TLC Logistics Management

Betting on Biodiesel

It's a good chance that fuel made from vegetable and animal feedstocks and then blended with diesel will some day be commonplace in trucking.

Oliver B.Patton
Washington Editor

Biodiesel is a pioneer industry. Its journey is in its early stages and will take years, but chances are good that fuel made from vegetable and animal feedstocks and blended with diesel will someday become commonplace in trucking.

This is not an absolutely sure thing.

Much is made of biodiesel's properties - clean-burning, renewable, an economic engine for rural revitalization and a step toward energy independence. But those claims must be tempered by the day-to-day reality of biofuel quality, production and distribution, engine performance, federal and state tax policy and the global petroleum market.

Start with the big picture. The trucking industry burns about 40 billion gallons of diesel fuel a year. U.S. biofuel refiners aim to brew about 2 billion gallons from vegetable and animal feedstocks by 2015, up from about 250 million gallons this year. So in eight years biofuel could make about a 5 percent contribution to the trucking industry's fuel supply.

Rich Moskowitz, who handles biodiesel issues at the American Trucking Associations, put it this way: "We are not going to grow our way into diesel independence"

That small but significant portion of the petroleum diesel market is the background against which biodiesel's operational, environmental and strategic attributes must be measured.

While biodiesel is not the fuel that will liberate heavy-duty transportation from the whims of the petroleum market, it is the harbinger of a future that will include a variety of fuels rather than just the old standby of diesel. It also is attracting the attention of a growing number of investors.

Weston Heide, senior manager of Global Energy Markets for Deloitte & Touche LLP, provides business services such as auditing, accounting, risk management, commodity transactions and tax advice to the emerging biodiesel industry.

"I think that the most important thing we can think of here is that (biodiesel) creates an environment in which people are looking for alternative and diverse sources of energy," he said. "The investment community is looking at all types of clean, renewable energy. In biodiesel's case there is a tremendous growth opportunity. If you just look at what, for example, a 2 percent biodiesel blend could mean relative to the overall distillate (diesel) market relative to the U.S. alone, let alone globally, it really presents an attractive opportunity."

Thomas Dorr, undersecretary for Rural Development at the U.S. Department of Agriculture, puts a high-torque spin on the same observation: "(Alternative fuels are) probably the greatest new opportunity for investment, for growth and for wealth creation for America in our lifetimes."

Dorr, who was speaking to agricultural carriers gathered recently in Washington, D.C., was referencing President Bush's call in his January 2007 State of the Union address for mandatory increases in alternative fuels. Bush wants Congress to set a goal of reducing gasoline use by 20 percent in the next 10 years, partly by increasing fuel efficiency and partly by expanding alternative and renewable fuel supplies to 35 billion gallons by 2017.

The bulk of the alternative fuel will be the gasoline additive ethanol. Ethanol is derived mainly from corn right now, but that particular feedstock has practical and political limitations. For example, demand for corn has risen to the point that it is affecting the price of tortillas in Mexico, setting up a conflict between fuel and food. Scientists and policy makers believe ethanol needs to migrate from corn to other "cellulosic" matter such as agricultural waste and switchgrass, but this will require technological breakthroughs to bring processing prices down.

Rep. Collin Peterson, D-Minn., chairs the House Agriculture Committee and heads the effort to write this year's farm bill - a key legislative vehicle for alternative fuel policy. He recently told the National Biodiesel Board that the U.S. will stop building ethanol plants within five years, saying, "There's a limit on how far we can go."

"To get where I want to get - 50 percent of our fuel out of agriculture - we need to go to cellulosic ethanol, and we will," he said. "Switchgrass, for example, will produce twice as much ethanol per acre as corn. That's going to be the big focus of our farm bill."

A Complex Market

Currently, the fuel that is blended with diesel to make biodiesel comes mainly from soybean oil, although other vegetable oils - palm oil, for example, and even used fryer oil - and animal fats also are used. Each feedstock has its own chemical, economic and political characteristics, all of which interact to create a fluid and complex supply-side market.

Take, for example, the recent announcement by ConocoPhillips and Tyson Foods that they have developed a new process to refine animal fats into a biofuel. ConocoPhillips says it can process the feedstocks in its refineries, blend the biofuel in concentrations of 5 percent to 10 percent with its diesel product, and distribute the blend in its pipelines. Tyson, the world's largest processor of chicken, beef and pork, will supply the animal fats.

