Analysis-Renewable diesel glut hits US refiner profits, threatens nascent industry

By Shariq Khan and Nicole Jao

NEW YORK (Reuters) - A rush by U.S. fuel makers to recalibrate their plants to produce renewable diesel has created a supply glut for low-emissions biofuels, hammering profit margins for refiners and threatening to impede a young industry.

Turmoil in the biomass-based diesel sector, an umbrella term for renewable diesel and biodiesel, could become a roadblock to future investments in biofuels, the U.S. Energy Information Administration (EIA) said this year. That could potentially stall the transition away from traditional fossil fuels.

Some producers of these biofuels have already shuttered plants this year, and industry participants say more are set to go out of business before the year's end.

U.S. renewable diesel production capacity nearly quadrupled following the coronavirus pandemic from just 791 million gallons a year in 2021 to 3 billion gallons by 2023, as refiners sought ways to survive the transition away from their petroleum-based products.

Combined with biodiesel, total U.S. output capacity for biomass-based diesel surpassed 5 billion gallons by 2023.

Renewable diesel is a complete substitute for diesel, whereas biodiesel can only be used as a blend, making the former more attractive for producers.

Both compete for the same feedstock - biomass, such as used cooking oil and vegetable oils - and are more expensive to produce than petroleum-based diesel, so their demand relies almost entirely on governmental blending mandates and tax credits.

But blending targets for biomass-based diesel, set under the U.S. Environmental Protection Agency's Renewable Fuel Standards (RFS) program, generate combined demand of just up to 4.5 billion gallons a year through 2025, according to Scott Irwin, a professor at the University of Illinois.

That is already below existing domestic production, before factoring in imports. By 2025, Irwin estimates U.S. renewable diesel and biodiesel output capacity will top 7 billion gallons.

"The crux of the matter is that market participants convinced themselves that 'if we build it, the EPA will mandate it'. That didn't happen," Irwin said.

The oversupply has cut prices of Renewable Identification Numbers (RINs) - the credits refiners earn under RFS for producing or importing biofuels - to the lowest in five years. D4 RINs tied to biodiesel and renewable diesel fell below 40 cents a gallon in February for the first time since 2019.

They were trading around 44.50 cents a gallon last week, down from an average of $1.50 from 2021 to 2023.

INDUSTRY RESPONSE

Refiners are feeling the pinch across multiple segments of their renewable fuels businesses.

Independent refiner Valero's renewable diesel margins in the first quarter fell 21.5% year-on-year to $1.02 a gallon.

Rival HF Sinclair said lower credit prices swung its renewables segment to an adjusted loss of $18.6 million before interest, tax, depreciation and amortization in the first quarter, from a $3 million profit in the prior year.

Vertex Energy plans to convert its 8,000-barrel-per-day (bpd) renewable diesel facility in Alabama back to fossil fuels production, citing macroeconomic headwinds for the biofuel which are likely to persist through next year. It had begun selling renewable diesel from this plant less than a year ago.

Other new plants are running around 50% capacity, said Zander Capozzola, vice president of renewable fuels at consultancy AEGIS Hedging.

U.S. oil major Chevron in March said it had mothballed two biodiesel plants, citing unfavorable market conditions. Biodiesel not only competes with renewable diesel for feedstock, its production generates fewer RINs, putting it at an even bigger disadvantage to the boom in renewable diesel.

Meanwhile, large renewable diesel producers are standing firm despite the oversupply, betting that they can withstand lower margins until smaller companies are pushed out of the industry, Capozzola said.

ROAD AHEAD

U.S. refiners are widely expected to turn to other markets in Canada and Europe for their excess renewable diesel, market participants said. However, they will face stiff competition from local producers.

Canada's Imperial Oil is proceeding with plans to build a 20,000-bpd renewable diesel plant near Edmonton which will be able to produce the fuel cheaper than it would have cost them to import from the U.S., the company told Reuters.

Braya Renewable Fuels, which began making renewable diesel in February at the Come-by-Chance refinery in Newfoundland and Labrador, believes operational issues will likely slow down new supply additions.

Braya is producing up to 18,000 bpd of renewable diesel from its plant and sells it through a marketing partner.

However, the biggest boost for the U.S. renewable diesel market will likely come once the Biomass-based Diesel Blender's Tax Credit (BTC) is replaced by the Clean Fuel Production Tax Credit (PTC) next year.

BTC allows importers to claim the same tax credits that domestic producers get, worsening the domestic oversupply, Irwin said. Once PTC comes into effect next year, it will disincetivize imports and at the least, slightly improve the supply side of the equation.

The U.S. imported roughly 900 million gallons of biodiesel and renewable diesel last year, according to EIA data. Imports in the first two months this year were around 200 million gallons, and Irwin said they are likely to rise through the rest of the year as importers squeeze out the last few tax credits they can get.

"Things don't look as desperate next year, but before it gets better, it will certainly get much worse," Irwin said.

(Reporting by Shariq Khan and Nicole Jao in New York; additional reporting by Rod Nickel in Winnipeg; Editing by Liz Hampton and Marguerita Choy)