Biodiesel Industry on the U.S. Soybean Complex

Transcription

1 Impact [Insert of Title] the [Year] U.S. Biodiesel Industry on the U.S. Soybean Complex Prepared for: Minnesota Soybean Growers Association Informa Economics Phone: December 2012

2 Table of Contents I. EXECUTIVE SUMMARY... 1 II. INTRODUCTION... 4 A. BIODIESEL INDUSTRY BACKGROUND... 4 III. THE SOYBEAN COMPLEX PRIOR TO THE EMERGENCE OF THE U.S. BIODIESEL INDUSTRY... 9 A. IMPACT OF LARGE SOYBEAN OIL INVENTORIES ON THE U.S. SOYBEAN COMPLEX... 9 B. BIODIESEL SHIFTED THE STRUCTURE OF SOYBEAN OIL DEMAND AND PRICES C. SOYBEAN OIL USE FOR BIODIESEL HELPED OFFSET THE IMPACT OF TRANS-FAT LABELING TO THE CONSUMPTION OF SOYBEAN OIL D. KEY TAKEAWAYS IV. BROAD IMPACTS OF THE U.S. BIODIESEL INDUSTRY ON THE U.S. SOYBEAN COMPLEX A. BIODIESEL RESULTED IN INCREASED DEMAND FOR SOYBEAN OIL IN THE U.S B. THE PRICE OF SOYBEAN OIL BECAME CLOSELY LINKED TO THE PRICE OF DIESEL C. BIODIESEL RESULTED IN HIGHER SOYBEAN OIL PRICES AND A POSITIVE TO THE SOYBEAN COMPLEX D. THE SHARE OF SOYBEAN OIL AS BIODIESEL FEEDSTOCK IS NOT A FACTOR IN THE CO-MOVEMENT OF ENERGY AND SOYBEAN OIL PRICES E. INCREASED SOYBEAN OIL PRICES AND THE CORRESPONDING EFFECT ON SOYBEAN AND SOYBEAN MEAL PRICES F. KEY TAKEAWAYS V. THE BIODIESEL INDUSTRY ALSO INFLUENCED SECTORS OUTSIDE OF THE SOYBEAN COMPLEX A. BIODIESEL RESULTED IN INCREASED PRICES FOR OTHER VEGETABLE OILS B. BIODIESEL RESULTED IN INCREASED PRICES FOR ANIMAL FATS AND GREASES C. BIODIESEL CREATED A PROFITABLE MARKET FOR INDUSTRIAL GRADE CORN OIL EXTRACTED FROM DDGS D. KEY TAKEAWAYS VI. FRAGILITY OF CURRENT BIODIESEL MARKET DRIVERS A. CURRENT RENEWABLE FUELS STANDARD & IMPLICATIONS OF POTENTIAL ANNUAL ADJUSTMENTS (a) Adjustment to the RFS B. STATE-LEVEL BIODIESEL MANDATES i

3 1. California Low Carbon Fuel Standard State-Level Biodiesel Mandates and Incentives C. POTENTIAL IMPLICATIONS OF RFS2 ELIMINATION Debate over the RFS Potential Impacts of RFS2 Elimination on Biodiesel and Soybean Industries (a) Could State-Level Mandates Support the Industry? (b) What Are the Impacts on Vegetable Oil Volumes And Prices As Well As Impacts on Other Feedstock Markets? D. KEY TAKEAWAYS VII. WOULD MORE INVESTMENT IN THE BIODIESEL INDSUTRY BE VALUABLE TO SOYBEAN FARMERS? (a) How Would Soybean Oil Used For Biodiesel Production Be Redistributed to Other Markets in the Absence of Biodiesel? 53 (b) Can Soybean oil Prices be Sustained Without a viable U.S. Biodiesel Industry? (c) Can Soybean Oil Prices Be Sustained If Soybean Oil Is Only a Small Share Of Biodiesel? (d) Would the Link Between Soybean Oil and Energy Prices Change If U.S. Biodiesel Production Stops; Or If Soybean Oil Is Only A Fraction Of The Feedstock Used? (e) How Will Prices Of Soybean Meal Be Affected Without Biodiesel? (f) How Have the Prices and Markets for Other Vegetable Oils, Industrial Corn Oil, Animal Fats and Greases Been Impacted By the Biodiesel Industry? (g) Conclusion Should Investment Continue in the Biodiesel Industry VIII. APPENDIX: RFS2 BACKGROUND ii

4 iii List of Exhibits Exhibit 1: U.S. Biodiesel Monthly Production History... 5 Exhibit 2: U.S. Biodiesel Existing Capacity (Active and Idled)... 6 Exhibit 3: U.S. Soybean Oil Use by Major Use Category... 7 Exhibit 4: U.S. Biodiesel Production by Feedstock Used... 8 Exhibit 5: Soybean Oil Share of Soybean Product (meal and oil) Value Exhibit 6: Price Spread between Soybean Oil Illinois (Processor Price) and Gulf (Export Price) Exhibit 7: Carry-in Stocks and Soybean Oil Prices, 1999/ / Exhibit 8: Market Share of U.S. Vegetable Oil Use for Food Uses Exhibit 9: U.S. Vegetable Oil Use for Non-Biodiesel Changed from 2004/05 to 2011/ Exhibit 10: U.S. Soybean Oil Consumption LOST to other Oils vs. Soybean Oil Consumption GAINED by Biodiesel Relative to 2004/ Exhibit 11: U.S. Domestic Soybean Oil and Biodiesel Share of Usage and Production Exhibit 12: Correlation between Soybean Oil and Diesel Prices Exhibit 13: Monthly Correlation of Diesel and Soybean oil Prices Exhibit 14: 2007 to 2012 Monthly Correlation of Diesel and Soybean oil Prices Exhibit 15: Prices of Soybean Oil in Btu Equivalent Exhibit 16: Impact of Biodiesel on the Price of Soybean Oil Exhibit 17: Co-Movement of Heating Oil-Soybean Oil vs. Soybean Oil Share of Biodiesel ( ) Exhibit 18: Heating Oil-Soybean Oil Correlation by 10 Month Periods, Exhibit 19: The Effect of Soybean Oil Prices on Soybean Meal and Soybean Prices Exhibit 20: Co-Movement of Vegetable Oil Prices: Exhibit 21: Animal Fats and Yellow Grease Prices Discount Relative to Soybean Oil Prices ( ) Exhibit 22: Impact of Biodiesel on the Price of Animal Fats and Yellow Grease Exhibit 23: Economics on Industrial Corn Oil and Its impact on Ethanol Margins Exhibit 24: Cellulosic Biofuel RFS2 Mandate vs. EIA Projections Exhibit 25: EPA Projected Biodiesel and Renewable Diesel Feedstock Use In Exhibit 26: LCFS Carbon Intensity Reduction Schedule for Diesel and Substitute Fuels Exhibit 27: Carbon Intensity Lookup Table for Diesel and Fuels that Substitute for Diesel Exhibit 28: Carbon Intensity Value Histogram of Registered Diesel Fuel Substitute Providers Exhibit 29: Registered Diesel Fuel Substitute Facilities by Feedstock Exhibit 30: State-Level Mandated Biodiesel Use... 49

5 Exhibit 31: RFS2: Fuel Categories, Targets (billion gallons), and Minimum GHG Savings iv

6 Disclaimer This report was produced for Minnesota Soybean Growers ( Minnesota Soy ). Informa Economics, Inc. ( Informa ) has used the best and most accurate information available to complete this study. Informa is not in the business of soliciting or recommending specific investments. The reader of this report should consider the market risks inherent in any financial investment opportunity. Furthermore, while Informa has extended its best professional efforts in completing this analysis, the liability of Informa to the extent permitted by law, is limited to the professional fees received in connection with this project. EPA = Environmental Protection Agency UAB = Undifferentiated Advanced Biofuel RFS = Renewable Fuel Standard FDA = Food and Drug Administration USDA = United States Department of Agriculture SB = Soybeans SBO = Soybean oil SBM = Soybean meal bgy = billion gallons per year mmgy = million gallons per year Cts/lb = cents per pound $/gal = dollars per gallon $/bu = dollar per bushel Acronyms v

7 I. EXECUTIVE SUMMARY Impact of the U.S. Biodiesel Industry on the U.S. Soybean Complex The objective of this project is to evaluate the broad impacts the biodiesel industry has had on the U.S. soybean complex and from the findings, determine if continued investment in the biodiesel industry is in the economic interest of soybean farmers and soybean industry stakeholders; the key takeaways of this study are summarized below. Soybean oil use for biodiesel positively shifted demand for vegetable oil in the U.S. allowing soybean oil to price at comparable or higher levels to soybean oil stocks than during the pre-biodiesel era. In fact, empirical evidence suggests that demand for soybean oil prior to biodiesel was supply driven with soybean oil stocks often viewed in the market as a drag. Post biodiesel, demand for soybean oil is more demand driven as very large supplies of soybean oil can be switched for use as energy products (i.e., diesel, heating oil) at a competitive price. The impacts of biodiesel throughout the soy complex are a consequence of increased demand of soybean oil and an increased correlation or link between the price of biodiesel feedstocks - including soybean oil - and the price of energy (e.g., diesel, heating oil). Since soybean use for biodiesel increased from 0.67 to 4.1 billion pounds for During the same period, U.S. soybean oil use for food applications declined 3.6 billion pounds, with most of this decline directly linked to increased use of other vegetable oils as a consequence of trans-fat 2 labeling and related government (federal and local) policies. Hence, biodiesel has offset the decline of soybean oil use for food. Energy markets now compete for vegetable oil in addition to food and other non-biodiesel uses. This shifted the demand for soybean oil in a significantly positive direction which effectively sets a floor price for soybean oil (and all biodiesel feedstocks) below which increasingly incremental demand for biodiesel would push soybean oil prices up to at least this floor price. Essentially, soybean prices and energy prices are now statistically linked and soybean oil, independent of the intended end use, can trade at its energy value to biodiesel is when the biodiesel production started to grow more significantly in response to Minnesota s biodiesel use legislation which was implemented in September of 2005 and the federal Renewable Fuels Standard (RFS1). 2 On July 11, 2003, the Food and Drug Administration (FDA) issued a regulation requiring manufacturers to list trans fat on the Nutrition Facts panel of foods and some dietary supplements. The new labeling rule became mandatory across the board on January 1, In 2005, Montgomery County, Maryland approved a ban on partially hydrogenated oils; New York City embarked on a similar campaign in 2005 to reduce consumption of trans fats 1

