Energy Transition, Part VI: Initiating on Next-Generation Fuels

THE COWEN INSIGHT

We initiate on Next-Generation Fuels with a focus on renewable diesel and Low Carbon Fuel Standards (LCFS). There are regulatory frameworks in place in North America and Europe to support profitable biofuel businesses, particularly renewable diesel. In the US, we see renewable diesel margins declining by $1/gal from 2018-2019 to 2025. In Europe, we see current growth fulfilling mandated blending to 2025. This view is based on our proprietary supply/demand balances and LCFS model.

Renewable Diesel: A Solution That Works Today

We are expanding the scope of our next-generation fuels coverage that began in June 2020 with our report on US renewable diesel. We are initiating today on next-generation fuels companies. This widens our focus beyond the US to European biofuels.

Biofuels, more specifically renewable diesel (RD) and sustainable aviation fuel (SAF), are gaining market interest as investors gravitate toward sustainability-driven companies. Like many other renewables, RD and SAF are gaining traction in OECD America and Europe, supported by market regulations.

Unlike other renewables, however, the current regulatory frameworks provide sufficient return rates to support rapid growth. These biofuels support the energy transition as they have lower carbon emissions (~50% or better) than traditional diesel.

What Is Proprietary About This Report?

This report focuses on renewable diesel, a topic relevant to pure-play renewables, refiners, and integrated oil companies. We include EU and US balances for production capacity against available regional feedstocks. We also developed a proprietary model on Low Carbon Fuel Standards (LCFS), a critical regulatory support for RD profitability. We bring the margin drivers together for feedstock-dependent margin forecasts. Additionally, we explore the potential impact from SAF.

Initiating On Next-Generation Fuels

We launch coverage of Next-Generation Fuels, focusing on renewable diesel names and those levered to Clean Fuel Standard programs. We caution that while the three stocks we are launching on are part of the same sector, they have unique business drivers. Specifically, these drivers are renewable diesel and renewable natural gas (RNG).

Forecast US Margins To Decline By ~$1/Gal To $1/Gal

US and EU renewable diesel margins have somewhat different drivers. Therefore we derive different margin forecasts. We forecast US RD EBITDA margins to compress by ~$1/gal from 2018-2019 levels to modestly above $1/gal in 2024 before rebounding marginally in 2025. However, even at these levels, companies should be incentivized to grow capacity. The margin declines are driven by an increase in vegetable feedstock prices and expected temporary decline in LCFS credits late 2023 through 2024.