EPA Biofuel Cuts Should Be No Surprise

The 2014 Renewable Fuel Standards proposed by the EPA on November 15 call for a cut in biofuel production and a review of the E10 Blend Wall. From its inception, ethanol blending has been a threat to the domestic gasoline market shared by the international giants alongside U.S.-based companies ExxonMobil, Chevron , and ConocoPhillips . Big Oil, via in part the American Petroleum Institute, lobbied extensively for a change in the status quo Renewable Fuel Standards that have contributed along with declining demand for gasoline to stagnant profits for oil producers. The reform that they were looking for may finally become reality.

Blending to boost biofuels
Under the Energy Policy Act of 2005, the EPA had the authorization to set biofuel blending percentages, a responsibility they used to triple the amount of biofuels blended (mostly ethanol) in just six years. The blending requirements provided stability to the ethanol market, and provided the base necessary to support the expansion of biodiesel into a viable business.

The lofty ambitions of the EPA were bumped even higher under the Energy Independence and Security Act of 2007, all furthering the nation's goal to 'to increase the production of clean renewable fuels' as part of the larger move toward 'greater energy independence and security.' All of these initiatives were viewed at the time as extremely supportive of biofuel producers, and viewed by many as detrimental to big oil companies. The strongest opponents were Senators and Representatives from oil-producing states in the South, who were able to remove from the final bill provisions that would have ended subsidies for Big Oil.

To energy companies, the least controversial components of these bills regarded efforts 'to increase the efficiency of products, buildings, and vehicles.' In the end, however, these are the initiatives that have most affected Big Oil companies and biofuel producers alike.

The road to energy independence
The United States is achieving the energy independence that was sought after, and oil companies and biofuel producers should have seen it coming. From the simplest viewpoint, if vehicles become more efficient (and if Americans drive less), then less fuel will be consumed. It doesn't matter whether the fuel is ethanol or gasoline, biodiesel or diesel, less fuel consumed equates to less demand. Unless there is a significant enough increase in price, profits will inevitably drop.

Oil profits have always been tied to some extent to oil prices, though the underlying assumption for half a century was that baseline fuel consumption would always be increasing, regardless of price fluctuations. That assumption has since been discredited, yet over the past decade despite no growth in quarterly profits, ExxonMobil has provided investors with a consistent and growing return. Likewise, Chevron and ConocoPhillips have both provided more than a 50% return on investment over the past five years.

The three largest public ethanol producing companies in the U.S., Archer Daniels Midland , Valero Energy , and Green Plains Renewable Energy , have reported consistent quarterly profits over the last five years. The 10% Blend Wall has played a major role in this result, though it has also limited the upside for these companies. Efforts to expand ethanol consumption with E85 were growth-minded, but did not yield dramatic results. If the amount of ethanol blended into gasoline is constant, and the demand for gasoline is dropping, there is very little that these companies can do to match the growth seen in the ethanol industry 10-15 years ago.

The takeaway
Mandated cuts in biofuel production may hurt ethanol producers, but decreased production was on the horizon regardless of EPA action due to decreasing consumption. The worrisome part of the 2014 Renewable Fuel Standards for ethanol investors could come in the form of changes to the E10 Blend Wall, the details of which are still to be determined.

If the proposed cuts to biofuel production go into place, the positive effects for Exxon and the other Big Oil companies will be negligible because the blending will likely remain constant. The bigger and still prevailing issue for Big Oil is the move toward more efficient vehicles that will limit the upside of ExxonMobil and the rest of Big Oil moving forward.

The article EPA Biofuel Cuts Should Be No Surprise originally appeared on Fool.com.

Fool contributor Shamus Funk has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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