Biofuels Cash In on US Tax Credits: Analyst Reaction

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This is Kamala Shelling, and you're listening to Switched On, the Bloomberg NEF podcast.

Biofuel producers in the U.S. had been waiting for years to find out how the so-called 45-Z tax credits will be calculated.

That guidance is finally here, so today we're bringing you another analyst reaction podcast,

considering what this specific event means for the energy transition more broadly.

With me at the microphone is Jade Patterson, a BNF specialist in renewable fuels.

According to the title of his note, Darian swine win big in new U.S. biofuel guidance.

But just how much can they hope to earn, and where will all that renewable fuel go?

BNF clients can find this as well as other analyst reactions by heading to BNF Go on the Bloomberg Terminal, or at bnef.com.

If you'd like to learn more about how BNF approaches strategy research on the energy transition,

including developments in commodity markets, trends across different sectors,

and the cross-cutting technologies shaping the future, you can find more information on bnef.com.

And if you'd like to speak with a member of our team about becoming a client,

email us at sales.bnef at Bloomberg.net.

So let's dive in and discuss this new biofuels ruling with Jade.

Welcome, Jade. Thank you so much for being here.

Thanks, Kamla. That's great to be here.

So biofuel producers have been waiting literally years for this final guidance on this 45Z tax credit.

So what exactly does it say?

Yeah, that's a great question.

So essentially this tax credit right was part of the present Biden's Inflation Reduction Act that was passed in 2022.

So producers have been waiting years for this guidance to be passed.

The Biden administration punted on actually giving out guidance.

And so it was left up to the Trump administration to essentially finalize how this would all work out.

And really, there wasn't a ton of changes that were made.

It was essentially some tweaks that were made in the one big, beautiful bill that were essentially

treasury kind of confirming and, you know, essentially giving some examples of how this would work.

And so one of the big things that we wanted to highlight here was essentially,

treasury saying we will enable negative emissions scores to be calculated.

And also what that means is, you know, dairy and swine projects that have these negative CI scores

and specifically are called out in the 45Z as being allowed to have negative emissions

are going to get a much higher credit value compared to other fuel sources for RNG

as well as other biofuels like ethanol and biodiesel.

There were a lot of terms there that I'm going to ask you to break down in a moment.

But for starters, your note says and you've just said that swine and dairy farmers are really coming out ahead.

So what actually is it from the swine and dairy farms that is going to be turning into a biofuel

and what kind of biofuel is it?

Yeah, so I'll kind of give a quick overview of how RNG is typically produced, right?

And RNG is renewable natural gas.

Renewable natural gas, yes.

And so what happens is, in general, what you have this organic matter could be, you know,

biomass from a landfill or manure from a dairy farm when not decomposes it produces methane and CO2.

Well, what renewable natural gas projects do is they strip out that CO2, they capture that methane

and then they use that as natural gas, which is essentially we use in our homes

and is all natural gas in pipelines today.

And so that's what we're using here.

And so the reason to kind of go to your next question on what makes them negative,

essentially what you're doing, and if you're using renewable natural gas for a dairy project,

you are avoiding the methane emissions that would have been released from that project.

And that's how you get this negative score is this sort of counterfactual that says,

okay, this methane would have been avoided.

Now this project is in place.

You're avoiding those methane emissions and therefore you can have this negative CI score,

which can sometimes be upwards of negative 300 to 600,

negative 600 grams of CO2 per megajoule.

So very, very low low emissions.

That's amazing.

So instead of saying these are the emissions associated with burning that natural gas,

that renewable natural gas, it says we're going to be burning some kinds of natural gas

anyway.

And in circumstance A, I'm burning natural gas, but this manure is off-gassing,

so to speak, methane.

And as circumstance B, so you have both the natural gas I'm burning and the methane from the manure,

but in circumstance B, we're using that so the manure is not emitting methane to the atmosphere.

That's why it's negative.

So the baseline is the assumption that methane will be used anyway.

Exactly.

You're not only avoiding use of fossil fuels,

you're avoiding the release of a more potent greenhouse gas,

which methane compared to CO2 is around, yeah, depending on the time frame around,

20 to 8 times more potent of a greenhouse gas than CO2.

So then another thing you said was CI, which stands for carbon intensity.

So how does that relate to these negative emissions,

and how does it work in the calculation for this tax credit?

Yeah, yeah.

And carbon intensity score is essentially another term used for the life cycle emissions.

And so this is really important when calculating the tax credit value.

And that's what we've been focused on this whole process is how does this tax credit value get calculated?

The formula is actually fairly simple.

You have two functions.

You have a base rate, which if you prevailing wages are met, it was $1.

And then you also have this emissions factor.

And the emissions factor is essentially, without getting too complicated with the math,

is essentially calculating what's your percent reduction.

So just, for example, if you have, let's say, a 50 percent reduction in your emissions,

and just ballparking here, you would get about 50 cents per gallon for your fuel.

And so what happens, though, with these negative CI scores in this formula,

the way it works, and you can go and look it up, is essentially,

if you have a negative CI value, your emissions factor can be greater than one.

And so, as you can imagine, as your emissions score goes from, you know, say one to like seven,

you know, you're multiplying that, you know, seven times the base rate of one.

So now you're getting $7 per gallon.

And so that's why these negative emissions are so important for these projects,

why a lot of people were wondering how this was going to work.

And luckily, Treasury gave some examples in their guidance on how that would actually be calculated.

And again, this is only for manure-based projects.

