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Home » BioRefineries, Business News/Analysis, Federal Legislation, Federal Regulation, Illinois, Policy

An Alternative View of Biodiesel Production Profits: The Role of Retroactively Reinstated Blender Tax Credits

Submitted by on April 13, 2017 – 1:28 pmNo Comment

by Scott Irwin (Farm Doc Daily/University of Illinois) Previous farmdoc daily articles (e.g. January 28, 2015; February 11, 2016; March 1, 2017) have documented a "feast or famine" pattern in production profitability of the U.S. biodiesel production industry. The feast or famine pattern is closely tied to expiration of the biodiesel tax credit in the face of binding RFS biodiesel mandates. More specifically, biodiesel profits spike in years when the credit expires because diesel blenders face a binding RFS biodiesel mandate and they can effectively purchase biodiesel at a discount in the current year, due to the tax credit, in order to meet mandates in later years. However, this is not necessarily the end of the story regarding the impact of an expiring tax credit on biodiesel production profits. In previous years when the tax credit lapsed, it has been reinstated retroactively, and it is widely-reported that blenders share the retroactive tax credits with producers. Previous estimates of biodiesel production profits reported in farmdoc daily articles have not accounted for this additional source of revenue. The purpose of today's article is to analyze the potential impact of shared retroactive tax credits on biodiesel production profits.

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Previous analysis of U.S. biodiesel production profitability has not accounted for a little known feature of marketing agreements between biodiesel producers and blenders. These agreements include provisions for sharing the biodiesel tax credit if it is reinstated retroactively. Since the biodiesel tax credit is $1 per gallon, sharing of the credit could have a major impact on profitability in years where the credit is reinstated (2010, 2012, 2014, and 2015). We estimate biodiesel production profits for a representative plant with 50/50 sharing of retroactively reinstated tax credit revenue and without sharing. A 50/50 split is reportedly the norm in the industry. The impact of adding the retroactive tax credit revenue to profits is striking, increasing returns by $15 million in each of the years when the credit lapsed. The effect on the overall profitability picture is equally striking. The average return to equity holders without adjusting for retroactive tax revenue is 10.5 percent over 2007-2016 and the standard deviation, a measure of risk, is 30.2 percent. With the addition of $0.50 per gallon in years when the credit lapsed, the average return increases to a whopping 36.1 percent and the standard deviation drops to 25.0 percent.

In sum, consideration of the tax credit revenue garnered through sharing agreements yields a very different picture of the profitability of U.S. biodiesel production. Unfortunately, we do not have comprehensive data on the actual prevalence and terms of such agreements, so the estimates in this article should be considered suggestive rather than definitive. We also have not addressed the rationale for the sharing agreements in the first place. We will take up that issue in an upcoming farmdoc daily article.  READ MORE

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