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ICCT suggests minor changes to Fed tax policy to cut higher investment risk of 2nd-gen biofuels and advance the industry

Minor changes to an existing Federal tax incentive for second-generation biofuels (i.e., biofuel made from cellulose, algae, duckweed, or cyanobacteria) could mitigate the current elevated risk of investing in the industry that is retarding its advance, according to a new paper by a team from the International Council on Clean Transportation (ICCT) and Johns Hopkins University. Some of the ICCT recommendations are mirrored in the recently released Baucus draft proposal for tax reform (earlier post), notes Dr. Chris Malins of the ICCT, one of the study’s co-authors.

Previous studies have attempted to explain the slow commercialization of cellulosic and algal biofuels qualitatively, however few have presented financial analysis across the sector, the authors observe. Using publicly available financial data, they applied investment analysis tools (the capital assets pricing model, CAPM) that are generally not applied to this space in order to develop a more rigorous understanding of the investment risk in the industry.

Over the last decade, the second-generation biofuels industry has struggled to reach commercialization. The United States and the European Union have some of the world’s most aggressive policies for alternative fuel promotion, including volumetric mandates, lifecycle fuel-carbon-intensity requirements, and fuel-taxation schemes. But these policies have not yet succeeded in bringing substantial volumes of new advanced biofuels to market. The Renewable Fuel Standard (RFS2) in the U.S. has proved to be a limited driver thus far, with the U.S. Environmental Protection Agency drastically lowering the amount of cellulosic biofuel that must be blended into gasoline and diesel each year. In addition, the industry faces barriers from the impending “blend wall” of 10% ethanol in gasoline and uncertainty regarding policies and oil prices.

…Using the capital assets pricing model (CAPM), we calculate beta coefficients, a metric of nondiversifiable market risk, from 2010 (post-financial crisis) to the present for nine companies that are producing or have a significant stake in cellulosic or algal biofuels. Seven of the nine companies have beta values greater than 1.0, indicating greater volatility than the stock market as a whole. Investors therefore see these companies as inherently riskier than other opportunities and, based on the CAPM analysis, would require a 15% average expected annual rate of return, compared with the S&P 500’s 8% return.

The elevated risk seen in second-generation biofuel companies is one dimension that very likely contributes to unsteady and insufficient investment and the poor financial health of the industry. A direct implication of this analysis is that additional policy measures are needed to reduce risk and build confidence in second-generation biofuel companies in the early stages of commercialization.

—Miller et al.

The authors used Amyris, Gevo, Green Plains Renewable Energy, KiOR, Lignol Energy Corp., Pacific Ethanol, Rentech Inc., Solazyme and Verenium in their analysis. The calculations showed that the CAPM return for these companies averages 15% (with a range from -4% to 27%). All of the publicly traded companies except KiOR have beta coefficients larger than 1, suggesting that these companies’ stock prices are more volatile than the market, on average. High beta values, up to 4 in the case of these second-generation biofuel companies, indicate substantially higher volatility and risk than most industries, the authors said.

Beta coefficients and expected return on investment for second-generation biofuel companies. Miller et al. Click to enlarge.

The study identified four specific changes to the US tax code that could help accelerate the commercialization of second-generation biofuels. While a Federal tax credit for the production of second-generation biofuels exists, its use has remained limited. The proposed changes are:

  1. Extend the existing second generation biofuel producer tax credit until 1 billion cellulosic RINs have been generated; at this point, support will no longer be needed.

  2. Allow companies eligible for the second-generation biofuel producer tax credit to opt instead for the business energy investment tax credit, worth 30% of expenditures on new property used in the production of second-generation biofuel or in new or retrofitted facilities. The construction phase is when biofuel companies need financial certainty to attract investors.

  3. Allowing eligible biofuel producers to opt for a grant in lieu of tax credit enabling them to use this support in the early stages, as they may not have tax liability against which to claim the credit for several years after construction begins.

  4. Harmonizing definitions of eligible pathways between this tax credit and the RFS2.

The changes are relatively modest and with clear precedents, the authors said, and fall squarely in line with Congress’s intention that the tax code and fuels policy promote the development of innovative domestic technology, displace petroleum consumption, and help spur long-term reductions in carbon emissions from the transport sector.

These adjustments would help achieve the goals of the U.S. RFS and California’s Low Carbon Fuel Standard. Without such policy changes, second-generation biofuel production will continue to fall far short of targets. The technology for these advanced low-carbon biofuels is here, but the financing and the investment security is not. Complementary fiscal policy will be a critical part of the shift toward a more sustainable fuel base in the United States.

—Miller et al.



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