8 A fundamental support to the value of soybean oil in biodiesel is the Renewable Fuels Policy passed in 2007 (RFS2) requiring use of 1.0 billion gallons of biodiesel by State biodiesel use mandates and incentives are very significant and also serve as a hedge against a change in the RFS2. In 2012, state mandates and incentives alone support biodiesel use of 0.5 billion gallons; state programs could grow to one billion gallons by From late 2006/07 to 2011/12 3, the combined impact of biodiesel to the price of soybean oil (and the overall soy complex) has been on average, an increase of 12.9 cents per pound 4 ; this value translates into a cumulative increase of soybean oil revenues alone of $15 billion from 2006/07 to 2011/12. These 12.9 cents per pound have effectively increased the price of soybeans by $0.74 per bushel and decreased the price of soybean meal by $25 per ton. This contribution is at stake if (i) the biodiesel industry were to contract or collapse due to lack of policy support or economic viability; or (ii) if the use of soybean oil for biodiesel was restricted or excluded for sustainability issues in either RFS2 or state mandates such as in California. Soybean oil share as a biodiesel feedstock declined from 86% in 2005 to 54% in Informa found the share of soybean oil is not a factor in the co-movement of energy and soybean oil prices. Thus, the key takeaways are that: Soybean oil s market share as a feedstock for biodiesel is not as important as ensuring that the biodiesel market remains viable (e.g. profitable) and soybean oil is viewed as a viable feedstock, and soybean oil, through its statistical link to energy prices, effectively provides hedging value against energy inflation (i.e., diesel, fertilizers and chemicals) by ensuring that soybean oil prices (and corresponding commodities) trend with energy values, which impact many aspects of a producers input costs. While the RFS2 mandate supports use of 1.0 billion gallons, Informa understands that the Environmental Protection Agency (EPA) has already examined the potential to support an increase of the mandate under RFS to 1.82 billion gallons of biomass-based diesel by 2022; this volume would contribute towards the biomass-based diesel and the Undifferentiated Advanced Biofuel (UAB) requirements. The takeaway is that there is potential beyond the initial 1.0 billion gallon by 2012 mandate to increase the use of soybean oil and solidify the position of the biodiesel industry. In addition to the direct positive impacts to the soybean complex, the biodiesel industry has had positive effects on other sectors. Biodiesel provides a key market and supports the price for industrial (or distillers) corn oil (produced 3 For 2012, information through November 30, 2012 was used. 4 Contribution was highest in 2011 at 16.0 cents per pound in spite of soybean oil s lower market share of biodiesel feedstocks. 2

9 from DDGs), animal fats, and yellow grease (produced by the meat processing and rendering industry). In the past two years: Ethanol companies realized $0.03 to $0.04 of extra margins per ethanol gallon by extracting distillers corn oil from DDGS and marketing it separately, Rendering companies (including meat processing companies) got higher prices for tallow (+17 cts/lb), poultry fat (+15 cts/lb), choice white grease (+16 cts/lb), and yellow grease (+15 cts/lb), but the full impact on these feedstocks was felt only since Livestock producers paid $25 per ton less for soybean meal. In summary, a viable biodiesel industry and unrestricted use of soybean oil (i) help maintain a link between soybean oil and energy values, (ii) create a floor for commodity values, and (iii) serve as a hedge against energy inflation for producers. Although soybean oil s market share within the biodiesel industry does not have significant impact on these benefits, continued stakeholder support/investment in the biodiesel industry is needed to ensure biodiesel production remains active and viable and the use of soybean oil as major feedstock is not restricted or limited by federal or state policy. 3

10 II. INTRODUCTION The objective of this project is to evaluate the broad impacts the biodiesel industry has had on the U.S. soybean complex and from the findings determine if continued investment in the biodiesel industry is in the economic interest of soybean farmers and soybean industry stakeholders. A. Biodiesel Industry Background A key factor driving the demand for soybean oil and, by extension, for soybeans over the last decade has been the growth in the U.S. biodiesel industry. While federal incentives fostered the growth of U.S. biodiesel production during the early part of the last decade and the Energy Policy Act of 2005 established a Renewable Fuel Standard ( RFS ) toward which the usage of biodiesel counted, it was the Energy Independence and Security Act of 2007 that provided a solid foundation for future consumption by expanding the Renewable Fuel Standard (now referred to as RFS2 ) and carving out a requirement for biomass-based diesel usage within RFS2. The biomass-based diesel requirement started at 500 million gallons in 2009 (which was combined with a 650-million-gallon requirement in 2010) and is slated to be a minimum of one billion gallons annually starting in 2012, which the administrator of the Environmental Protection Agency has the authority to increase. Indeed, the volume requirement has increased to 1.28 billion gallons for 2013 and EPA requirement could increase to 1.82 billion gallons by 2022 if EPA continues to judge that there is suffiient feedstock and production capacity to increase production. Although the policy foundation for biodiesel has been accommodative over the last decade and has provided a volume floor via RFS2 in recent years, the trajectory of the biodiesel industry has not been smoothly upward. U.S. biodiesel production steadily increased from 2005 to A significant portion of production was exported to the EU during this time. U.S. biodiesel production fell from 678 million gallons in 2008 to only 516 million gallons in 2009 as a result of the combination of the 2009 and 2010 RFS2 requirements and the imposition of anti-dumping and countervailing duty investigations on U.S. biodiesel by the European Union (formerly a large-scale importer). Production fell further to 343 million gallons in 2010 due to a lapse in the federal tax credit for biodiesel blending. Then, with the restoration of the blender s tax credit in 2011 and an increase in the RFS2 biomass-based diesel mandate to 800 million gallons, production rebounded to 967 million gallons. With the increase in the mandate to 1 billion gallons in 2012, production appears to have continued apace. 4

11 Exhibit 1: U.S. Biodiesel Monthly Production History Source: USDA, EIA, Informa Economics U.S. biodiesel production capacity increased substantially during 2007 and 2008 due to favorable biodiesel production margins benefiting from a biodiesel blender tax credit of $1.00 per gallon. Current production capacity is estimated at just below 3 billion gallons; however effective capacity is much lower in the order of billion gallons as many plants have ceased operations permanently. Biodiesel production capacity is above the mandated usage level that increases to 1.28 million gallons in

12 Exhibit 2: U.S. Biodiesel Existing Capacity (Active and Idled) Source: EIA, NBB, Informa Economics Increased soybean oil usage in biodiesel production initially offset the ongoing decline in non-biodiesel (mainly food) domestic usage of soybean oil. More recently, the large biodiesel usage has limited the amount of soybean oil available to export. 6

13 Exhibit 3: U.S. Soybean Oil Use by Major Use Category Source: USDA, EIA, Informa Economics 7

14 Exhibit 4: U.S. Biodiesel Production by Feedstock Used Source: U.S. Census, EAI, Informa Economics 8

15 III. THE SOYBEAN COMPLEX PRIOR TO THE EMERGENCE OF THE U.S. BIODIESEL INDUSTRY In this section, the question of how the advent of the biodiesel industry has impacted the soybean complex (soybean crop farming, soybean meal, and soybean oil) is analyzed by reviewing the soybean complex before and after biodiesel became a user of significant quantities of soybean oil as well as other feedstocks. The several specific analyses are presented below. A. Impact of Large Soybean Oil Inventories on the U.S. Soybean Complex In the early 2000 s, soybean oil was viewed as a drag to the soybean complex. In the U.S.market, supply chased demand and in fact, soybean crushers and soybean oil distributors stored soybean oil for longer periods until there was sufficient export demand to market soybean oil. While there is no adequate data series to show the relative longer inventory turnover rates prior to the emergence of biodiesel, conversations with industry members provide ample examples or anecdotal information to support this point. The so called drag was significantly reduced by the emergence of biodiesel, particularly after 2006, when soybean oil use for fuel increased to meaningful volumes 5. A few critical factors were noted: a. Increased demand for soybean oil and the potential to increase this biodiesel demand significantly if soybean oil prices were lower. For example, in 2007 soybean oil use for biodiesel could have been 2 to 3 times higher if soybean oil prices were low enough to bring the already existing biodiesel capacity to full production. b. A shift in the pricing structure of all vegetable oils nor just soybean oil - to reflect a higher value to energy (or energy value ) uses. That is, a shift to reflect the value of vegetable oil for biodiesel as opposed to its value for a lower cost energy product such as heating oil. In other words, the price floor for vegetable oil as an energy source increased, and increased to a level higher than its food value was prior to biodiesel. Both of these factors are discussed in more detail layer in this report; however, the results are observed in two indicators. 5 Soybean oil use for biodiesel increased from 675 thousand tons in 2005 to 1.8 and 2.9 billion pounds in 2006 and 2007 respectively. 9

