Monday, April 8, 2013

Diamond Green Diesel Refinery

Eric Nelson is the Chief Investment Strategist at ABE Capital Management.
Mr. Nelson has years of experience performing investment research for
several financial firms including Oppenheimer Capital and The MDE Group. He graduated with honors from Columbia Business School where he earned an MBA and was in the prestigious and highly-competitive Value Investing Program. Mr. Nelson is a graduate of Villanova University School of Law where he focused his studies on matters of international law and is a licensed attorney in the States of New York and New Jersey. At Washington University in St. Louis, Mr. Nelson conducted research on speculative financial markets and behavioral finance while earning a BSBA at the John M. Olin School of Business. He is intrigued by matters of international economic development and enjoys traveling in pursuit of this interest.  He lives in New Jersey with his wonderful wife and precious daughter.


Gratitude: I would first like to extend my appreciation to Dr. Sened and Ben Gottesdiener for engaging into such a worthy endeavor.  Bridging intellectual thoughtful and sharing information on our energy choices is a wonderful societal contribution. It is with this gratitude that I share my first contribution.   

What is Diamond Green Diesel?  Diamond Green Diesel (“DGD”) is a new refinery in Narco, Lousiana that is scheduled for commission over the next few months.  This facility is a Joint Venture between Darling International and Valero Energy Corporation.  The DGD refinery is designed to convert approximately 1.1 billion pounds per year of recycled animal fats, recycled cooking oils, and other feedstocks (e.g. inedible corn oil) into 136 million gallons of biodiesel and 22 million gallons of liquefied petroleum gases and nathpa each year. This equates to roughly 11% of the historical 10-year average supply of animal fats and used cooking oils in the United States being used to satisfy roughly 4% of 2013 Undifferentiated Advanced Biofuel mandate and the Biomass Based Diesel mandate under the current Renewable Fuel Standards (RFS 2). As a background to the Renewable Fuel Standards, the initial tax credit for Biodiesel/Renewable Diesel was implemented in 2005.  The RFS 2 standards were implemented in 2010 which was the same year that the DGD partnership was founded.  The RFS2 is overseen by the United States Environmental Protection Agency and mandates minimum usage requirements for different types of biofuels. It provides economic incentives (RINs) to make such production economically viable.  The following chart illustrates the existing biofuels mandate.  DGD qualifies for both Undifferentiated Advanced Biofuel and Biomass Based Diesel.
    


·       Source: Darling International Presentation

·      Strategic Partnership?  The idealized aspiration of maximizing resources efficiently is a well followed tradition in North America that is perhaps best encapsulated in the use of the buffalo for food, clothing, soap, and even religious alters by Native Americans.  With regards to biodiesel, some Wesson oil and alcohol, can help you cook up some “backyard biodiesel”.  But to produce biodiesel on a cost effective scale requires not only the feedstock, but also the appropriate processing equipment and transportation infrastructure. For instance, backyard biodiesel, cannot be transported through pipelines. Many corporations including Tyson Foods (in a partnership with Syntroleum) have struggled with processing the inedible remnants of their meat production into a viable biodiesel.  The DGD partnership has the right strategic partners in an effort to maximize our societal efficiency with regards to animal bi-products and used cooking oil.  Here is a description of the key players.  Darling International is a leading national provider of rendering and used cooking oil recycling solutions to the nation’s food industry.  The company collects and recycles animal bi-products and used cooking oil from poultry and meat processors, grocery stores, butcher shops, and food service establishments.  It processes these raw materials into finished products such as protein (primarily meat and bone meal), poultry meal, hides, and fats (poultry grease, yellow grease and bleachable fancy tallow).  It Perhaps it is the least glamorous business in the United States but without the readily available supply of feedstock that Darling can provide, the DGD partnership could not have rationally allocated over $400 million in capital expenditure to building the Norco facility.  This figure is more than twice the stated expenditure in the Tyson Foods project.   Valero is North America’s largest independent petroleum refiner and marketer.  The company brings expertise in refining and gasoline distribution, has refinery throughput capacity exceeding 1 billion gallons per year, and can market the product through its nearly 2000 retail gas stations.  Furthermore, the DGD facility is conveniently located next to Valero’s St. Charles refinery infrastructure. This allows DGD to ‘piggyback’ off of tremendous embedded infrastructure (e.g. wastestreams) and technological know-how of personnel as well as benefit from the proximate location to pipelines and waterways for ease of transport.  

