Gevo, Inc. (GEVO), Valero Energy Corporation (VLO) & The RFS Reform Bill

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The Renewable Fuel Standard, or RFS, was first passed in 2005 to mandate the use of biofuels in America’s transportation sector. Despite being amended in 2007, it still has some pretty big flaws that need to be addressed. Now, four members of Congress have drafted legislation that seeks to make some pretty important changes. The proposed bill is far from perfect, but it could devastate the country’s biggest ethanol producers and even disrupt the global ethanol market. Here’s what investors need to know and two potential opportunities to keep in mind.

Renewable Flawed Standard
There’s no debating that the RFS has done exactly what it was designed to do: create a market for American biofuels. In just a few short years, the United States went from a marginal producer of ethanol to the world’s largest, surpassing even the mighty Brazil.

Source: Energy Information Administration.

The mandate caps corn ethanol production at 15 billion gallons per year, which is smart and necessary. However, current laws dictate that an additional 16 billion gallons per year of second-generation cellulosic ethanol must be produced by 2022. That brings the total amount of ethanol produced to 31 billion gallons per year and poses several problems.

That thing called math
Sure, ethanol blends could be increased from the mandatory 10%, or E10, to a still safe 15%, or E15. But even then, producers would be swimming in ethanol. The problem is that the original mandates called for growing fuel consumption — perfectly in tune with reality in 2005 — but increased efficiency and decreased driving have actually sent fuel consumption in the opposite direction.

Looking at historical gasoline consumption and ethanol production demonstrates the misguided targets of the current mandate. If America were to use all of the ethanol it produced in 2022, annual gasoline consumption would have to swell to 200 billion gallons! The new fuel efficiency targets announced last year should actually cut consumption to half of that amount.

Year Finished Gasoline Sold (Billion Gallons) Fuel Ethanol Sold (Billion Gallons) Approximate Blend Ratio
2005 140.411 4.040 2.88%
2006 141.841 5.615 3.96%
2007 142.349 6.960 4.89%
2008 138.182 9.838 7.12%
2009 137.917 11.136 8.07%
2010 137.900 12.915 9.37%
2011 133.940 12.90 9.63%
2012 133.9 13.018 9.70%

Source: Energy Information Administration. Fuel ethanol sold equals production less net imports.

The blending requirements could be lowered relatively easily. Unfortunately, they represent only one major flaw. The RFS heavily favors ethanol while neglecting to give equal opportunities to other, potentially better biofuels. You’d never know it from current laws, but the EPA considers methanol, butanol, hydrogen, natural gas, and even electricity as renewable fuels. By making detailed procedures for ethanol, the government has inadvertently abandoned these other alternative fuels that can be compatible with current engines and infrastructure, as well as cheaper, cleaner, or more energy-efficient.

The RFS Reform Bill is a good start, but …
A group of lawmakers from both parties proposed legislation to overhaul the mandate. The bill intends to slash the production mandate by 42%, limit blends to E10, and completely disallow corn ethanol from the mandate. At face value, the proposed law has good intentions and addresses the 31 billion-gallon elephant in the room, which lawmakers will have to deal with eventually.

Unfortunately, the bill does little to encourage research into or the eventual adoption of other alternative fuels. The early transcripts from the bill also show that it is deeply rooted in the food-versus-fuel debate. Ethanol critics love to point out that more than 40% of the country’s corn crop goes to ethanol. But it’s a bit misguided to stop counting there. Ethanol producers only want the starch in corn. Once that’s extracted with enzymes, the corn is dried again and sold back to farmers as animal feed. Thus, the net acreage devoted to ethanol is really closer to 17%.

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