16 The soybean oil share of product value (i.e., the value of soybeans expressed by its content and value of oil and meal) has increased. The existence of the biodiesel industry has been supportive to soybean oil prices. The soybean oil share (soybean oil s share of the combined value of meal and oil per bushel of soybeans) has averaged 41.0% during the past five years (the 2007/08 marketing year through 2011/12). This compares with averages of 37.7% from 1992/93 to 1996/97, 36.8% from 1997/98 to 2001/02, and 39.1% from 2002/03 to 2006/07. Exhibit 5: Soybean Oil Share of Soybean Product (meal and oil) Value Source: The spread between the price of soybean oil in Illinois and the Gulf has expanded. Exhibit 6 shows the average spread prior to 2007 was 0.70 cts/lb and after 2007 was 2.67 cts/lb. This indicates the margin for soybean oil exporters improved (this behavior was corroborated by anecdotal information) or that soybean oil exports were discounted (thus a drag to the soybean complex) as they sometimes were in the past. For example, the negative spread shown in Exhibit 6 indicates that prices at the Gulf (export prices) did not cover freight cost from an Illinois 10

17 processor to the Gulf. Note that increased freight rates also contributed to the higher price spread, but freight costs are not the main factor. Exhibit 6: Price Spread between Soybean Oil Illinois (Processor Price) and Gulf (Export Price) Source: Trade News Services, Informa 11

18 B. Biodiesel Shifted the Structure of Soybean Oil Demand and Prices In commodity markets, the market price for a given commodity such as soybeans, or soybean meal or soybean oil, is related to demand for those commodities (i.e., intensity of bidding) and available supply relative to the consumption of the commodity. Generally, a market is expected to rationalize, through negotiated trading, the costs of production and the benefits of use through a market clearing price. This dynamic usually manifests itself as an identifiable relationship between the production of a given commodity and consumer preferences to buy that commodity instead of others. Soybean oil, a principal feedstock for U.S. domestic biodiesel production, has a somewhat more complex supplydemand relationship because it is produced as a co-product of crushing soybean meal, which traditionally has accounted for the larger share of volume and revenue of soybean crushing. Soybean meal prices are driven by changes in demand from the global livestock/meat industry for high-protein feed ingredients, which in turn influences soybean prices. However, soybean oil prices were historically driven by changes in supply, not demand, because soybean supply changes with respect to soybean meal production, regardless of the demand for soybean oil as a vegetable oil. Before the advent of the biodiesel industry, there was a strong, observable relationship between the stocks of soybean oil relative to consumption and its price. However, this relationship has changed. Exhibit 7 shows the relationship between carry-in stocks of SBO and SBO prices as well as soybean prices. Even in just the past couple of years there were large inventories of soybean oil without a return to the lower prices of the pre-biodiesel era. Stocks and prices should be opposite, all else equal, because if inventories are high, prices must go lower to clear the market. This is all the more so for soybean oil which has limited storage ability; and this was the case before 2004, for the most part. However, as Exhibit 7 shows, starting in 2005, rather than stocks and price moving opposite each other, prices and stocks for soybean oil begin to move in tandem, at least when compiled at an annual level. This means the traditional relationship between production costs for soybean oil (mainly soybeans) and uses of such oil changed; that is, the price pattern of the soybean oil effectively changed (i.e., a shift of the demand curve) to reflect higher prices at similar, and even higher levels, of relative scarcity or stocks. 12

19 Exhibit 7: Carry-in Stocks and Soybean Oil Prices, 1999/ /11 C. Soybean Oil Use for Biodiesel Helped Offset the Impact of Trans-Fat Labeling to the Consumption of Soybean Oil In July, 2003, the U.S. Food and Drug Administration (FDA) started to regulate the labeling of trans-fats for foods sold in the U.S. In January of 2008, such labeling became mandatory for all vegetable oil sold at retail outlets. While food service institutions are not required to label trans-fats, many high-profile food service chains such as McDonalds started to shift away from trans-fats as consumers learned about the health risks associated with the consumption of trans-fats oils. 13

20 The result was a very rapid transition away from trans-fats vegetable oils (mainly hydrogenated soybean oil 6 in North America) and towards more stable (i.e., stable for frying purposes) oils such as palm and towards vegetable oils perceived as healthier than trans-fat such as rapeseed/canola oil or sunflower oil. These oils have a lower polyunsaturated fatty acid profile than soybean oil and, as a result, are more stable for frying applications. Exhibit 8 shows the rapid decline of soybean oil share for non-biodiesel (or food market), particularly after 2005, at the expense of palm and canola oil. Soybean oil is still the primary oil used in the U.S. for all non-biodiesel uses accounting for 61% in 2011/12 which is down from 74% in 2004/2005. For perspective, U.S. soybean oil consumption for non-biodiesel uses started to decline after 2005 and since then domestic use for non-biodiesel has declined 3.6 billion pounds from 2004/2005 to 2011/2012 (Exhibit 9). The decline is a consequence of the substitution of soybean oil for other oils (mainly canola and palm) and an overall decline in the overall consumption of vegetable oil in the order of 0.9 billion pounds during the same period. Exhibit 10 shows the use of soybean oil for biodiesel has offset the losses soybean oil sustained due to the trans-fat issue and the overall decline in vegetable oil use in the U.S. domestic food and non-biodiesel industrial market. That is, absent a biodiesel market, soybean oil processors/traders would have had to find alternative export markets and incur additional marketing and logistics costs. 6 Note that the trans-fat content of soybean oil is a consequence of the hydrogenation process which was widely used to increase the stability and shelf life of soybean oil. 14

21 Exhibit 8: Market Share of U.S. Vegetable Oil Use for Food Uses Source: USDA, Informa 15

22 Exhibit 9: U.S. Vegetable Oil Use for Non-Biodiesel Changed from 2004/05 to 2011/12 Source: USDA, Informa 16

23 Exhibit 10: U.S. Soybean Oil Consumption LOST to other Oils vs. Soybean Oil Consumption GAINED by Biodiesel Relative to 2004/05 Source: USDA, Informa Economics 17

24 D. Key Takeaways Soybean oil use for biodiesel positively shifted demand for vegetable oil in the U.S. allowing soybean oil to price at comparable or higher levels to soybean oil stocks than during the pre-biodiesel era. In fact, empirical evidence suggests that demand for soybean oil prior to biodiesel was supply driven with soybean oil stocks often viewed in the market as a drag. Post biodiesel, demand for soybean oil is more demand driven as very large supplies of soybean oil can be switched for use as energy products (i.e., diesel, heating oil) at a competitive price. The impacts of biodiesel throughout the soy complex are a consequence of increased demand of soybean oil and an increased correlation or link between the price of biodiesel feedstocks - including soybean oil - and the price of energy (e.g., diesel, heating oil). Since 2005 soybean use for biodiesel increased from 0.67 to 4.1 billion pounds for During the same period, U.S. soybean oil use for food applications declined 3.6 billion pounds, with most of this decline directly linked to increased use of other vegetable oils as a consequence of trans-fat labeling and related government (federal and local) policies. Hence, biodiesel has offset the decline of soybean oil use for food. Energy markets now compete for vegetable oil in addition to food and other non-biodiesel uses. This shifted the demand for soybean oil in a significantly positive direction which effectively sets a floor price for soybean oil (and all biodiesel feedstocks) below which increasingly incremental demand for biodiesel would push soybean oil prices up to at least this floor price. Essentially, soybean prices and energy prices are now statistically linked and soybean oil, independent of the intended end use, can trade at its energy value to biodiesel. 18

25 IV. BROAD IMPACTS OF THE U.S. BIODIESEL INDUSTRY ON THE U.S. SOYBEAN COMPLEX A. Biodiesel Resulted in Increased Demand for Soybean Oil in the U.S. Exhibit 11 shows how biodiesel has, overtime, become a major market for soybean, accounting for 25% of SBO production and 27% of domestic use for the marketing year end in September of Although small in total magnitude in 2004, the use of soybean oil in biodiesel production increases rapidly since 2004 at the same time as non-biodiesel use of soybean oil also begins to decline. Exhibit 11: U.S. Domestic Soybean Oil and Biodiesel Share of Usage and Production Source: Informa Economics, USDA, EIA 19