·      Technology and Process: According to Valero and Darling management, here is a general description of the process.  The fats and greases can arrive via rail car or truck.  The facility can welcome 42 rail cars per day and 50 trucks per day.  This equate to 2.5 days and .75 days of daily facility processing capability, respectively.  The facility has 9 tanks which include 3 for storing raw material, 3 for mixing tanks prior to pretreatment, and 3 for use following treatment.  In total, there are 30 days of feedstock storage at the facility.  The pretreatment process is designed to remove impurities which will enhance the eco-fining catalyst and employs numerous redundancies due to the differentiated nature of the feedstock.  The Eco-fining technology, a product of Honeywell, is called UOP.  The process has 3 stages which ultimately converts the feedstock into a true hydrocarbon that maintains the same cold flow properties as in diesel fuel.  

·      Why is Diamond Green Diesel Preferable to Existing Biodiesel Alternatives used to Meet the RFSII mandate?  As referred to above, biodiesel lacks certain hydrocarbon properties which restrict it from being blended into diesel products.  In addition, it cannot be distributed in any quantity through a pipeline that transports jet fuel.  Therefore, biodiesel requires special tanks at distributors.  This has put it at a price disadvantage relative to diesel fuel without government incentives.  In contrast, the DGD product will have the requisite cold flow properties to use pipelines without a distinct segregation from other fuels. DGD will market at the price of traditional diesel (not at a discount) minus only the transportation costs to get to the ultimate marketing destination.  In addition, the cost of yellow grease and poultry fat which are DGD’s primary feedstocks are materially lower than competitive products like soybean oil that currently dominate the industry. So DGD is backed by significant corporate backers, government incentives which appear durable for the foreseeable future, and a compelling distribution model. If the facility does produce as advertised, are there any remaining questions about whether society should want this to be a part of our energy solution.

·       The Outstanding Moral Question: The population of planet Earth has expanded from roughly 800 million people in the year 1800 to roughly 7 billion today. Furthermore, increasing wealth has increased meat consumption. Specifically, it takes 2, 4, and 6 pounds of grains to produce 1 pound of chicken, pork, and beef, respectively.  As we eat more meat, we are eating more grain per capita.  Human population growth coupled with increasing meat diets juxtaposed against finite arable land poses a societal challenge. Various forms of fertilizers, seed innovations, and water utilization have enhanced productive yield per acre.  Nevertheless, yields are increasing at a slower rate.  The boundaries of innovation, for the time, have seemingly arrived. Specifically, according to the Food and Agricultural Organization of the United Nations, the 10-year average annual growth in crop yields at the end of the 1960’s was roughly 3.5%.  At the end of the 1970s, it was closer to 2.5%.  By the end of the 1980s and 1990s it was closer to 2.0%.  By the 2000, the 10-year average was approaching 1.5%.  Today it is closer to 1.3%.  We are generating diminishing marginal returns for our efforts.  Since world hunger is still a problem, using government subsidies to turn 30%-40% of the annual United States corn crop into ethanol through an energy intensive process is subject of significant public consternation.  In the case of DGD, there isn’t the same conflict of interest since the inputs are animal bi-products, used cooking oil, and potentially inedible corn oil.  This makes DGD a more “moral” energy choice than alternatives in the feed versus fuel debate.  

·      On financial viability of DGD: Even if DGD can produce diesel as its management has indicated, the ultimate economic viability still relies on government incentives through RIN credits.  A moving scale of RIN values, diesel fuel prices and processing costs will ultimately determine the economic viability of the project.  The estimated cost of production and distribution is slightly over $4 per gallon.  Assuming the machinery works as advertised, the one clear winner here is likely to be Darling International since it has increased the prospective market for its animal bi-products and used cooking oils by 10%.  Therefore, if the customers who buy their protein and fat products are not offering a high enough value for their bi-products and used cooking oils, they can ship the products to Norco.  Through the arbitrage of government incentive structures, they have created demand for their product which was not available previously and can use this demand to get preferred pricing in either the food or fuel market.  That is one Darling of a deal!
 

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  2. Eric-

    Do you have any insight to the viability of DGD with the new EPA mandates?

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