With the focus on lofty gasoline prices still fresh on many minds in the wake of Superstorm Sandy and refiners soon looking to transition production from winter to summer blend fuels, I wanted to look back at a topic which recently garnered national interest. Who could forget TV crews broadcasting live as gas lines went on for miles and eerily resembled what was seen here in the States during the 1973 Oil Crisis? This has me thinking President Obama has a chance to make the advancement of fuels a top priority in his second term and that could spell opportunity for investors.
The carnage that Sandy left across many states, including my hometown in New York, should be yet another wake-up call that the lack of refinery capacity in the U.S. is still a major issue that simply won’t go away. Did you know there are currently about 144 operable U.S. refineries, the fewest since at least 1949, which is as far back as Energy Department data goes? Whichever way you slice it, refinery numbers in the U.S. continue a three-decade contraction which means investors must consider the future of fuels.
With more stringent government fuel requirements coming and many older refineries incapable of breaking down crude to more eco-friendly gasoline (they weren’t built for that), it is possible to see pump prices run higher this summer. This point would be helped along with any easing of oil transportation surrounding the Cushing, Oklahoma hub, the largest oil storage facility in the U.S.
This “easing” could be accomplished thanks in part to the Seaway Pipeline or if the President moves forward with the Keystone XL pipeline. As a result, I’d expect WTI crude oil, which has trailed Brent crude oil for north of a year due to overcapacity near Cushing, to gain more investor interest and narrow the spread with Brent. A higher WTI oil price due to an easing of supplies near Cushing along with any hiccups of production or from further severe weather patterns which disrupt supplies (most notably in the Northeast) would likely boost investor interest in refiners short-term. However, I believe the real alpha in the refinery space will come from refiners that move aggressively to position for the future and focus on “greener” pastures in light of government mandates to produce cleaner-burning fuels. This has me thinking refiners are going to be forced sooner than later to add biofuels to their business models in a big way in order to sustain revenue growth.
This leads me to San Antonio-based Valero Energy, the largest independent oil refiner in the world. The company has quietly changed the direction of its massive enterprise in recent years by becoming a major player in ethanol. In fact, Valero is now one of the country’s largest ethanol producers with capacity of 1.2 billion gallons – that figure only trails Archer Daniels Midland who has production capacity of 1.8 billion gallons. Keep in mind, Valero, made a $60 million equity investment last year in Enerkem, a Montreal-based company that converts waste into ethanol. This move only solidified Valero’s intention of growing with the times and putting more chips on green, something that could also pay off in a big way if Enerkem moves forward with an initial public offering in 2013 (Enerkem did file a Form F-1 with the SEC in February of 2012).
Through its subsidiary Valero Renewables, the company is looking to commercialize biofuels, including ones made from switchgrass cellulosic ethanol. To that end Valero invested as much as $50 million in Mascoma biofuels back in 2011 (the plant should produce ethanol in Michigan in 2013).
Why is this future of biofuels even more important today? As fuel output in the Northeast declines in the wake of refinery closures, asset sales (including from Valero) and the industry focus turns to more appealing margins in the West Coast and the MidAtlantic regions, there has become a void in distillate and gasoline production. As a result, opportunities for biogas development in the eastern U.S. are growing.
We could soon witness crack spreads, the margin differential between crude oil and the conversion of refined products, being replaced by what I like to refer as “pesto” spreads, representing a new paradigm for refiners to create green fuel, or the “green sauce” for making fuel, by distilling garbage, plastics and biomass such as wood chips, plastics, corn husks, wood residues, straw and switchgrass into “syngas” rich with complex hydrocarbons that can power commercial vehicles and airplanes.
So who are other biofuel players to keep an eye on? Marathon Petroleum, a leading blender of corn-based ethanol and General Motors through its Ventures unit are also principal investors in Mascoma primarily to advance non-food feedstocks such as switchgrass which are needed to produced next generation biofuels that in GM’s case may directly lower fuel prices and benefit auto sales more than biodiesel autos which in many cases are not covered under automotive warranties.
While ExxonMobil is focusing on creating biofuels more from algae through it relationship with Synthetic Genomics, in 2007, ConocoPhillips may be a major oil company to keep on the radar since it entered into an 8-year $22.5mln biofuels research program with Iowa State to help diversify fuel supply and reduce pollution. Furthermore, ConocoPhillips also entered into a deal with Archer Daniel Midland five years ago to develop biofuels from crops, wood and switchgrass.
Rentech has patented technology that converts a wide range of biomass and waste feedstocks, including wood, wood residues, straw, switch grass, refuse-derived fuel, energy crops and agricultural residues, into syngas rich complex hydrocarbons that can be used to fuel commercial vehicles and planes. Despite a weak economic climate witnessed in many parts of the world, Rentech was active in 2012 buying back some of its stock under its $25 million share repurchase program. As a result, confidence in the outlook for biogas appears strong. So when you go toss out the garbage tonight after dinner, just think that our future energy is in that hefty bag.
I’m also intrigued by microcap player Metabolix. The company, which sports a market cap of ~$55mln despite having $53.6mln in unrestricted cash and investments (short and long-term) as per the Q312 earnings release, was awarded $6mln by the Department of Energy (DOE) in 2011 to develop biofuels from switchgrass. Keep in mind Metabolix operates in cash intensive sector, so my bias towards the company will improve further when the company gains more funding. Through a restructured business that is more streamlined, they have also been working on developing ways to use switchgrass to improve plasticization (most notably with PVC resins). New samples of the polymeric modifiers, marketed under the brands Mirel and Mvera, are now available and are gaining a buzz since they are very strong and can biodegrade in soil, water as well as in composting facilities (residential and commercial). Considering Earth911.com reported in 2010 that over 7 billion pounds of PVC are thrown away in the U.S. each year, only 18 mln pounds of that, about one quarter of 1%, is actually recycled, that potentially presents big opportunity for Metabolix to develop a more sustainable plastic versus petroleum-based resins.
It is clear, or at least I hope it is from this article, my enthusiasm for biofuels is strong. Like any industry there will be hiccups along the way (i.e. Dell laptops, early Apple iPhones, etc.). With that said, I believe much has been learned from the early evolution of the ethanol industry and that will only result in a cleaner, more sustainable market that can actually store more CO2 in soils and roots and advance technologies to convert waste into energy. Considering the U.S. is one of the largest markets for Renewable Fuels according to the below chart from Enerkem, tomorrow’s refinery sector may look a lot different than it does today, and that’s exciting.
John Licata is founder and Chief Energy Strategist at Blue Phoenix.
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