On Tuesday, EPA granted only two biofuel waivers for year 2019, well below the 31 which were initially granted for year 2018 and the 35 which were granted for year 2017. This sets a precedent for incoming EPA under the Biden administration. We expect minimum if any SRE (small refinery exemptions) will be given on a go-forward basis, which is bullish for all biofuels producers.
Bio-fuel producers. One gal of biodiesel generates 1.5 D4 RINs, while one gal of Renewable diesel generates 1.7 D4 RINs. Higher RIN prices directly add to gross margins of biodiesel and renewable diesel. We are revising REGI and DAR’s 2021 and 2022 earnings estimates to reflect higher ULSD prices and higher D4 RIN prices. We raise REGI’s price target to $110 from $92. We raise DAR’s price target to $80 from $76. We believe the EPA under President Biden will take multiple steps to encourage the use of renewable fuels with the aim of cutting carbon emissions. One of the ways this can be achieved is by raising the RVO for biomass-based diesel (D4 RINs). This will encourage/force more blending of bio-diesel and renewable diesel to meet higher volume obligations. Higher D4 RIN prices under a stronger RFS mandate will likely drive upside to renewable diesel prices, positive for REGI, DAR and all refiners investing in renewable diesel projects. REGI is the most pure play bio-fuel producer and highest beta name that benefits the most from higher RIN prices. As more states adopt programs similar to LCFS, they will place a premium on lower CI feedstocks and DAR is 100% lower CI feed.
▪ Refiners – near-term pain, long-term gain. While in the near term higher RIN prices will be a margin headwind, in the long run higher RIN prices will help with capacity rationalization, helping set up the next upcycle. Higher RIN prices incentivize refiners to continue making investment in renewable diesel and bio-diesel. VLO, PSX, MPC, HFC and CVI are all making significant investments in RD. We believe HFC has been unfairly targeted for making investment in RD projects, although it helps the company achieve RIN neutrality. In our view, HFC is much better off investing $700M to diversify earnings and lower RVO vs. spending $1Bn to buy a tier 2 refinery in California. There are multiple refining assets in the US which are unprofitable after we account for RFS obligation and which have continued to operate with the help of SRE. These assets will have to shut, as we do not expect the Biden administration to issue any SRE. We would like to highlight that the US has hit the critical ~1M/day vaccination rate, which will help restore product demand, so set-up is good for refiners despite higher RIN prices. Once VLO’s, HFC’s and CVI’s RD facilities do come online, RVO drops materially, so RIN headwind is somewhat temporary for these names.
▪ DK and PBF. We don’t believe DK’s Krotz can operate at even breakeven levels without SRE. Given Uzi Yemin’s (CEO of DK) focus on positive cash generation and value creation, if Krotz cannot generate FCF, DK will shut the asset down. In our opinion, DK will not operate an asset only for nameplate capacity. We believe higher RIN prices could force PBF’s hand and shut some uneconomic refining capacity.