Fuel Forward: The Digest’s 2019 Enhanced Multi-Slide Guide to Renewable Energy Group

Quarterly Results Q&A

Q: The first thing I wanted to ask about is the BTC for 2018. Can you remind us what the cash value would be for REGI if that was reinstated tomorrow? What would you apply for from the IRS that would show up on your balance sheet?

Chad Stone, REG CFO: Craig, this is Chad. Thanks for the question. So the 2018 amount of the net benefit of the BTC is $237 million, and the net benefit for the first quarter is $5 million. So in total, that’s $292 million.

Q: But the onetime cash payment from the IRS would be a $237 million cash payment for 2018, is that correct, and then everything this year would be additive?

Chad Stone: Yes. That’s correct, that benefit.

Q: Second question, just a big-picture item. So there is some optimism out there for a trade settlement with China. But when we looked over the last year, soybeans, soybean oil prices have been compressed with this trade fight, seeing things trade in the $0.27 to $0.30 range on average for soybean oil. But over the same time period, distiller corn oil has actually rallied.

Would you expect a trade settlement with China to provide an uplift on soybean oil pricing? And the spread between soybean oil and distiller corn oil that was quite wide a couple years ago and narrowed over the course of the last year. Would you expect that to widen again, or that the rise in soybean oil prices would be accommodative for further increases in distiller corn oil pricing?

Chad Stone: Craig, this is Chad again. So first, I agree with your comment on the trade with China, that I believe what we’ve experienced is downward pressure on the entire soybean complex, including soybean oil. So I think that’s been a force at work to keep a lid on soybean oil prices. So that’s one part of the equation.

On the other side of the equation on distiller corn oil, I think there’s a couple of things going on there. First of all, it’s a lower carbon intensity feedstock that’s very advantaged for markets like California, Oregon, and others that give us a premium for the low CI, or the low carbon intensity. And that’s been very helpful, but that’s been supportive of strong demand for distiller corn oil. And then I would say take a look at the ethanol producers because they’ve had some challenging margins and operational environment, so the supply has been somewhat impacted.

The net of all that is we certainly have seen a significant amount of compression year-over-year in the spread between soybean oil and distiller corn oil and used cooking oil, and I think it’s because of those forces at work. The other variable out there that you’ve got to keep an eye on is growing supplies of palm oil. That keeps pressure, in addition to the China trade, that’s also keeping pressure on soybean oil prices.

So all that being said, I think that increasing demand and increasing premiums from the advantaged markets is going to continue to provide a floor for the low carbon intensity feedstocks, like animal fats, used cooking oil, inedible corn oil, or distiller corn oil. So the historical spread may not get back to where it used to be. It’s just my opinion. I know there’s lots of opinions out in the market and lots of other forces, but I’ll kind of stop there.

C. J. Warner, REG CEO: This is CJ. There’s a couple other interesting things to keep a very close eye on in the market with some fairly large dynamic. One of them is the swine flu epidemic. And the slaughter rates that have been required in China have been absolutely tragic. And as they’ve had to slaughter their herd, of course, the implication on the need for feed is going to change dramatically. And that is likely to put some pressure downward on soy prices in the near-term, so that’s a fairly significant thing for us to keep an eye on.

And the other dynamic, which I know people have been watching for, and we’re waiting for it to happen probably in the second half of 2019, is the effective IMO fuel standard for marine where the sulfur regulation is going to go down for marine fuel. And all views at this point and predictions are that the diesel demand to blend down the sulfur level in the marine pool is going to go up, and so ULSD prices are likely to spike in the second half of 2019.

Q: My next question is about the capital projects that you’ve been executing. I know there are a number of smaller projects that were in consideration at Geismar. As your most profitable facility, I could see many of those potentially being the highest return projects at RHE. Can you maybe discuss what you’re actually executing now and what you expect to continue to work through in the second quarter and this summer? How should we look at these specific projects impacting the ability of Geismar either to take advantage of the local waterways or sell into alternative markets that could have different dynamics of demand?

C. J. Warner: Yes, great question. And our capital plan is something we keep a close eye on and can seek to keep the momentum going. So we focus on the projects first in order of priority with the highest impact, and that’s kind of across the category. So safety, maintenance as well as strategy and growth all get their highest priority projects first in line. And in Geismar, we are continuing to do the engineering for access to the waterway as an example because that’s highly strategic for us.