This "renewable diesel," as ConocoPhillips calls it, must be cleared by the Environmental Protection Agency, but is scheduled to come to market by the end of the year. ConocoPhillips also is processing vegetable feedstocks at its plant in Ireland and is evaluating whether or not to bring that process to the U.S., says company spokesman Phil Blackburn.

This product is made from a refining process that is different than the one used to make soy-based biofuel, and it could change the biodiesel market in two significant ways.

For one, it may signal a change in the current biodiesel distribution system, and possibly the creation of a second biodiesel industry.

Currently, most biofuel is refined at plants that are close to the fields where the feedstock is grown, and is distributed by truck or rail to diesel distributors who manage the blending. This logistical circumstance, which makes biodiesel more a regional fuel than a national one, arises in part from the reluctance of petroleum refiners to allow biofuels to enter their pipelines. They fear that the solvent properties of biofuel can break down deposits in the pipelines and contaminate other products such as jet fuel.

ConocoPhillips' move would alter the status quo by introducing the economies of scale that accrue from producing fuel in a large refinery, and the distribution savings from using pipelines rather than trucks.

Over the next three to five years, ConocoPhillips will spend $100 million on renewable diesel, says CEO James Mulva. The company expects to be producing 175 million gallons a year within 18 months of startup, which will amount to 3 percent of the company's domestic diesel output, Blackburn says.

The other important aspect of the deal is that it relies on a tax interpretation by the U.S. Treasury Department that gives ConocoPhillips a dollar-per-gallon tax credit for the fuel. ConocoPhillips convinced the IRS that a credit Congress originally gave to promote a new refining process for turning waste, including poultry offal, into boiler fuel should also apply to its business.

The credit makes renewable diesel "marginally commercial," Blackburn says. Without the credit, he says, it is not commercial.

The biodiesel industry, which has its own dollar-per-gallon blender's credit from the IRS as well as tax incentives in some states, views this tax development with absolute alarm.

"We oppose the IRS ruling," says Joe Jobe, CEO of the National Biodiesel Board. "It's bad public policy. It's bad energy policy. It's very bad agriculture policy. It's extremely bad fiscal policy."

An NBB statement goes right to the heart of the matter: "The oil companies could put a stranglehold on materials used to make biodiesel, stunting the growth of the biodiesel industry."

In addition, Jobe argues, the incentive subsidizes oil companies without adding any new refining capacity, does nothing to sustain the rural revitalization that biodiesel is driving, and creates an unexpected drain on the U.S. treasury. The NBB is pursuing legislative relief on Capitol Hill.

The ConocoPhillips-Tyson deal illustrates just part of the turbulence on the supply side of biofuels.

In the biodiesel sector, for example, pricing is driven by the blender's credit and by fluctuations in commodity prices. The blender's credit is necessary for most producers to be profitable, although that is changing, says Heide of Deloitte & Touche. Some producers have grown and improved operations to the point that they can make money without it - depending on the price of feedstocks.

"You definitely have volatility in feedstocks," Heide says. "In the past year soybean oil has gone up substantially - it's now up to 35 cents per pound on the Chicago Board of Trade. This can make the economics a little challenging."

Charles "Shorty" Whittington is president of a truck line, Grammer Industries, and of a biofuel enterprise, Integrity Biofuels, which makes him perhaps the preeminent pioneer in the business (See related story, page 62).

His take on the supply side: "The economics of biodiesel are hard to pin down - extremely complex and in constant motion, propelled by local, regional, national and global forces that are hard to understand and impossible to control. It takes a lot of nerve to play this game."

Given the economic and political turbulence on the supply side, not to mention questions about the quality and performance of biodiesel, it is no wonder that trucking interests are approaching biodiesel with their eyes wide open.

The American Trucking Associations sees biodiesel as a way to extend the diesel supply and it supports managed growth of the industry.

At this point, ATA wants to stick to a low blend - 2 percent by 2015 is a reasonable goal, Moskowitz says.

"We hope that research and experience will lead to higher blends, but we're not there yet," ATA President and CEO Bill Graves recently told the NBB. "That should not be taken as an unwillingness to embrace higher percentage blends.