26 B. The Price of Soybean Oil Became Closely Linked to the Price of Diesel A key impact throughout the soy complex is the increased correlation or link between the price of biodiesel feedstocks - including soybean oil - and the price of diesel and heating oil (i.e., referred to as energy prices) which are substitute products for biodiesel and bioheat respectively. The biodiesel market (i.e., a fuel/energy market) now competes for vegetable oil (and other feedstocks) in addition to food and other non-biodiesel uses. This shifted the demand for soybean oil in a significantly positive direction which effectively sets a higher floor price for soybean oil (and all biodiesel feedstocks) below which increasingly incremental demand for biodiesel would push soybean oil prices up to at least this floor price. Before biodiesel - a floor price for soybean oil was its energy value as compared, in Btu 7 basis, to heating oil (i.e., burn value). That is, if soybean oil prices declined below their Btu equivalent to heating oil, consumers could use soybean oil instead of heating oil, as the former becomes an economical substitute. Historically, there has been no correlation between the two prices, and only in a few instances was soybean oil actually less costly than heating oil. However, anecdotal information suggests that in these few instances soybean oil was used for energy purposes. After biodiesel - a floor price for soybean oil became equivalent to its value to the biodiesel industry, which on-average, has been roughly equivalent to the break-even value of biodiesel which would be the price of biodiesel minus the cost to process soybean oil into biodiesel. So, the first impact is an increase in the value/price of soybean oil relative to the era prior to biodiesel. Furthermore, the correlation between soybean (and similar feedstocks) became much tighter to the price of biodiesel/diesel/heating oil because the biodiesel industry has the capacity to use a substantial share of soybean oil and thus other users (mostly food manufactures/retails) of soybean oil need to bid up the price of soybean oil high enough to limit the use of soybean oil into biodiesel. For perspective, if one assumes active biodiesel capacity of 2.1 to 2.3 billion gallon per year, if used at 100%, this capacity is equivalent to over 80% of the total U.S. production of soybean oil. Note that if biodiesel production capacity did not exist in such excess, the soybean oil price would still remain high to keep the biodiesel industry from building more capacity. 7 BTU: British thermal unit is a traditional unit of energy equal to about 1055 joules. It is approximately the amount of energy needed to heat one pound of water by one degree Fahrenheit. 20

27 Essentially, soybean oil prices and energy prices are now statistically linked and soybean oil, independent of the intended end use, will trade at its energy value to biodiesel. Exhibit 12 provides a visual representation of the linkage between soybean oil and energy prices after the periods indicated. The two year rolling correlation between diesel spot prices and soybean oil was very inconsistent prior to Since it is a two year correlation, during the two years ending in 2007 through to today, soybean oil and diesel were highly correlated despite significant price swings in the market. The correlation coefficient on the left vertical axis is the indicator of the common relationship shared by soybean oil and diesel. The closer the correlation is to 1.0, the closer the relationship is between soybean oil and diesel. The chart suggests that since 2007, soybean oil prices have been closely linked. Note that the passage of the Energy Independence and Security Act of June of 2007 provided a solid foundation for future consumption by expanding the Renewable Fuel Standard (now referred to as RFS2 ) and carving out a requirement for biomass-based diesel usage within RFS2 of at least 1.0 billion gallons by The relationship between soybean oil and energy prices using average diesel spot prices as a proxy, is limited prior to 2007, but increased thereafter. Exhibit 13 and Exhibit 14 also present similar conclusions; scatter plots graphically illustrate the lack of correlation prior and after

28 Exhibit 12: Correlation between Soybean Oil and Diesel Prices Source: EIA, USDA, & Informa 22

29 Exhibit 13: Monthly Correlation of Diesel and Soybean oil Prices Exhibit 14: 2007 to 2012 Monthly Correlation of Diesel and Soybean oil Prices Source: CBOT, EIA, Informa. Source: CBOT, EIA, Informa. C. Biodiesel Resulted in Higher Soybean Oil Prices and a Positive to the Soybean Complex As indicated earlier, an effective floor price for soybean oil was its energy value as compared, in Btu basis, to heating oil (i.e., burn value). If soybean oil prices become low enough relative to the price of heating oil, soybean oil becomes an economical substitute for one or more marketable uses of heating oil. This burn value floor price for soybean oil was reached recently in the fall of 2008 and during parts of 2005 and 2006 when energy prices were increasing rapidly but a close link to soybean oil had not been established (Exhibit 15). In the period in particular, soybean oil was indeed used as heating oil substitute in small quantities - thus providing an observable floor for soybean oil prices. 23

30 Exhibit 15: Prices of Soybean Oil in Btu Equivalent 24 Source: With the development of biodiesel, the floor price for soybean oil became equivalent to its value to the biodiesel industry which on-average has been roughly equivalent to the break-even value of biodiesel (i.e., the price of biodiesel minus the cost to process soybean oil into biodiesel). So, as illustrated in Exhibit 15, the value of soybean oil increased relative to the era prior to biodiesel increased; however, not all the soybean oil price increase from the low 20 cts/lb to around 50 cts/lb can be attributed to biodiesel. That is, soybean oil prices would have increased during the high energy price environment of the late 2000s independent of the existence of the biodiesel industry. Why? To keep soybean oil competitive with heating oil and to keep soybeans and soybean meal competitive with other crops such as corn. The question and key economic impact is what portion of the soybean oil price increase is attributed to biodiesel only; Exhibit

31 16 shows the results of the Informa estimated impact attributed to biodiesel only. Exhibit 16 illustrates that the biodiesel support to soybean oil price is not a constant. In fact, it is a function of the prices of diesel, biodiesel, heating oil and soybean oil. Findings from the analysis suggest the following: From October 2006 to , the combined impact of biodiesel to the price of soybean oil (and the overall soy complex) has been on average cents per pound. The cumulative impact of increased soybean oil prices from October 2006 to November 2012 is equal to an increase of soybean oil revenues alone of over $15 billion during this period. These 12.9 cents per pound of soybean oil is reflected in the soybean complex via a combination of a price increase of soybeans and/or a decrease in the price of soybean meal. An average estimate is that soybeans increased by $0.73 per bushel and price of soybean meal declined by $25 per ton. The results can also be interpreted as an increase of up to $1.48 per bushel for soybeans or a decrease of up to $50 per ton of soybean meal. This contribution is at stake if (i) the biodiesel industry contracted or collapsed due to the lack of policy support or economic viability; or (ii) if the use of soybean oil for biodiesel production was restricted or excluded for sustainability issues in either RFS2 or state mandates such as in California. 8 For 2012, information through November 30, 2012 was used. 25

32 Exhibit 16: Impact of Biodiesel on the Price of Soybean Oil Source: Informa Economics 26

33 D. The Share of Soybean Oil as Biodiesel Feedstock is Not a Factor in the Co-Movement of Energy and Soybean Oil Prices The soybean oil share as a biodiesel feedstock declined from 86% in 2005 to 54% in 2012, this change questions whether the value/contribution of biodiesel to the soybean complex is declining or changing significantly. The results from the analysis suggest the following. Informa found that the share of soybean oil is not a factor in the co-movement of energy and soybean oil prices. Soybean oil s market share as a feedstock for biodiesel is not as important as ensuring the biodiesel market remains viable (e.g. profitable) and soybean oil is viewed as a viable feedstock, and soybean oil, through its statistical link to energy prices, effectively provides hedging value against energy inflation (i.e., diesel, fertilizers and chemicals) by ensuring that soybean oil prices (and corresponding commodities) trend with energy values, which impact many aspects of a producers input costs. Exhibit 17 shows a comparison of the difference in the monthly percent changes of heating oil and soybean oil prices (i.e., the relative co-movement) is graphed on the market share of soybean oil since late For example, if the prices of soybean oil and heating oil move perfectly together, the difference would be zero ( 0 ). As the difference moves farther from zero (either greater or less), the prices are moving more independently. As the black line in Exhibit 17 shows, the average of these differences is very close to zero for every market share value and movements outside above and below zero are random. In other words, it is not really the actual amount of soybean oil used in biodiesel that links the prices; it s the fact that soybean oil can be used in biodiesel production. Another approach to show the influence of the share of soybean oil as a feedstock of biodiesel is to examine how the correlation between soybean oil price and heating oil has changed in a meaningful way. Exhibit 18 shows the correlation between nearby heating oil futures and soybean oil prices divided into 10 month periods; the correlation does not change much from period to period after 2006 even though the share of soybean has generally declined. 27

34 Exhibit 17: Co-Movement of Heating Oil-Soybean Oil vs. Soybean Oil Share of Biodiesel ( ) 28

35 Exhibit 18: Heating Oil-Soybean Oil Correlation by 10 Month Periods, E. Increased Soybean Oil Prices and the Corresponding Effect on Soybean and Soybean Meal Prices As noted in previous sections, the emergence of the biodiesel industry resulted in an increase on average soybean oil by 12.9 cts/lb from 2006/2007 to 2011/2012. If soybean oil prices had not increased from pre-biodiesel levels, (i) soybean meal prices would have to be higher to maintain a soybean price to effectively compete for corn acreage and/or soybean prices would have to be lower to reflect the lower value of the oil in the overall crush value. Exhibit 19 shows for each year the maximum impact that the soybean oil price increase (e.g., 13.3 cts/lb in 2011/2012) could have on soybean meal (e.g., a decline of $51/ton) or soybean (e.g., increase of $1.52/bu). The maximum impact means that the change in soybean oil is reflected exclusively on meal or beans, not both. 29