Q: And then last question if I may, reinstatement of BTC, this is something we were all very comfortable, very confident in 9 months ago, and it’s done nothing but drag on. Now, I know that there was something that was supposed to happen and then the shutdown changed everything, but then with the change in the House, there’s a fairly different dynamic, I mean a dramatically different dynamic as far as the support and the votes, particularly given the hostility of Democrats to ag policies in the past.

Can you maybe highlight for us the specific items that give you confidence that the House will support putting the BTC reinstatement into some bill at some point this year? And can you just reaffirm for us that your key champions in the Senate are still with us and obviously committed to American ag?

C. J. Warner: Yes. Well, I’ll jump in on that, and then Chad can back me up. He’s had a lot of direct experience in Washington lately. It is no doubt frustrating to all of us, but we continue to hear and see and get feedback to us that it really isn’t a matter of if. It’s a matter of when. And we know it’s not just the BTC that has been having trouble actually being activated, but there are a lot of other things in Congress. So BTC in many ways appears to be a bit of a victim of the polarity that’s stymieing a lot of other movement, as well.

We do see actually ongoing growth in bipartisan support. So that’s a very good sign. And as you’ve pointed out, the dynamics in the Senate are changing, but the good thing is because there’s strong bipartisan support that’s not really affecting the resolve with which we see for the BTC to be attached to some other bill from the House to be brought and floated to the Senate, where the Senate can act upon it.

As you know, we have a strong champion on the Republican side in Chairman Grassley from the Ways and Means Committee, but the Ranking Democrat, Senator Wyden, is also a sponsor. And so that’s a very good sign. We have 27 co-sponsors of the bill. And there does appear to be a couple different vehicles that the bill could still be attached to in the coming weeks. One of them is retirement security. The other is the Tax Administration Bill. And we know from speaking to them that we have many Senators who are really just waiting for the House to float a bill so that they can attach this to it. Chad, do you want to add anything?

Chad Stone: Yes. I think that’s great. The only thing I would add is just, even as recently as yesterday, there was a D.C. fly-in of biodiesel producers, and it was hosted by a bipartisan, bicameral group of congress folks. And really, it was highlighting and demonstrating the types of good-paying jobs, a lot of times rural, a lot of times good-paying production jobs in communities that need those. And again, in the Senate, I think that’s been fairly well documented of the bipartisan support there.

Of the 27 cosponsors of that bill that CJ referenced, first of all, to get 27 congress folks to co-sponsor something is a lot. Nine of those 27 are House Ways and Means Democrats, so that’s important progress that the industry has made to make inroads to the newly in-power House Democrats, to make sure that they were on board with our issues and our industry and the types of things we’re trying to accomplish.

Q: Could you just talk about a little bit as to what you’re expecting here with the increase in production that you would be certain to get some sort of positive traction on the margin side?

C.J. Warner: Well, I guess the two are somewhat separate, but we continue to focus on underlying performance because we know the volume production is getting us a positive contribution margin. In the winter months, which we’re just coming out of now — some of us have still had snow just in the last week — we’ve been using our production capacity to build inventory and basically play and arbitrage with the lower feedstock prices that we tend to experience in the winter and the higher product margins that we get in the summertime. So that enables us to take advantage of that increased production. And of course, we are developing a very substantial BTC benefit as we’re doing that.

Q: And how much excess capacity do you have to keep producing right before we get into the summer months? Are you producing at maximum now? Or do you have more capabilities? I know because you just raised guidance for how many gallons you’re expecting to sell through.

C.J. Warner: Yes. Our guidance is based on our production capabilities and our improvement, and we’re able to sell everything that we produce.

Q: The capital spending plan you guys have in place. If I heard it correctly, you said you still have something like $65 million to $75 million left in the authorized plan. I was wondering if you could talk about a cadence of that CapEx plan.

C.J. Warner: :  I’ll start, and then I think it’ll be good for you to hear from our CFO in terms of the fiscal prudence that he’s put in place for our spending. But we do use, of course, a very strict stage gating policy, and so within that capital expenditure plan, as I mentioned earlier, we have a prioritization activity that we undertake and make sure that we’re working first on the highest-impact projects, which include some of the longer-term strategic items.

