Capitalizing with decarbonization: Biofuels poised to shake up the energy landscape

This article was first published in March 2021 by GMO, Biofuels poised to make major impact by Alex Hebert, Lucas White, compiled by JieJingWiKi, and originally published as GMO | Capitalizing with Decarbonization: Biofuels poised to make major impact

While electric vehicles continue to dominate the headlines and gain attention in clean energy circles, biofuels are increasingly becoming an important alternative to carbon-based fuels. Biofuels have a smaller carbon footprint and offer the same or better performance than oil-based fuels. Importantly, biofuels require little or no infrastructure investment, which is a far cry from the requirements for mass adoption of electric vehicles. Given these attractive features, we believe this often overlooked industry could see huge growth in the next decade.

  1. What are biofuels?

Biofuels are the by-products of any fuel derived from living things (including plants, algae, animals, etc.). Bio has a much lower carbon content than traditional fossil fuels, resulting in a significant reduction in greenhouse gas (GHG) emissions. Biofuels are a broad category that includes biodiesel, renewable diesel, sustainable aviation fuel (SAF), and renewable natural gas, among others.

  1. The case for biofuels

As governments strive to meet aggressive emissions reduction targets, biofuels are emerging as an effective, low-cost solution. Biodiesel and renewable diesel contain carbon emissions that are 80% to 90% smaller than conventional diesel (see Table 1). In fact, biofuels are clean enough to reduce the carbon emissions of more than 60% of electric vehicles currently powered by a mix of coal, natural gas, nuclear, and renewable energy sources in the United States. (Even compared to the carbon emissions of electric vehicles generated by California’s super clean grid are reduced by 40%).

Biofuels do not require massive infrastructure investment because the fuel can be distributed through existing storage tanks and pumps, making them even more attractive to policy decision makers. Comparing this to the infrastructure investments required for renewable energy generation (solar, wind projects, grid enhancements, energy storage), and increased EV penetration (charging infrastructure, increased power generation), one can clearly see why governments are increasingly focusing on biofuels.

Capitalizing with decarbonization: Biofuels poised to shake up the energy landscape

Note: EV is electric vehicle. average U.S. grid represents the average generation mix of the U.S. CA grid represents the generation mix of California, one of the cleanest grids in the U.S.

  1. Public Policy Support

Policies at the federal and state levels increasingly require blended biofuels or support a shift to blended biofuels, a trend that even gathers sand. Low carbon fuel standards promote the growth of biofuel applications, and these standards are already in place in California, Washington, Oregon, and Canada. After Europe and the U.S. federal government, at least 13 other U.S. states are considering developing their own standards. Norway began mandating sustainable aviation fuel (SAF) for jet aircraft last year, and Sweden is following suit this year. Biofuels are likely to receive more support in the years to come.

  1. Interaction with oil

An interesting feature of biofuels is that they act indirectly on oil. However, the replacement of oil demand by clean energy also benefits the price of oil itself. For example, renewable diesel is a direct alternative to diesel, and biodiesel can be blended with diesel. When diesel prices rise, renewable diesel and biodiesel producers sell their products at higher prices, but production costs are unaffected. On the other hand, if carbon policies discourage the consumption of traditional diesel, biodiesel and renewable energy, diesel producers will be more inclined to capitalize. Last year the new crown virus outbreak reduced oil demand and oil prices fell. On the other hand, biofuel prices rise in 2020 due to the policy incentives mentioned previously (see Table 2 for details).

Capitalizing with decarbonization: Biofuels poised to shake up the energy landscape
  1. Investment methods

There is much to be said for investing in biofuels. For one, the growth prospects are very strong, and growth in biofuels is almost a given if policy makers are to meet their climate commitment targets. Second, it is a relatively new industry, little is known about it, it is complex and uncertain, and all of these things create opportunities for those willing to look deeper and take risks. For many, companies that are good for the world are becoming increasingly attractive.

When analyzing companies in the biofuels industry, we carefully evaluate the protocols for their feedstocks. Different types of feedstocks (e.g. used cooking oils, fats, animal fats, soybean oil) have different carbon emissions, and our subject companies have access to low-carbon-intensity feedstocks [1]. Companies that have established feedstock agreements or access to feedstocks from other businesses (i.e., integrated companies upstream and downstream of the industry) have an advantage. We are also looking for companies working on innovative feedstock solutions, such as algae and waste plastics. As usual, we keep a close eye on valuations, focusing on companies that we believe are mispriced given their growth prospects and optionality risk profile.

  1. Conclusion

We see exciting investment opportunities in the biofuels sector, and GMO has a plethora of investment strategies, including climate change, resources, long/short resources and cyclical focus. We believe biofuels will be an important part of the decarbonization process worldwide. Companies that make strategic feedstock purchases and have the necessary logistics expertise have a bright future.

[1] On top of reducing GHG emissions, low carbon density feedstocks enhance company profitability because they have higher bargaining power in incentivized markets (e.g. Canada).

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