36 In reality, the impact of higher soybean oil prices has resulted in a combination of both higher soybean and lower soybean meal prices. While one would expect the impact to be reflected more in a decline of meal prices that in an increase of soybean prices, there is no good method to calculate the difference. The overall results can be interpreted as follows: The biodiesel industry through its effect on soybean oil prices resulted in an increase of up to $1.48 per bushel for soybeans or a decrease of up to $50 per ton of soybean meal. An average estimate would be that soybeans increase by $0.74 per bushel and the price of soybean meal decline by $25 per ton. This contribution is what is at stake if (i) the biodiesel industry contracted or collapsed due to the lack of policy support or economic viability; or (ii) if the use of soybean oil in biodiesel was restricted or excluded for sustainability issues in either RFS2 or state mandates such as in California. Exhibit 19: The Effect of Soybean Oil Prices on Soybean Meal and Soybean Prices CBOT Oil (cts/lb) CBOT Soybeans ($/bu) CBOT Soybean Meal ($/Ton) Share of Estimated w/o MAX Impact of Share of MAX Impact of Actual Actual Actual Period Value Biodiesel Biodiesel Value Biodiesel 2005/ % % 2006/ % % / % % / % % / % % / % % / % % / % % - 50 Source: Informa 30

37 F. Key Takeaways Biodiesel created a floor price for soybean oil based on its value to biodiesel by creating a link between the price of soybean oil to the prices of diesel and heating oil. Effectively, the shift in demand and the change in the pricing relationship between the supply and demand for soybean complex commodities is due to the establishment of a price floor for soybean oil, and thus other vegetable oils. From late 2006/2007 to 2011/2012 9, the combined impact of biodiesel to the price of soybean oil (and the overall soy complex) has been on average, an increase of 12.9 cents per pound 10 ; this value translates into a cumulative increase of soybean oil revenues alone of $15 billion from 2006/2007 to 2011/2012. These 12.9 cents per pound have effectively increased the price of soybeans by $0.74 per bushel and decreased the price of soybean meal by $25 per ton. This contribution is at stake if (i) the biodiesel industry were to contract or collapse due to lack of policy support or economic viability; or (ii) if the use of soybean oil in biodiesel were restricted or excluded for sustainability issues in either RFS2 or state mandates such as in California. Soybean oil share as a biodiesel feedstock declined from 86% in 2005 to 54% in Informa found that the share of soybean oil is not a factor in the co-movement of energy and soybean oil prices. Thus, the key takeaways are that: Soybean oil s market share as a feedstock for biodiesel is not as important as ensuring that the biodiesel market remains viable (e.g. profitable) and soybean oil is viewed as a viable feedstock, and soybean oil, through its statistical link to energy prices, effectively provides hedging value against energy inflation (i.e., diesel, fertilizers and chemicals) by ensuring that soybean oil prices (and corresponding commodities) trend with energy values, which impact many aspects of a producers input costs. While the RFS2 mandate supports use of 1.0 billion gallons, Informa understands that the Environmental Protection Agency (EPA) has already examined the potential to support an increase of the mandate under RFS to 1.82 billion gallons of biomass-based diesel by 2022; this volume would contribute towards the biomass-based diesel and the Undifferentiated Advanced Biofuel (UAB) requirements. The takeaway is that there is potential beyond the initial 1. 9 For 2012, information through November 30, 2012 was used. 10 Contribution was highest in 2011 at 16.0 cents per pound in spite of soybean oil s lower market share of biodiesel feedstocks. 31

38 V. THE BIODIESEL INDUSTRY ALSO INFLUENCED SECTORS OUTSIDE OF THE SOYBEAN COMPLEX The impacts of the biodiesel industry are not isolated to the soybean complex; in fact, the overall oilseed and vegetable oil, corn-based ethanol, and livestock/meat rendering sectors also directly benefited from the development of the biodiesel industry and via an increase in the prices of vegetable oils and rendering products. A. Biodiesel Resulted in Increased Prices for Other Vegetable Oils The vegetable oil market in the U.S., and the world, is driven by soybean oil; thus, the prices of all major vegetable oils, including palm oil, are a function of soybean oil and typically trade at a premium/discount to soybean oil. Exhibit 20 shows the co-movement among prices for the major vegetable oils. The disconnects observed from 2005 to 2007 were a consequence of trans-fat labeling which rapidly increased the demand for canola, sunflower and other oils and resulted in an increased premium price over soybean oil for these oils. Given the price relationship among vegetable oil mentioned, the 12.9 cts/lb calculated can be applied to the price of all other vegetable oils, even if some of these (e.g., sunflower) are not used for biodiesel. 32

39 Exhibit 20: Co-Movement of Vegetable Oil Prices: Source: Trade News Services, Informa B. Biodiesel Resulted in Increased Prices for Animal Fats and Greases Historically animal fats and yellow grease prices (i.e., recycle cooling oil and other greases) traded at a discount to soybean oil. These commodities were used as feed ingredients and in a multitude of industrial uses. Also a large portion of U.S. production was exported. As these feedstocks started to be used as a lower priced feedstock alternative to 33

40 soybean oil in the production of biodiesel, their prices started to reflect their value as fuel for biodiesel more and more. Consequently, the prices of animal fats and yellow grease started to increase relative to soybean oil. Thus, value provided by the biodiesel industry is derived from two sources: The increase of soybean oil prices attributed to biodiesel (i.e., 12.9 cts/lb), but adjusted to reflect the price relation (discount) that exists between soybean oil and animal fats and grease. The correction coefficient between the prices of soybean oil and various animal fats and greases exceeds The reduction of the price discount that animal fats and grease have relative to soybean oil prices as illustrated in Exhibit 21. Exhibit 21 shows how the soybean oil premium relative to animal fats and yellow grease have declined practically starting in 2009 when the amount of animal fats and yellow grease used for biodiesel started to increase substantially. The price increase attributed to the development of biodiesel and that benefited rendering companies (i.e., meat processors such as Tyson and independent rendering companies such as Darling) as shown below in Exhibit

41 Exhibit 21: Animal Fats and Yellow Grease Prices Discount Relative to Soybean Oil Prices ( ) Source: Informa Economics 35

42 Exhibit 22: Impact of Biodiesel on the Price of Animal Fats and Yellow Grease Impact Due to SBO Price Increase Impact Due to Lower Discount to SBO Combined Impact Average Impact * Average Impact * Average Impact Average Impact Cts per Lb Renderer Tallow, Chicago Choice White Grease, Chicago Poultry Fat, Southeast Points Yellow Grease, Chicago * Adjusted for the relation between SBO and each animal fat and yellow grease. Source: Informa Economics C. Biodiesel Created a Profitable Market for Industrial Grade Corn Oil Extracted from DDGS Edible corn oil extracted from corn wet milling facilities and ethanol plants with front-end fractionation technology produced edible corn oil. An alternative and less capital-intensive technology to extract corn oil from ethanol facilities is a method generally called corn oil extraction 11 or spin corn oil which produces industrial corn oil for use in biodiesel and other non-food uses. Information developed from interviews with industry players suggest that production in 2012 will reach ~1 billion pounds. Going forward, production of 2.2 billion lbs. could be reached before Total maximum capacity to produce industrial corn oil is between 2.5 and 4.2 billion lbs. (the range is a function of technology, oil yields, and technology adoption.) Biodiesel represents 50-60% of the market for industrial corn oil in 2012 Informa estimates that 543 million pounds of industrial corn oil will be used in the production of biodiesel (i.e., 7% of all feedstocks). 11 Corn oil extraction is a method of mechanical separation, often by centrifuge, used to extract the crude corn oil from the thin stillage (the nonethanol liquid left after fermentation) and the DDGS before drying, or a combination of both. 36

43 Investment in the corn oil industry is driven by: Biodiesel provides an ample market for industrial corn oil. The price of industrial corn oil is driven by its value in biodiesel. Thus as production of industrial corn oil increases, prices will not be significantly impacted. Industrial corn oil economics are very attractive due to the relative high price of the oil that is in part supported by the biodiesel market. Exhibit 23 shows how the production of industrial corn oil by ethanol producers is quite profitable. EBITDA (earnings before interest, depreciation, taxes and amortization) of $3.8 million for ethanol producers in 2011 compared to a capital investment of $4-5 million. In 2011, corn oil extraction in the sample facility would have contributed 9% to an ethanol s company EBITDA or $3.8 cents per gallon. The analysis suggests that a viable biodiesel industry provides meaningful support to ethanol producers and consequently corn farmers. 37

44 Exhibit 23: Economics on Industrial Corn Oil and Its impact on Ethanol Margins Economics of Industrial Corn Oil from DDGS * Price Price $ 000 Inputs $/ton $/ton $ 000 Conventional DDGS , ,579 Operating Costs Output Low Fat DDGS , ,013 Industrial Corn Oil 810 8, ,459 EBITDA 3,813 2,293 Deprecation Interest Expenses Net Income Before Taxes 2,925 1,405 Impact on Average 100 Mil Gal Minnesota Ethanol Plan D. Key Takeaways * Ethanol EBITDA w/o Corn Oil 41,468 17,134 Ethanol EBITDA with Corn Oil 45,281 20,946 % Change in Profit 9% 22% Change on EBIDTA Margin per Gallon * Jan-Nov 2012 EBITDA: earnings before interest, taxes, depreciation and amortization. Source: Informa Economics In addition to the direct positive impacts to the soybean complex, the biodiesel industry has had positive effects on other sectors. Biodiesel provides a key market and supports the price for industrial (or distillers) corn oil (produced from DDGs), animal fats, and yellow grease (produced by the meat processing and rendering industry). In the past two years: Ethanol companies realized $0.03 to $0.04 of extra margins per ethanol gallon by extracting distillers corn oil from DDGS and marketing it separately, Rendering companies (including meat processing companies) got higher prices for tallow (+17 cts/lb), poultry fat (+15 cts/lb), choice white grease (+16 cts/lb), and yellow grease (+15 cts/lb), but the full impact on these feedstocks was felt only since

