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The ETF Advisor: Energy Edge

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The nearly $100 per barrel plunge in oil prices since last summer, coupled with the credit crisis and stock market decline, hit the nascent biofuels industry particularly hard. South Dakota-based VeraSun, one of the largest U.S. biofuel producers, filed for bankruptcy protection in October 2008, and many other producers have either shut down facilities or slashed their output and are struggling to stay in business.

With the economics of biofuels beholden to volatile oil markets, most biofuel production around the world is driven by government mandates and regulations. Through 2008, the U.S. government mandated that oil refiners add an ever-increasing amount of ethanol–a gasoline substitute that in the United States is made primarily from corn–into their fuel blends. No such mandate had existed for biodiesel, which is a version of diesel fuel that is made from vegetable oils and animal fats. As a result, the biodiesel industry languished in relative obscurity, with 2008 U.S. production volumes less than 8% of that for ethanol, according to the National Biodiesel Board (NBB).

Beginning in 2009, however, the Renewable Fuels Standard (RFS) will require oil companies to blend increasing amounts of biodiesel, in addition to ethanol, into their fuels. And while that may not turn the industry around in the near future, Standard & Poor’s Equity Research thinks it may serve to tide the industry over until oil prices rise again and make the product more competitive.

“Biodiesel has a lot of potential,” says Tina Vital, equity oil analyst for Standard & Poor’s. “Recent studies indicate that biodiesel has a higher energy yield than ethanol and, on combustion, results in less greenhouse gas emissions than ethanol.”

Why Biodiesel Is Attractive

Biodiesel has many attractive properties: it is nontoxic and biodegradable, and emissions from biodiesel-fueled vehicles have lower levels of unburned hydrocarbons, carbon monoxide, and particulate matter than conventional diesel. Biodiesel contains almost no sulfur, allowing it to meet increasingly stringent diesel sulfur content regulations, and has good lubricity properties, which are important in automotive fuel injection systems. Blends of at least 20% biodiesel, and probably much higher, can be used without any modification of today’s diesel engines.

There are currently about 176 companies in the United States making biodiesel at facilities with capacity of 2.61 billion gallons per year, according to the NBB. Previously announced construction projects could add another 850 million gallons by mid-2010.

For 2009, the RFS mandates that 500 million gallons of biodiesel be sold in the United States, and an additional 100 million gallons of “advanced biofuel” that includes biodiesel and ethanol derived from non-food sources. The biodiesel mandate doubles to one billion gallons by 2012.

In addition to the mandate, biodiesel consumption should get a major boost from ASTM International (formerly known as the American Society for Testing and Materials), which published standards in October 2008 for biodiesel blends ranging from 6% to 20%.

While there are no exchange-traded funds tracking the biodiesel market exclusively, the ETFs listed in the table invest in many different alternative energy sources.