The Quality Question

The problem revolves around the market uncertainties described by Heide and Whittington - and around the quality of the fuel.

"I can tell you first hand that while biodiesel is relatively simple to manufacture, high-quality biodiesel is very difficult to produce consistently," Shorty Whittington told a panel of senators at a hearing earlier this year.

Problems show up when the biofuel blender or distributor gets a product that has not gone through a complete quality process - the fuel contains water or too much glycerin, a byproduct of the refining method, Whittington told HDT.

Also, the fuel requires additives to maintain its flow properties in cold weather. Trucking companies learned this the hard way in Minnesota, which in 2005 began requiring 2 percent biofuel content in diesel that is sold in the state. Carriers that used the B2 blend found their filters clogging up in winter, an incident that got the National Biodiesel Board scrambling to upgrade industry performance.

On the other hand, Whittington and others say that if the fuel comes from good feedstock and is refined and blended properly, it works just fine. Whittington is running some of his trucks on B20, and used B10 in some through this past winter. "Once it's blended properly, we're having great luck."

The mix of biodiesel with ultra low sulfur diesel raises questions, Whittington acknowledges. "We have found now, when you look at some of the major producers of ULSD, their processes can vary greatly and it can have a large effect on the product. Then you add a little bit of questionable biofuel and you have a real problem. The trucking industry will take one unknown, but why take a chance on two or three unknowns?"

The National Biodiesel Board is well aware of trucking's concerns about quality. It has put together a voluntary program called BQ9000 designed to promote compliance with guidelines for biodiesel set by the international quality standards group ASTM (the ASTM 6751 standard). That program is a work in progress. At this point just 40 percent of the biodiesel industry has made the commitment. (For more on fuel quality issues with biodiesel and ULSD, see story beginning on page 30.)

ATA wants to see the federal government step into a quality enforcement role. "It is a mistake for the federal government to promote biodiesel and at the same time abrogate its responsibility to ensure biodiesel quality," says ATA's Moskowitz.

State weights and measures agencies are supposed to be enforcing quality, but the right outfit for the job is the Environmental Protection Agency, he says. EPA already has fuel-testing labs around the country as part of its reformulated gasoline program.

"And," he added, "they have an enforcement division that has experience in bringing cases against fuel producers who are making off-spec gas."

The Control Question

Concerns about quality and enforcement inevitably lead to the overarching issue of who should set biodiesel standards - the states or the federal government.

Until now it has been a matter for the states. Minnesota, for example, has implemented its own 2 percent mandate. Washington and Louisiana have laws that are supposed to take effect next year that will require 2 percent biodiesel consumption over the course of a year. And New Mexico has set a 5 percent standard to take effect in 2012.

For the trucking industry, this situation creates the risk of multiplying current problems with boutique fuels - different diesel standards in different states. And in this case the multiplier is a fuel whose quality may be unknown and is at this point not adequately regulated.

To solve this problem, ATA and the National Biodiesel Board are working on legislation that would set a national standard for a biodiesel blend.

What ATA wants is a voluntary standard so carriers can use biodiesel where it makes sense to use it - in the farm belt, for example, where most biodiesel is refined, or near ports where refineries might use imported feedstocks.

While ATA would prefer a lower blend to start, a political consensus around a 5 percent blend seems to be emerging, Moskowitz says.

Whatever blend level is set, ATA wants there to be a safety valve in the event that commodity prices take an unexpected upward turn and drive up the cost of biodiesel. The secretaries of Energy and Agriculture should have the power to jointly adjust the mandate so carriers are not hit with an uncontrollable spike in costs, Moskowitz says.

Also, the standard should include a labeling requirement so carriers can know exactly what biodiesel blend is going into their tanks. "We need to be educated consumers. If it's February and we're refueling in Southern Indiana on the way to North Dakota, we might want to be careful about the amount of biodiesel we use because of its cold-weather performance."

In political terms, these issues are relatively straightforward compared to the difficulty of passing a law that pre-empts the states' right to set their own diesel standards.

House Agriculture Committee Chairman Peterson is keen to move biodiesel along. But state pre-emption will be hard to achieve, he adds.

Peterson's farm bill is due to be completed this year. Meanwhile, there are at least 25 measures in Congress that address biodiesel in one way or another - a level of activity that reflects the public's intense interest in cleaner, renewable fuels.

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