45 VI. FRAGILITY OF CURRENT BIODIESEL MARKET DRIVERS The impacts/benefits derived from a growing biodiesel industry are directly linked to federal and, in some cases, state renewable fuel policies. This chapter examines current biodiesel market drivers and identifies major threats to the market and their potential implications for the soybean complex. A. Current Renewable Fuels Standard & Implications of Potential Annual Adjustments The Energy Independence and Security Act of 2007 (EISA) revised the original Renewable Fuels Standard (RFS) due to continued support by both government parties and increases in energy prices. The revised mandate is herein referred to as RFS2. Under the RFS2, the total overall renewable fuels mandate increases from 7.5 billion gallons for any renewable to 36 billion gallons, made up of several categories, by (For a more detailed description of the RFS2, please refer to Appendix section of this report. The most critical provisions for biodiesel of RFS2 include: RFS2 created separate nested categories as opposed to a generic renewable fuels mandate The Biomass Based Diesel fuel category was created to provide conventional biodiesel produced from multiple biomass feedstocks a minimum market of 1.0 bgy by Biodiesel can qualify as Undifferentiated Advanced Biofuels (UAB) and thus compete in this fuel category of 4.0 billion gallons to 2022 with others biofuels that meet the 50% lifecycle GHG threshold requirement (i.e., cellulosic biofuels, biomass-based diesel, sugarcane-based ethanol; co-processed biomass with a petroleum feedstock (i.e., renewable diesel). This has proven to be a critical point as the biodiesel use mandate already increased beyond the 1.0 billion to 1.28 bgy for 2013 and can continue to increase. While the RFS2 provides a framework to view potential biofuel consumption over the next decade, there is a notable amount of flexibility provided to the EPA, which could have a significant impact on how biofuel demand actually unfolds. The EPA has the authority to make annual adjustments to RFS2 requirements based on biofuel supply, demand, infrastructure and other issues. These adjustments have important implications for biomass-based diesel and UAB demand. 39

46 There are also state waiver provisions which allow states to request a waiver from the EPA. The requirements of the waiver include a demonstration that implementation of the renewable fuels requirements would severely harm the economy or environment of a state, a region, or the United States or that there is an inadequate domestic supply of renewable fuel. To date, all state waiver requests were denied by the EPA. There was one waiver request by Texas in 2008 and at least 6 states filed requests in August of (a) Adjustment to the RFS2 There are several ways in which annual adjustments to the RFS2 could impact biodiesel demand. Insufficient supply exists to meet category requirements for example, if the EPA determines there is insufficient cellulosic ethanol available to meet the cellulosic requirement in the upcoming year, they can reduce the cellulosic requirement and take any of the following actions. a. Lower the total advanced biofuel requirement by an equal amount and keep the total biofuel requirement in tact essentially raising the conventional biofuels requirement and keeping the requirements for other advanced biofuels at levels established by the RFS2, b. Lower both the total advanced biofuel requirement and the total biofuel requirement by an amount equal to the reduced cellulosic requirement thus keeping the requirements for all other categories constant and only impacting the cellulosic requirement. c. Not make any changes to the advanced biofuel or the total biofuel requirements thus increasing the UAB requirement. Recall that excess biomass-based diesel (above that needed for the biomass-based diesel requirement) can be used to help meet the UAB. According the RFS2, Congress gave EPA the flexibility to lower the required total and advanced volumes, but Congress also wanted to encourage the development of advanced renewable fuels as well and allow in appropriate circumstances for the use of those fuels in the event they can meet that year s required volumes that would have been met by the cellulosic mandate. Thus, as long as there is available advanced biofuel supply, this would be the option likely preferred. d. Any of the above, but by amounts less than the change in the cellulosic biofuel requirement thus leading to a combination of effects. For example if under option a, the total advanced biofuel requirement was reduced by an amount less than the reduction in the cellulosic biofuel requirement, there would be an increase in both the conventional biofuel and the UAB requirement. 40

47 On an annual basis, the EPA can increase the biomass-based diesel requirement above the minimum 1.0 bgy established by the RFS2. In December 2011, the EPA established the 2012 final volume requirements for the RFS2, setting the cellulosic biofuel requirement at 8.65 mgy, the biomass-based diesel requirement at 1.0 bgy, the total advanced requirement at 2.0 bgy and the total biofuel requirement at 15.2 bgy. In September 2012, EPA set the final 2013 volume requirements for biomass-based diesel at 1.28 bgy. It is projected there will be a premium for advanced biofuels in the future, relative to corn-based ethanol. The amount of this premium will depend, in large part, on the annual adjustments made (or not made) by the EPA, the relative supply of advanced biofuels, and world sugar (i.e., for ethanol production that qualifies as UAB) market dynamics and the competing demand for sugarcane for sugar use. However, as this premium increases, biomass-based diesel becomes relatively more competitive and the odds of continuing (as is the case for 2013) to increase the biomass-based diesel requirement. Going forward, one likely scenario, particularly over the next few years, is that the EPA will have to reduce the cellulosic biofuel requirement. Whether they choose to reduce the advanced biofuel and/or the total biofuel requirements by an equal amount is unknown at this time. However, it is likely that if increased volumes of biomass-based diesel are available and the EPA increases the biomass-based diesel requirement this could help ease the additional burden that might otherwise have been placed on UAB (primarily sugarcane-based ethanol imports). This is particularly relevant given the recovering sugarcane sector in Brazil and the resulting impact on world sugar prices. Over the past several years, there has been a decline in Brazil s sugarcane production (major world sugar producer) due to a confluence of adverse weather conditions and a lack of investment in replanting sugarcane fields, and it may take 2-3 years to regain acres and fully productive yields. To provide further context to the above scenario, Exhibit 24 illustrates the cellulosic biofuel requirement established by the RFS2 against EIA s projections for cellulosic ethanol consumption. As depicted in this exhibit, the projected cellulosic ethanol production falls 15.4 bgy short of the 2022 mandate. If the EPA reduced the cellulosic mandate by this amount without changing the advanced biofuel requirement, 19.4 bgy of UAB would be required (assuming a minimum of 1.0 bgy of biomass based diesel). While it is acknowledged that this volume requirement would be unlikely, as the EPA would likely have to reduce the total advanced requirement at this point due to unavailable supplies and severe economic harm, this scenario illustrates the point that there could be a notable increase in biomass-based diesel demand above the minimum 1.0 bgy. Even though a large portion of the UAB requirement will be met by sugarcane-based ethanol, there are constraints on the sugarcane-based ethanol supply, as it competes for sugar for sugar use and there are rebuilding 41

48 and infrastructure challenges to expanding Brazil s sugarcane production while meeting its own growing domestic demand and world sugar demands. Thus, under this scenario, there is notable potential, if economically competitive, for biomassbased diesel to play a significant role in contributing toward the increased UAB requirement. Exhibit 24: Cellulosic Biofuel RFS2 Mandate vs. EIA Projections 42 *EIA consumption volumes are given in quadrillion BTUs. A conversion factor of 1 quadrillion BTUs per 12 billion gallons of ethanol (or 83,333 BTU / gallon) is utilized to calculate the consumption values in this chart. Sources: 2012 EIA Annual Energy Outlook; EPA RFS2 Given the RFS2 mandate, along with specific state level mandates discussed below, Informa believes that under the baseline (RFS2 as established), EPA s projected case to increase use of biomass based diesel to 1.82 bgy of biomassbased diesel by 2022 and following the schedule illustrated in Exhibit 25 is possible. When the 1.82 bgy is contrasted against about 3.0 bgy of current biodiesel production capacity or the 2.1 to 2.3 bgy of active capacity, there is a potential reach the 1.82 bgy and contribute towards this higher UAB scenario if the EPA continues to mandate for a greater allocation to biodiesel of the UAB. Note that under EPA s estimate for 2022, soybean oil s share of feedstocks is assumed to be under 36% of total.

