Big Four Refiners See Growth in Animal Fat as Gas Use Wanes

(Bloomberg) -- Animal fat is gaining new prominence among the top U.S. petroleum refiners, who see it as a potential growth engine in a climate change-driven future.

Marathon Petroleum Corp., Phillips 66 and HollyFrontier Corp. are joining Valero Energy Corp., a pioneer in the field, in developing a range of new projects designed to produce what’s been dubbed “renewable diesel,” a second-generation fuel made from animal fat that’s almost chemically identical to the petroleum form and offers the same performance.

Early forms of biodiesel have been available to drivers for decades, but lacked the punch of the petroleum-based fuel, particularly in cold weather. The newest version, processed at much higher temperatures in specialized equipment, solves that issue. Valero’s existing joint venture could generate $1.4 billion in earnings by 2024, according to a report by the research firm Piper Jaffray. That’s opening up eyes in the industry.

“Valero is the only one that’s broken it out on its own and shown how good this thing is,” said Patrick Flam, a Piper Jaffray analyst who has been following the emergence of renewable diesel. “Others are looking at this and they’re saying, ‘Oh man those returns are actually pretty compelling.’”

The push toward the new fuel, which avoids the nasty emissions of petroleum-based diesel, comes at a time when gasoline use by drivers is flagging as vehicles get more fuel efficient, drivers become more concerned about climate change and states beef up their environmental regulations.

“There is a pretty good drive from the shareholder side that we need to be growing this business somehow or another,” Flam said. “Traditional refining is probably not the best way to do it at the moment.”

While the renewable fuel is more costly than the petroleum-based version on a wholesale basis, the pump price is competitive thanks to tax credits designed to promote use of the environmentally friendly alternative.

Renewable diesel first popped up about 10 years ago. It uses the same feedstock as the original biofuel, the scraps and fat left over when food companies process their products for the market, as well as leftover grease from restaurants, according to the Washington-based National Biodiesel Board. Valero is the second-biggest maker of renewable diesel, trailing only Helsinki-based Neste Oyj. The San Antonio-based refiner, which owns a 50% stake in Diamond Green Diesel, has invested about $1 billion in developing and producing the fuel.

“We just think it’s a really good business,” Valero Chief Executive Officer Joe Gorder told analysts and investors last month on a conference call. “When we look at the opportunities to produce products where there is going to be growth in the market, and they’re going to have sustainably high margins, we look to renewable diesel.”

While it’s been tough to break driver habits, the combination of renewable diesel and biodiesel has at least chipped away at traditional diesel’s dominance.

About 2.6 billion gallons of both biodiesels were produced last year, according to the biodiesel board. The industry group forecasts production of the fuels to grow roughly 5% a year in the U.S. for the near future. By contrast, the petroleum diesel market for vehicle use stands at about 40 billion gallons.

Here’s how the development of renewable diesel breaks down among the refiners:

• Valero, working with Diamond Green Diesel, aims to produce 675 million gallons a year of renewable diesel, and is getting a $1.26 per-gallon margin, according to the Piper Jaffray report.
• HollyFrontier announced last week it will expand its Artesia, New Mexico, plant with new equipment to make as much as 125 million gallons a year, using soybean oil and other renewable feedstocks. It expects an internal rate of return of as much as 30% on the initiative.
• Phillips 66 plans several projects stretching from the U.K. to Washington state, including two plants built in Nevada in the next year with Ryze Renewables, its joint venture partner. Eventually, the biggest U.S. fuel maker expects to have 650 million gallons a year of capacity contributing $800 million before interest, taxes, depreciation and amortization, according to Piper Jaffray.
• Marathon, the No. 2 U.S. refiner, has begin work to convert an existing refinery in North Dakota into a renewable diesel plant it expects to contribute $180 million yearly in Ebitda.

To contact the reporters on this story: David Wethe in Houston at dwethe@bloomberg.net;Jeffrey Bair in Houston at jbair4@bloomberg.net

To contact the editors responsible for this story: Simon Casey at scasey4@bloomberg.net, Reg Gale, Carlos Caminada

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