Best stock to invest in – Ethanol and Biodiesel: Production Cost and Profitability



Best stock to invest in

For a number of years, this (now old and outdated, but) very
useful chart has been in circulation in energy circles, mapping
the supply of energy to the world by looking not at prices, but at
production costs.

best-stock-to-invest-in

For one thing, it goes a long way to explaining why the price of
oil can tumble so quickly when there is a fall off in demand, and
explains why OPEC is troubled by unconventional oil
in a way it is not so bothered by other energy sources such as
renewable fuels.

Renewables not only have been traditionally at the expensive end
of the curve, the supply has been generally quite limited when we
look at total global demand. OPEC makes so much money off $100 oil
that they don’t mind sacrificing a few market share points to
other fuels, when demand spikes and prices reach those levels.

The shale oil revolution and its impact

Conversely, shale oils uncovered through US fracking
operations
— to use another example — are able to
supply lots of oil to meet world demand at prices well below the
OPEC target, and they can also be competitive with some of the
more expensive conventional oils. So, they bite into market share
and also price.


Updating the charts: Where does ethanol fit now in the cost
curve?

Back then, ethanol fitted in the $90-$120 per barrel slot. But
today, the cost of production has changed, dramatically. You can
see it in this
wonderful data set
that Bruce Babcock and the Center for
Agricultural and Rural Development at Iowa State have maintained
for many years.

As you can see from the hard data, the production cost
for ethanol today
is $1.22 per gallon, which translates
to $51.24 per barrel. Now, on an energy basis — given that ethanol
has 67% of the energy content of a barrel of oil, that translates
to $76.86 on a barrel-of-oil-equivalent basis.

To make a fair comparison, we have to take into account the
refining cost of making gasoline — we need to compare finished
ethanol and finished gasoline, not compare corn to gasoline or
ethanol to crude oil. Estimates of the variable cost of refining
are not easy to obtain and vary based on the product mix, cost of
utility power and so on, but tacking on at least $4 per barrel is
fair (this older estimate from PSU puts
it at $20
). The EIA has this data from 2012, here.

$76 is well above today’s oil price, even if you tack on $4 for
refining costs to make gasoline. But it’s not well above the price
that oil is expected to reach by next year, according to the
wizards at Raymond James (whose energy desk correctly forecast the
collapse in oil prices, so we approach their forecasts with great
respect, although timing is always an issue with any projection).
They expect oil to reach around $70
per barrel by the end of 2017
. Of course, we’ll wait to see
what impact that might have on corn prices, the price for DDGs and
for corn oil — but it would be a remarkable step in ethanol’s
journey.

We’ve put the latest data from the IMF, and the new numbers for
renewables, into the chart you see below.

best-stock-to-invest-in

As Aemetis CEO Eric McAfee notes:

“The general perception is that
biofuels are more expensive to produce than petroleum fuel
products. That perception is not accurate for the net cost of
production of ethanol in the US after considering the value of
animal feed byproducts (DGrain and corn oil) and CO2 production
for the human food market.”

The impact of carbon on profitability

Let’s look at the impact of carbon.

Under the Renewable Fuel Standard, there’s an
implied carbon credit for ethanol, and that’s in the value of the
D6 RIN.

And that tells you that there’s a significant inflection point in
ethanol and gasoline prices, and it’s this. If, one day, the
production cost + the RIN cost of corn ethanol falls below any
given source of conventional oils, it just makes economic sense
for an obligated party to switch towards increased renewables
production (as opposed to, say, investing in tight oil operations)
— not because of obligations to government, but
because of obligations to shareholders. That’s a
step-change.

And it’s getting close. Thanks to the pricing data from our
friends at PFL, we see that the D6 RIN is trading at 41 cents per
gallon.

That adds $17.22 in carbon value to a barrel of
ethanol. Putting the ethanol production price together with the
RIN price, it makes sense to buy or make as much ethanol as you
can stuff into the system — mandated or not — starting at $55 per
barrel.

That’s not far at all from the world oil price.

Over to the biodiesel side

All the same math applies in the world of biodiesel, but there
are different data points. So let’s look at those.

Starting again with CARD’s
data on operating costs
, the production cost of biodiesel
right now is at $2.76 per gallon, or $115 per barrel.

