Market Monitor: The Role of Distribution in a Successful Biofuels Business
By Charles R. Brettell, Principal
Energy Asset Solutions, LLC
March 2, 2010
Biofuels operate largely as commodity fuel additives & petroleum hedging vehicles resulting in an inability of producers to extract value beyond the conversion cost of inputs. In order to break free of this paradigm, producers must find a way to move beyond the wholesale & refiner fuel markets and “own the customer.” In this month’s installment of our Market Monitor series, we look at three (3) models focused on getting further down the value chain to the end-user to see what’s working and what’s not.
Read more below.
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Biofuels operate largely as commodity fuel additives (replacing MTBE) and RBOB hedges. As global petroleum prices rise, the value of blending cheap, readily available biofuels (especially ethanol) rises; conversely, as petroleum prices fall, so does the thirst for biofuels. The result is an inability of producers to extract value beyond the conversion cost of their inputs. In order to break free of this paradigm, producers must find a way to move further down the value chain and “own the customer.” Three different efforts are underway to do just this, namely the joint American Coalition for Ethanol’s (ACE) and Renewable Fuels Association’s (RFA) “Blend Your Own Ethanol” (“BYOE”) campaign, public-behemoth Green Plains Renewable Energy’s (GPRE) Blendstar initiative and the smaller-scale producer-pump model evidenced in both the ethanol & biodiesel industries.
The BYOE initiative, announced at last year’s ACE conference in Milwaukee, is ACE & RFA’s effort to encourage C-Stores and other distributors to install retail pumps capable of allowing for a broader range of biofuel options for end-users. While ACE indicates that its goal is to have 5,000 blender pumps in operation by 2012, currently only about 100 locations are listed on its website locator (http://maps.google.com/maps/ms?msa=0&msid=114795702092705781866.0004506e7cf3ae206a7c0). Other than scale, a major problem is the disconnect between the economic realities on the ground for the C-Store business owner and the goals of the initiative itself. National Convenience Store Association Vice President of Government Relations John Eichberger told ACE conference attendees in August 2009 that “if every retailer is required to replace equipment in order to sell higher ethanol blended fuels, the economics will not support the transition. More than 60 percent of retail locations are single-store companies who cannot afford to replace their fueling infrastructure.” He also pointed out that ACE’s efforts to focus on shifting the pump switching costs on major oil companies were “misdirected because the companies are leaving the marketplace, meaning all costs will be borne by independent business owners” who don’t have the means to undertake the conversion. Finally, the legal issues & liabilities associated with blender pumps have yet to be resolved. As Eichberger noted at the ACE conference “NACS is not opposed to moving forward with renewable fuels, provided . . . retailers are not going to be held liable or found in violation of the law for selling the product.” As a result of the above, barring a breakthrough on multiple fronts, our guess is that BYOE, as currently conceived & implemented, will stagnate yielding little real opportunity for producers to move downstream in the value chain.
Shifting to GPRE’s Blendstar effort, here we see the midpoint between wholesale production and retail distribution from a producer. Blendstar describes itself as a developer and operator of a network of facilities that provide “terminaling and logistics solutions to the fuel industry as a reliable method to distribute ethanol and biodiesel in markets that do not have efficient access to renewable fuels.” Currently, Blendstar operates facilities in 7 states all of which “accept deliveries by both rail and truck, are located within 3 miles of the major petroleum terminals, and offer the same quality controls, safety, security, and back office functionality of a major petroleum terminal.” In public statements, GPRE CEO Todd Becker described the initial investment in Blendstar as “an important investment in downstream biofuel enterprises", while their September 2009 10Q stated it as a “strategic investment within the ethanol value chain”; from the outside looking in, it appears to be exactly that. Through Blendstar, GPRE now has the ability to reach further down the value chain, by-passing the petroleum-based biofuels commodity market and selling into the distributor / retail space from close proximity to under-served markets. Whether or not it’s enough to simply move closer to the customer, rather than directly serving them, remains to be seen (given segment results disclosed in their most recent SEC filings, it appears to be working pretty well). One thing is certain, it’s an effort worth keeping an eye on as a model that supports the general proposition that anything other than the current petroleum-dominated commodity model is a better mouse-trap.
The final step down the distribution path is the direct-to-consumer, producer-pump model. Here, biofuels producers simply put up a retail pump on-site or nearby their production facilities and sell directly to retail customers; as a result, producer-retailers end up utilizing petroleum as a wholesale commodity to be blended according to prevailing economics (the economic argument for this is nicely laid out on the BYOE website). For obvious reasons (think: corn ethanol), this model is found mostly in a tight cluster of Midwestern states, but several examples exist in the biodiesel market on the East & West coasts. While this structure is largely deployed by smaller, single-site producers, it also used by some larger names, including ICM, GPRE, RENEW (recently purchased out of bankruptcy by Valero). In our opinion, this model represents the clearest, most effective path toward capturing the end-user. Rather than selling to intermediaries – like refiners & distributors – these producer-retailers develop a brand & customer relationship while extracting more revenue from the sale of their products. Theoretically, this would also work around a cluster of producer-owners retailing under a co-branded platform and, using a model like that employed by Blendstar, these same firms could then reach out beyond their local production markets to far-flung, underserved locations around the US.
No matter the model that ultimately prevails, owning the consumer is clearly the best path forward for biofuels producers for the long-term.
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