It doesn't qualify for other types of fuels that might have a negative CI score as well.

So you have this amazing chart in your React showing what producers could hope to get for different types of RNG.

And for manure from dairy farms and pig farms, it's off the chart high.

As you just said, you know, mean value of about $7.

For the other things you looked at, so that's landfill waste, wastewater treatment,

and then other forms of organic waste, it's much lower.

We're talking 70 cents.

So a factor of 10 there.

Why is the manure so much higher?

Yeah, so a lot of that really comes back to, again, this baseline assumption on what's going on with the methane.

And so with manure projects, you're assuming that the methane would not be captured otherwise.

And so you're getting that methane avoidance, which gets you that really low CI.

And then with wastewater treatment plans, landfills, those are a lot of the other main sources for producing RNG.

The baseline assumption there is that that methane was already being captured.

And so they don't get that additional credit for capturing that methane because it's assumed that would already happen.

And so they're essentially in their CI score, they're just dispoising fossil fuels and getting credit for that.

And so most of them, what that means is they can only really go down to zero as their CI score.

Right. So whereas wastewater treatment is likely contained, a cow farm may not be.

Exactly.

Let's talk about where all this renewable natural gas is going.

You mentioned in your react that most RNG these days is going into the road transport sector.

But that sector is already pretty saturated.

So where is this manure-based RNG going to go?

That's a great question.

So essentially what's likely going to happen is because the market is already saturated,

producers are going to have to incentivize fleets or natural gas vehicle consumers to buy their gas.

And so the way they can do that is they can actually share the credit incentives with those off-takers.

And so they're going to have to sweeten that deal.

And because the way these incentives are structured, you have the 45-Z.

So there are other programs like the California LCFS program which adds additional credit value because these all stack.

And that stands for low-grub and fuel standard LCFS.

Low-carbon fuel standard, that's right.

And so what will happen is because these dairy and manure producers will have such a much higher credit value,

they can incentivize these off-takers to buy their gas instead of someone else's.

We've already seen this happen in California's program where essentially what happened is dairy has gone in and really cannibalized the usage of landfills.

So those landfills R&G projects are going to have to find a different home.

And so they'll likely go to other markets whether it's gas utilities or maybe feeling data centers or going into shipping field.

There's lots of other ways they can go.

But likely dairy is going to keep focusing it on the road transport where the incentives are the highest.

So that was actually my next question.

Where is that displaced R&G that's been going into cars and trucks and bands up to this point?

Where is that going?

Yeah, it kind of remains to be seen.

Because like I said, most of the R&G day, I'd say 80% or more, is going into the road transport sector because of those high incentive values.

The other markets, whether it be electricity generation or heating for homes, they don't have those same incentive programs.

And you really do need those because when we think about producing renewable natural gas, it's much more expensive than fossil natural gas.

On the order of let's say three to five times more expensive at minimum.

So they really need those incentives in order to make it profitable.

And so it's really going to be a question of what are the policy programs they can go into?

Shipping is actually one of the big ones.

We have potentially big shipping mandates coming in for international maritime organization, IMO.

You also have refuel EU in Europe.

And so some of those R&G could be converted into shipping fuels like biomethanol or bio-LNG.

And so we'll kind of have to see how that shakes out.

And is R&G a drop in fuel?

So chemically identical to standard methane and therefore can be used in any usual methane situation?

That's correct, Kamala.

It is 100% interchangeable with traditional fossil gas.

So anywhere you're using like natural gas today, whether it be an LNG or to make a methanol, you can drop in RNG and it's no change in your process.

And finally, this tax credit expires in just a few years, December 31st, 2029.

So what happens after that to farmer suddenly stop making manure based R&G?

Is it a situation of they have built it?

They've come.

The infrastructure is in place.

This is going great.

We keep going forward.

What do you think is going to happen next?

Yeah, I mean, it's hard to speculate on where we're going to be politically in the next four to five years.

I think the benefit for biofuels is they tend to have pretty good bipartisan support, right?

From both the left and the right.

Particularly, you're reducing emissions on the most part, which gets support from the more liberal side.

And then a lot of biofuels come from agriculture, which is supportive of the conservative side.

So what that means is we're likely going to see more this continued support.

How valuable that could be and how much that would be is remains to be seen.

Could we have changes to this tax credit value?

Are people going to come in and say, hey, you're getting too much value for R&G?

We want to take that down.

Anything is possible.

So it's hard to speculate on that.

But I would say that, you know, by and large, biofuels tend to have really good bipartisan support.

So this tax credit could get extended in future years, like its predecessor,

what was called the Biody Sumblanders Tax Credit.

And so we'll probably see that happen in later years.

Well, thank you so much, Jaden.

It has been fantastic to talk to you.

Thanks.

Today's episode of Switched On was produced by Cam Gray,

with production assistance from Kamala Shelling.

Bloomberg NEF is a service provided by Bloomberg Finance LP and its affiliates.

This recording does not constitute nor should it be construed as investment advice,

investment recommendations, or a recommendation as to an investment or other strategy.

Bloomberg NEF should not be considered as information sufficient upon which to base an investment decision.

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If you follow markets, you know the value of long-term thinking.

You plan, you diversify, you prepare for volatility.

But even the best strategies can prevent every bad day.

For more than 75 years, Cincinnati Insurance has helped individuals and businesses navigate tough moments

with expertise, personal attention, and independent agents who focus on relationships, not transactions.

The Cincinnati Insurance companies let them make your bad day better.

Find an agent at CINFIN.com.

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