It happens that CARD data is based on the soybean oil
price
of $0.31 cents per pound. Technologies that can
use recycled oils that are sold as low as $0.22
per pound will have a production cost of roughly $2.61 per gallon.
Now, biodiesel is much closer to petroleum on energy density —
it’s between gasoline and diesel. So, depending on whether you
want to compare biodiesel back to gasoline that comes out of a
barrel of oil or to diesel, you’ll come up with a production cost
range (on a barrel of oil equivalent basis) of $105-$115, after
we’ve adjusted for energy density.

So, biodiesel is well above the $52 Brent crude oil price, right
now. But biodiesel RINs are more valuable, and
close the gap a little. According to PFL, D4 biomass-based diesel
RINs are trading at $1.03 per gallon, and are adding $43.26 to the
value of the barrel.

Putting the production price together with the RIN price, it
makes sense to buy or make as much biodiesel as you can stuff into
the system — mandated or not — starting at $62-$72 per barrel.
That’s high compared to today’s price, but inside the predicted
crude oil price of $70 that we referenced above.

So, we live in interesting times — and we’ve charted the costs
and supply figures, taking carbon into account, in the chart
below.

best-stock-to-invest-in

Considering California

When we look at the California market and its Low Carbon
Fuel Standard
(and Oregon, too, which also has an LCFS)
we are looking at a different animal, since the carbon value is
added on top of RIN credit values.

Right now, our friend at PFL advise that the LCFS credit price is
at $74 per ton of carbon avoided. For locally-produced ethanol,
that means around an additional $6.21 per barrel for ethanol
delivered into the California market.

For biodiesel, the credit bites harder because biodiesel
really, really reduces carbon
. The LCFS credit
translates into around $26.64 in added value for biodiesel.

Putting the ethanol production price together with the RIN price,
it makes sense to buy or make as much ethanol as you can stuff
into the California system — mandated or not — starting at $49
per barrel
.

Putting the production price together with the RIN price, it
makes sense to buy or make as much biodiesel as you can stuff into
the system — mandated or not — starting at $36-$46 per
barrel
.

We’ve charted all that in this California-only chart below.

best-stock-to-invest-in

Two Takeaways

The current barrel of oil costs $49.38 (WTI) and $52.52 (Brent)
right now. Which tells you two things:

1. The renewable fuel credit markets work with remarkable
efficiency,
after just a few years in operation. The
credits reach almost exactly where they should, because a credit
should in some ways make a mandate obsolete, it should incentivize
a market player exactly to the point where they have a financial
gain from deploying a renewable fuel. In the real world,
incumbents don’t act with perfect economic rational actors, but
you get the idea.

2. In California at least, a remarkable threshold
has in fact been reached. In the actual markets that exist –
carbon and fuel markets — ethanol and biodiesel have achieved market
parity
. Now, you can argue all night that carbon
markets are not free markets — they are created by government
fiat. And, you can argue all night that fuel markets are not free
markets — they are created by cartel fiat. And you’ll find
supporters and detractors by the zillions, and the shouting will
drive you crazy.

But they are markets, and they are the markets we have. And don’t
get me started on how free and transparent financial markets
really are, Mr. Madoff. But they are the markets we have, and in
the markets we really have, we can say that markets in
California
are telling us this:

You can make more money producing
ethanol than producing gasoline from petroleum, according to our
math. And investors might take note — because making money is
generally what investors are trying to accomplish in the
petroleum markets.

So, a step change worth noting.

[A brief explanatory note. As a sharp-eyed Digest reader
noted, the CARD model tracks what may be considered “operating
costs” and excludes amortization, depreciation and so forth — if
all those were added in, the “production cost” would be higher —
as high as $1.46 per gallon, vs $1.22 per gallon. So, why
exclude those? As it happens, the EIA model for oil refinery
costs (that we noted above) also excludes amortization,
depreciation and so forth, which is why the refining add-on is
$4 per barrel instead of $20-$30. Since we don’t have a good
source of overall oil refinery costs, these capex related costs
were excluded for both, to esnure that we are comparing apples
to apples. If you like, you can add $10-$15 per barrel to both
sides of the equation to account for these charges, and it
doesn’t change the comparison, but you may feel that although it
would be an approximation, it may be closer to a fully-loaded
“production cost” as opposed to an “operating cost”.]

Jim Lane is editor and publisher  of Biofuels Digest where this

article

was originally published.
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