And in addition to the Geismar [to the] water project, another obvious example probably is the P66 co-engineering that we’re doing on that JV. But so far, we’ve been able to carry that natural cadence through and ensure that we are carrying through the project plan in the order that we would want to and be able to pull through the value that we would like. At the same time, our CFO ensures that we’re following some strict guidelines for fiscal prudence. So Chad, you might want to add some color to that.

Chad Stone: Sure. Thanks, CJ. So Patrick, to that point, I mean, if you look at first quarter, we had about $8 million of CapEx in first quarter. We had generally guided in the $70 million to $80 million range for the full year. And sometimes these projects take 12 to 15 months. So you can imagine, as we go out throughout the year, the sooner you have certainty around BTC, the more likely you execute on all these.

In the meantime, we’re going based on cash flow and forecasting and availability, obviously prioritizing safety first, maintenance first, but then we’ve got some very profitable, fast payback, rapid payback projects that are the first in the queue that we have underway. For example, we’ve got a great one at Seneca. We’ve talked several times about our planned venture with Phillips 66. Of course, there’s some engineering work going on with that, some improvements at Geismar and Seneca. So that said, the fiscal prudence is obviously driven by our cash forecasting and availability.

Q: As a follow-up question, on their recent call, Phillips 66 talked about that Ferndale project potentially being FID’d before year-end, which would time it for a 2022 startup. Is there anything on that that you can comment on? And is it in any way tied to the renewal of the BTC? Or is that a second issue?

C.J. Warner: No, we would just support our partner in that cadence for the project. We’re working closely together and (inaudible) stage-gating. So that enabled us to work together to get the decision-making at the right time and in the right place and ensure we’re spending capital wisely together. And it’s basically a schedule-driven project because we both want to get the [R&D] production going as soon as possible.

Q: A quick question on the deferred LCFS topic. So that I understand, during Q2 2019, you guys will not be able to book any LCFS credit, and all that — so that $25 million to $30 million that you’re supposed to be booking in Q2 is all pushed into Q3? Is that the right way to think about it?

Chad Stone: Yes. This is Chad, Alex. Think about it this way. Before that deferral, we normally would have been issued those credits from California in June and would have been able to monetize them. Now we’re going to get them in — let’s just say July because of the 1-month further delay. And I can’t record the benefit of those before we get them and deliver them. So that’s why, for us, there’s kind of a 1-quarter shift out.

And really, what California is doing is trying to improve their validation and auditing of people who comply with the program, so they’re kind of asking participants for more time so they can do better diligence. The way that affects us is our ability to get our hands on them and then sell them separately to customers is delayed slightly. So that’s why we’re really highlighting the impact on this second quarter. And then, going forward, we expect it to become ratable again.

Q. So in Q1 2019, you had your LCFS credit, but because the rule changed, it just — in Q2 2019, you booked zero. In Q3, you will resume this — you get to book 3 months’ worth of LCFS.

C.J. Warner:  Correct.

Chad Stone: That’s exactly right. And the other thing we said earlier in CJ’s comments is that quarter 1 2019 was $27 million higher than quarter 1 of 2018. And part of that is driven by a significant increase in the number of credits, in the amount of fuel we’re selling into California. And the other is attributable to a year ago LCFS credits were down near $100 per credit, and they’ve increased substantially. So they’ve become more — things like this have become more significant in dollar value to us, and that’s why we really wanted to flag this and get it on people’s radar so they can model and start to give a sense of what the value is to the quarter.

C.J. Warner:  To wrap up, everyone, we continue to deliver on the controllable elements of our plan and have put in place several exciting programs that we believe will accelerate growth into the future. We remain confident in our long-term earnings power and the value we continue to create. Now, before we close, Todd’s going to mention some upcoming investor events for REG. Todd?

Todd Robinson: Thanks, CJ. As shown on Slide 23, we will present at the BMO 13th Annual Farm to Market Conference on May 15th in New York. Attendance at this conference is invitation-only, so please contact your BMO sales representative if you want to attend or schedule one-on-one meetings with us. We will also be attending the Baird Consumer Technology and Services Conference June 4th through the 6th and the Roth 5th Annual London Conference June 17th through the 19th. Attendance at these conferences is invitation-only, so please contact your sales representative if you want to attend or schedule one-on-one meetings.

Lastly, our Annual Meeting will take place on May 8th at 10:00 at our office in Ames, Iowa. Doors will open at 9:00 for registration.