-based diesel fuel at 371 million gallons this year, up 27.5% from 2015, with state demand forecast at 785 million gallons by 2023.

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