49 Exhibit 25: EPA Projected Biodiesel and Renewable Diesel Feedstock Use In 2022 Source: EPA B. State-Level Biodiesel Mandates 1. California Low Carbon Fuel Standard Background Following the enactment of the California Global Warming Solutions Act of 2006 (Assembly Bill No. 32) requiring limits on statewide greenhouse gas (GHG) emissions by 2020, California Governor Arnold Schwarzenegger in early 2007 issued Executive Order S that established a statewide goal of reducing the carbon intensity (CI) of California s transportation fuels by at least 10% by The order specifically tasked the Air Resources Board (ARB) with 43

50 establishing and implementing a Low Carbon Fuel Standard (LCFS) for transportation fuels in California. The ARB undertook a large-scale rulemaking process, and on April 23, 2009, it approved the adoption of the LCFS. However, since that time, the LCFS regulations have been subject to significant scrutiny. In December of 2011, a U.S. District Court judge in Fresno California ruled that the LCFS was unconstitutional in that it discriminates against out-of-state producers and tries to regulate activities outside of state borders. However, this ruling was then overturned in April of 2012 by the ninth Circuit Court of Appeals. Since then, despite continued scrutiny, regulations have preceded. Over the past months, arguments were heard by three judges from the Ninth Circuit Court of Appeals and a ruling is expected to be made in the first half of However, some note that even this will not likely be final, as regardless of the ruling, it is anticipated by some to be appealed to the Supreme Court. The LCFS is currently trudging ahead, but there is great uncertainty regarding its future. Under the LCFS, the CI of diesel and substitute fuels will have to be reduced 10% by The reduction is gradual at first, starting in 2011 at 0.25%, but it becomes steeper in each subsequent year; reaching 10% by 2020 (see Exhibit 26). Technically, the standard took effect in 2010, but no reduction was required as 2010 was intended to be a reporting year where any difficulties in the reporting system could be resolved. 44

51 Exhibit 26: LCFS Carbon Intensity Reduction Schedule for Diesel and Substitute Fuels Carbon intensity (CI) schedule from ARB s Final Regulation Order (including Feb 2011 changes). CI is measured in grams of carbon dioxide equivalent per megajoule of energy. Source: ARB Exhibit 27 is the ARB Carbon Intensity Lookup Table which lists the default carbon intensity values for various diesel and diesel fuel substitutes, including biodiesel produced from a variety of feedstocks. However, these values can be amended if a regulated party proposes and receives the Executive Officer s approval, modifications to one or more inputs to the CA_GREET model used to generate these CI values. Alternatively, a regulated party may also propose a new pathway not included in the below Lookup Table. 45

52 Diesel Fuel Biodiesel Renewable Diesel Source: ARB Exhibit 27: Carbon Intensity Lookup Table for Diesel and Fuels that Substitute for Diesel Pathway Identifier ULSD001 BIOD002 BIOD003 BIOD001 BIOD004 BIOD005 BIOD007 RNWD002 Pathway Description Carbon Intensity Values (gco2e/mj) Direct Emissions Land Use or Other Indirect Effect ULSD - based on the average crude oil delivered to California refineries and average California refinery efficiencies Conversion of waste oils (Used Cooking Oil) to biodiesel (fatty acid methyl esters -FAME) where "cooking" is required Conversion of waste oils (Used Cooking Oil) to biodiesel (fatty acid methyl esters -FAME) where "cooking" is not required Conversion of Midwest soybeans to biodiesel (fatty acid methyl esters - FAME) Conversion of waste oils (Used Cooking Oil) to biodiesel (fatty acid methyl esters -FAME) where "cooking" is required. Fuel produced in the Midwest Conversion of waste oils (Used Cooking Oil) to biodiesel (fatty acid methyl esters -FAME) where "cooking" is not required. Fuel produced in the Midwest Conversion of corn oil, extracted from distillers grains prior to the drying process, to biodiesel Conversion of tallow to renewable diesel using higher energy use for rendering Total RNWD003 Conversion of tallow to renewable diesel using lower energy use for rendering RNWD001 Conversion of Midwest soybeans to renewable diesel The average CI of currently registered biofuel facilities supplying diesel substitute fuels is 35.9 gco2e/mj. Exhibit 28 is a histogram of the CI values of these registered facilities and Exhibit 29 shows the percentage of these facilities by feedstock. Notice that the distribution is skewed to those with CI values less than 45; 73% of the facilities report a CI less than 45 (which is not soybean oil based). Additionally, the majority (46%) represent biodiesel produced from waste oils. However, it is important to keep in mind that these values represent the number of registered facilities and not necessarily relative volume supplied. 46

53 Exhibit 28: Carbon Intensity Value Histogram of Registered Diesel Fuel Substitute Providers Exhibit 29: Registered Diesel Fuel Substitute Facilities by Feedstock Source: ARB *Percent of registered diesel fuel substitute facilities by feedstock. 47 Source: ARB Informa estimates that approximately 600 million gallons of biodiesel is required to meet the 2020 LCFS CI reduction for diesel and diesel fuel substitutes, based on projections of California diesel use and the CI values for various diesel fuel substitutes. It is assumed that overtime, more and more of the total diesel substitute fuel use will be derived from feedstocks with a lower CI value than soybean oil (e.g., waste oils, tallow, and corn oil). This assumption was also reviewed from a supply side, and 600 million gallons of biodiesel and renewable diesel from these feedstocks was deemed a reasonable minimum.

54 2. State-Level Biodiesel Mandates and Incentives Exhibit 30 illustrates Informa estimates of state-level biodiesel consumption volumes based on projected diesel use and state-wide use mandates (excludes state mandates that require use for state agency vehicles only) and/or states with strong consumption incentives (e.g., Illinois). It is estimated that roughly 1.0 bgy of biodiesel use could be mandated at the state-level by This does not include non-mandated use in these states, or other states. The big question marks that could significantly alter this estimate are: Will upcoming court hearings uphold the California Low Carbon Fuel Standard? If LCFS is not upheld, this estimate could be roughly 600 mgy lower. Will the Illinois incentive, which is currently scheduled to expire in 2018, get extended? If so this estimate could be up to 400 mgy higher, according to Informa s estimates. 48

55 Exhibit 30: State-Level Mandated Biodiesel Use 1. CA - Based on Informa estimates of soybean oil vs. other feedstocks (e.g., waste oils and tallow). Assumes increasing utilization of "other feedstocks" overtime. 2. IA - Estimated use based on biodiesel meeting 1% of IA's RFS. The remaining is met by ethanol. 3. MA - The mandate was suspended in June For purposes of this analysis, it is assumed that it returns by OR Starting from Apr 2011, Oregon increased biodiesel blending (and thus usage) level from 2% to 5%. 5. LA - Louisiana has a usage credit that goes into effect only after the state produces 10 mgy. 6. NM - Implementation of the use mandate is questionable 7. IL - Illinois does not have a usage mandate but a consumption credit which favors biodiesel distribution in the state. The credit ends in Source: Informa Economics 49

56 C. Potential Implications of RFS2 Elimination 1. Debate over the RFS2 Over the years since the original RFS was enacted, there has been continued debate over its merits. A debate which heated up throughout the summer of 2012 as worsening drought conditions continued to threaten the corn and soybean crop. As a consequence, calls for a RFS2 waiver became louder, which in turn revived discussion of complete elimination. In August of 2012, EPA opened up a 45 day comment period in response to several RFS2 waiver requests. Those calling for the waiver and/or RFS2 reform believed that in light of the drought, a waiver would help provide relief from tight corn supplies and high corn prices, which would continue to increase livestock production costs and ultimately lead to higher consumer food costs. However, during late summer and early fall, there were several studies released which evaluated the impacts of a waiver and/or complete RFS2 elimination (e.g., University of Illinois, Irwin and Good; University of Missouri, FAPRI ; CARD, Bruce Babcock; Purdue, Tyner et. al.), and many of these studies concluded that an RFS2 waiver would not significantly reduce corn demand for ethanol. Furthermore, others commented that a waiver would only cause policy uncertainty and jeopardize efforts to build out an advanced biofuel industry. In October 2012, the EPA comment period came to a close and in November they officially denied requests to waive the RFS2, stating that they did not find evidence to support a finding of severe economic harm, noting that waiving the RFS2 would have little, if any, impact. Despite the EPA s denial of the waiver request, the debate was renewed and discussions of RFS2 reform and/or elimination continue. In the American Fuel and Petrochemical Manufacturers (AFPM) response to the EPA s denial, they commented that The issues highlighted during the waiver comment period further emphasize the fact that the RFS is fundamentally flawed and should be repealed. Failing to eliminate this mandate will adversely impact consumers and our economy (quote from AFPM President Charles Drevna via OPIS). While this debate over the RFS2 has largely focused on corn and ethanol, if RFS2 elimination occurred, the biomassbased diesel mandate would likely go with it. 50

57 2. Potential Impacts of RFS2 Elimination on Biodiesel and Soybean Industries (a) Could State-Level Mandates Support the Industry? State-level mandate are expected to reach roughly 1.0 bgy by 2022 with California s LCFS alone accounting for 60% of this volume (it is only a coincidence that this number is the same as the RFS mandate for 2012). If this is compared against the minimum biomass-based diesel mandate under the RFS2 of 1.0 bgy, then removing the RFS2 would not have a significant impact on biodiesel use. However, as discussed in the previous chapters, there are a number of political and technical uncertainties around these estimates which makes the federal mandate preferable to stakeholders and investors. More importantly, state mandates also may change if RFS2 changed. The California mandate also is vulnerable. What can change state mandates more significantly? Is the California Low Carbon Fuel Standard upheld in upcoming court hearings? The California LCFS is projected to result in roughly 600 mgy of biodiesel demand by 2020, but the constitutionality of this program is being challenged in the court system. While the most recent court finding backed the program, some industry representatives anticipate that this could reach the Supreme Court before anything becomes final. Does the Illinois consumption incentive, which is currently scheduled to expire in 2018, get extended? If so, this could be roughly 400 mgy higher. Under the RFS2, use of biodiesel could be larger than 1.0 bgy, as the EPA has the authority to annually set this mandate above 1.0 bgy, as they did for 2013 at 1.28 bgy. While state mandates provide some assurances to investors, these do not provide the type of support for investment that a national and federal mandate do. Hence, one would expect that biodiesel investors will place a higher risk premium without the RFS2, even if state mandates remain in place. Biodiesel use under RFS2 has the potential to reach 1.82 bgy by 2022 if EPA s continues to increase the biomass based diesel allotment to the 1.82 bgy target by 2022 as EPA already in 2012 when it increased the mandate from 1.0 to 1.28 bgy for (b) What Are the Impacts on Vegetable Oil Volumes And Prices As Well As Impacts on Other Feedstock Markets? If the RFS2 were eliminated the following impacts would be expected: 51

58 Biodiesel use and production would decline to a volume close to the state mandate in place for that year. However, state mandates would be more vulnerable in the absence of the RFS2 as the elimination of the federal tax credit and the RIN system would lower biodiesel margins. The industry will forgone the potential to add 820 mgy by 2022 in addition to the existing RFS2 mandate of 1.0 bgy. This potential is equivalent to an increase demand of around 6 billion pounds of biodiesel feedstocks, including soybean oil. This change in demand alone would impact a change of soybean prices in the order of 1 to 6 cts/lb. Note that because the increase in demand would be gradual ( ), the impact on feedstocks prices is minimized. If the RFS is eliminated and state mandates are removed or phased out, biodiesel production will decline overtime and soybean prices will decline up to the 12.9 cts/lb estimated in Section IV.B earlier in this report. D. Key Takeaways A fundamental support to the value of soybean oil in biodiesel is the Renewable Fuels Policy passed in 2007 (RFS2) requiring use of 1.0 billion gallons of biodiesel by State biodiesel use mandates and incentives are very significant and also serve as a hedge against a change in the RFS2. In 2012, state mandates and incentives alone support biodiesel use of 0.5 billion gallons; state programs could grow to one billion gallons by The RFS2 sets the minimum mandate volume for biomass-based diesel going forward thru 2022 at 1.0 bgy. Biodiesel use under RFS2 has the potential to reach 1.82 bgy by 2022 if EPA s continues to increase the biomass based diesel allotment to the 1.82 bgy target by 2022 as EPA already in 2012 when it increased the mandate from 1.0 to 1.28 bgy for The industry will forgone the potential to add 820 mgy by 2022 in addition to the existing RFS2 mandate of 1.0 bgy. If biodiesel economics are favorable (blending economics have not been favorable for most of the past 5 years), biodiesel demand could increase beyond the 1.82 bgy as it is unlikely that sufficient cellulosic production will exist to meet the cellulosic RFS2 requirements and this requirement will need to be reduced. 52

59 VII. WOULD MORE INVESTMENT IN THE BIODIESEL INDSUTRY BE VALUABLE TO SOYBEAN FARMERS? The purpose of this section is to provide answers to specific questions about the biodiesel industry. Information in this section brings the facts outlined earlier in the report to provide direct answers to critical questions that soybean farmers often ask about the future of biodiesel. (a) How Would Soybean Oil Used For Biodiesel Production Be Redistributed to Other Markets in the Absence of Biodiesel? In the absence of a RFS2 or state mandates, biodiesel would only be produced in the U.S. when its cost of production is consistently below the price of diesel minus the cost to manufacture biodiesel. Consistency is needed to stimulate capital investment to maintain and/or build processing facilities. Historically, blending economics (price of biodiesel excluding credits/subsidies 12 minus the prices of diesel) were mostly negative. Production of biodiesel for the export market, mainly the EU, could only support small quantities of biodiesel production in the U.S. because Argentina has a tax advantage over the U.S. and the EU prefers to import oil and produce biodiesel internally. Thus, If the U.S. reduced biodiesel production, the following impacts would occur in the soybean complex: Most soybean oil will be redirected to exports markets, but some volumes will compete with other oils for the domestic food market. Increased exports will impact soybean oil prices as indicated in section III.A Impact of Large Soybean Oil Inventories on the U.S. Soybean Complex. If biodiesel production is totally eliminated, the link of soybean oil prices to energy prices is reduced or eliminated and the price of soybean oil is reduced up to 12.9 cts/lb. Soybean production and soybean crush would be marginally affected. In the U.S., the soybean industry is still driven by meal revenue. 12 This includes the $1.0 gal tax credit, small producer s credit, state tax credits or incentives and the income generated from RINs. 53

60 Takeaway in the absence of soybean oil use for biodiesel, excess oil supplies will find a market, mostly abroad, however, the impact will be felt through a decrease of soybean oil prices, increase of soybean meal and reduction of soybean prices. (b) Can Soybean oil Prices be Sustained Without a viable U.S. Biodiesel Industry? If the U.S. biodiesel market was no longer viable, there would be downward price pressure on the U.S. soybean oil market. Soybean oil prices are higher as a result of the U.S. biodiesel industry as it was shown in section IV.C Biodiesel Resulted in Higher Soybean Oil Prices and a Positive to the Soybean Complex and Exhibit 16. Takeaway No. Soybean oil prices will decline up to 12.9 cts/lb and have corresponding effects on soybean and soybean meal prices. (c) Can Soybean Oil Prices Be Sustained If Soybean Oil Is Only a Small Share Of Biodiesel? Yes. Soybean oil prices would remain high due to the link between soybean oil, biodiesel and diesel/energy prices. This relation would remain as long as there is an economic viable potential to use soybean oil for biodiesel. Changes to the RFS2 or elimination of RFS2 and state mandates can alter and or eliminate the link of soybean oil and energy prices, thus maintaining biodiesel production as viable in the U.S. is more critical than maintaining soybean oil s share of feedstocks. Note that a change in policy (e.g., change in the RIN system for biodiesel) or market event that effectively results in a lower net revenue for biodiesel (i.e. biodiesel price plus RIN revenue) will place a corresponding downward pressure on soybean oil prices. Takeaway Yes, as long as soybean oil is an eligible feedstock for biodiesel and the link between biodiesel feedstocks and energy prices remain strong. Maintaining biodiesel production as viable in the U.S. is more critical than maintaining soybean oil s share of feedstocks. (d) Would the Link Between Soybean Oil and Energy Prices Change If U.S. Biodiesel Production Stops; Or If Soybean Oil Is Only A Fraction Of The Feedstock Used? The biodiesel industry has been marginally profitable and difficult to finance, with narrow or negative margins often occurring. While the floor price for converting soybean oil to biodiesel (a diesel substitute) keeps the price of soybean 54

61 oil higher even without using large proportions of soybean oil as feedstock, this depends upon the existence of the infrastructure to convert relatively large amounts of vegetable oils to biofuel. If the industry were gone (i.e., no capacity), the price floor is reduced and thus soybean oil prices would move downward and lose the strength of its relation with energy prices. Instead, the floor prices for soybean oil would be provided by either corn prices (since soybean oil can be substituted for corn energy values if corn is expensive enough), or by the conversion value of soybean oil as heating oil. Takeaway Not entirely. Soybean oil prices would move downward and lose the strength not the entire relation - of its relation with energy prices and also lose its hedge to energy price inflation. Heating oil prices will remain as price support but very low correlation to soybean oil. (e) How Will Prices Of Soybean Meal Be Affected Without Biodiesel? Without biodiesel, the price of soybean meal would be higher. Given the estimate of a decline of soybean oil prices of up to 12.9 cts/lb, soybean meal would increase up to $50/ton as estimated in section IV.E Increased Soybean Oil Prices and the Corresponding Effect on Soybean and Soybean Meal Prices. Takeaway Up to $50/ton price increase. (f) How Have the Prices and Markets for Other Vegetable Oils, Industrial Corn Oil, Animal Fats and Greases Been Impacted By the Biodiesel Industry? Since other vegetable oils, industrial corn oil from ethanol companies, and animal fats and greases can also be used as feedstock for biodiesel and their prices are driven by soybean oil prices, these feedstocks experienced a demand and price increase as a result of the development of the biodiesel industry. In the case of other vegetable oil, the price increase attributed to biodiesel is similar to that of soybean oil; that is 12.9 cts/lb. In the case of animal fats and grease, the price increase attributed to biodiesel ranges from 15 cts/lb for yellow grease to 17 cts/lb for tallow. 55

62 (g) Conclusion Should Investment Continue in the Biodiesel Industry Biodiesel is an industry not yet assured of survival without government requirements of biodiesel use or mandates for sustainable, biomass-sourced fuels. Many states now effectively have requirements for biodiesel use as well, making a loss of RFS2 requirements less damaging in the short term to the biodiesel industry if that occurred. A viable biodiesel industry and unrestricted use of soybean oil (i) help maintain a link between soybean oil and energy values, (ii) create a floor for commodity values, and (iii) serve as a hedge against energy inflation for producers. Although soybean oil s market share within the biodiesel industry does not have significant impact on these benefits, continued stakeholder support/investment in the biodiesel industry is needed to ensure that biodiesel production remains active and viable and that the use of soybean oil as a major feedstock is not restricted or limited by federal or state policy. 56

63 VIII. APPENDIX: RFS2 BACKGROUND Under the original RFS, renewable fuels were defined as any motor vehicle fuel used to replace or reduce the quantity of fossil fuel present in the fuel mixture used to fuel a motor vehicle. Furthermore, renewable fuels include motor vehicle fuels produced from biomass materials such as grain, starch, fat, greases, oils, and biogas. The EPA definition under RFS2 changes the interpretation of renewable fuels and biomass to renewable biomass. The change opened doors to include the following: A minimum lifecycle greenhouse gas (GHG) emission displacement for renewable fuels relative to petroleum fuels, A GHG profile for each feedstock used to produce biodiesel (or ethanol), The inclusion of indirect land use change (ILUC) to the GHG lifecycle value of each feedstock. Exhibit 31: RFS2: Fuel Categories, Targets (billion gallons), and Minimum GHG Savings 57