Biodiesel Economics - Costs, Tax Credits and Co-product

AgMRC Renewable Energy Newsletter
June 2009

Dr. Robert WisnerDr. Robert Wisner
Professor Emeritus
Iowa State University

rwwisner@iastate.edu

As we noted last month, a wide variety of fats and oils can be used for biodiesel. We noted that a large number of biodiesel plants in the U.S. have been idle.  The primary reason for that is because economics have been unfavorable—costs have exceeded market prices.  We could add that the picture may change somewhat next year with the anticipated enforcement of the mandates prescribed in the Energy Independence and Security Act of 2007.(1)  In this article, we will look at costs of producing biodiesel and its relative competitive position with petroleum-based diesel fuel.

A companion article in this newsletter titled Tracking the Profitability of Biodiesel Production, provides the track record and monthly update of the profitability of producing biodiesel in a typical Iowa production facility.

Costs of producing biodiesel vary with the feedstock being used, the plant size, type and design details, when it was built, and how it is managed.  By far, the most common feedstock in the U.S. is soybean oil, because of its widespread availability and relative cost.  The second most common feedstock is yellow grease, which is another name for used cooking oils.  Some biodiesel refineries also use animal fats or canola oil.  In Europe, rapeseed oil is commonly used, along with palm oil. 
 
In this article, we will look at one example of the costs of producing biodiesel from soybean oil, as well as key influences on cost, and how costs have fluctuated over the last few years.  A companion article in this newsletter, Tracking the Profitability of Biodiesel, provides a monthly track record and monthly update of the profitability of producing biodiesel in a typical Iowa biodiesel production facility.  We will compare these costs with diesel fuel prices before and after the blending credit is factored in.  We also will look briefly at alternative feedstocks that are being researched as possible sources of lower-cost biodiesel for future use, as well as implications of the government biodiesel blending mandates for the next few years.

The Biodiesel Production Process

To provide a general understanding of what takes place in a biodiesel production facility, here is a brief summary.  Biodiesel refineries typically are less complex and less expensive to build than those for ethanol production.  They also require much less heat and water than ethanol production.  Several modest variations of the typical production process can be used to convert vegetable oil or animal fats into biodiesel fuel.  The variations may involve differences in chemicals used for the conversion process, depending partly on the cost of these materials and how they affect the conversion efficiency. 

Transesterification is the process by which vegetable oil or various fats can be converted into biodiesel fuel.  A common procedure for processing soybean oil into biodiesel involves combining, for example, 100 pounds of soybean oil with 10 pounds of methanol and a catalyst.  The catalyst can be either a strong acid or a base.  Frequently used catalysts include sodium hydroxide, sodium methoxide, or potassium hydroxide.  Sodium methoxide is preferred in Europe due to cost advantages from local production and because water absorption is less of a problem.  Sodium hydroxide appears to be more commonly used in the U.S.  The catalyst is mixed with the methanol before mixing it with the vegetable oil.  Ethanol can also be used as an alternative to methanol but it typically involves higher cost.  Ethanol’s tendency to absorb water can add complications.  It is important that all of these inputs be free from water. (2)  The resulting chemical reaction is held at 150 degrees for from one to eight hours.  The output from this example would be about 100 pounds of biodiesel and about 10 pounds of glycerin.  Thus, for every 100 gallons of vegetable oil entering the plant, about 100 gallons of biodiesel are produced.  A portion of the methanol is recovered, dried by distillation, and re-used. 

There is a weight difference between glycerin and biodiesel (methyl ester) that allows the glycerin to be separated through a gravity process, much like milk can be separated into cream and skim milk.  Other aspects of the process involve cleaning the glycerin and biodiesel to remove any soapy fatty acids and other impurities.  This glycerin cleansing process typically utilizes an acid treatment that requires later neutralization.  The fatty acids may be recycled back into the biodiesel production process for later conversion to biodiesel, or in some cases may be removed as a co-product. 

Careful management of all these processes is essential for maintaining peak efficiency of the plant.  It is also essential for the production of high-quality biodiesel fuel.

Costs of Producing Biodiesel

Figure 1 shows estimated costs of producing biodiesel from soybean oil in recent years.  These cost estimates are developed from data from the U.S. Energy Information Agency in the U.S. Energy Department (3), with modifications to update input costs and with additional detail on utilities and other costs from studies in New York (4) and Montana (5).  Current costs for natural gas using Iowa as the geographic location were obtained from the U.S. Department of Energy (6).  They represent costs for a 12 million gallon plant.  Biodiesel refinery sizes range from 2 or 3 million gallons to 40 or 50 million gallons and possibly even larger.  Most plants are closer to the lower end of this range.

Estimated Soy Biodiesel Cost Per Gallon

In previous articles, we noted that the cost of corn was by far the largest expense of producing fuel ethanol.  The corn cost was around 65% to 75% of the total cost of producing ethanol.  For soy-based biodiesel, the feedstock cost has been much higher in the last two years, at 75% to 83% of the total cost.  Four years ago, it was about two-thirds of the total cost.  The higher percentage of total cost in the past two years reflects higher soybean oil prices.

Figure 2 shows the approximate contribution of the co-product, glycerin, in reducing the cost of biodiesel.  Glycerin will be discussed in more detail later in this article.  The value-stream generated by glycerin slightly reduces the price the biodiesel firm has to receive for biodiesel to break-even.  Most of the cost of producing biodiesel has to be recovered through the price of biodiesel.  Figure 3 compares the cost of producing soy biodiesel in this type and size of plant with the wholesale price of diesel fuel. 

Estimated Soy Biodiesel Costs After Co-product value deduction 

Larger biodiesel plants likely have economies of size that reduce production, marketing, and transportation costs.  However, data behind Figure 1 indicate that a 20% reduction in non-soy costs under recent conditions would lower total costs of producing biodiesel by about 1.5%.  With mid-2008’s much higher feedstock price, the indicated reduction would be about 0.6%.  These reductions are significant, but from a marketing viewpoint, reductions in feedstock costs are very important in making biodiesel competitive with petroleum-based diesel fuel.

Figure 3 shows the price competition biodiesel faces with petroleum-based diesel fuel.  The chart shows estimated production costs for biodiesel, net of the co-product value credit in the upper line.  The middle line is the breakeven wholesale price for biodiesel after adjusting for the $1.00 per gallon blenders’ tax credit (7).  In addition, there is a small-producer tax credit and other incentives in some cases.  Some states also have a tax credit for biodiesel.  U.S. average retail prices for petroleum-based diesel fuel were obtained from Clean Cities Alternative Fuel Price Reports.

Estimated b-100 soy biodiesel cost breakeven cost at the plant vs. wholesale diesel fuel price 

From Figure 3, it is clear that B-100 (100% biodiesel) biodiesel is currently unable to compete with petroleum-based biodiesel fuel on price alone.  However, government mandates, clean air and green-house gas emissions are other considerations influencing the market potential for biodiesel.

Figure 4 shows a similar comparison of the price competitiveness of B-5 with petroleum diesel fuel.  Our estimates show a 2.7 cent higher B-5 break-even price per gallon at the plant than diesel fuel in this case.  Some state tax credits and the federal excise tax credit would narrow the difference.  For B-2 blends, the difference is quite small.  Under current conditions, the estimated break-even price at the plant is one cent higher than the estimated wholesale diesel fuel price. 

estimated b-5 soy biodiesel breakeven costs vs. wholesale diesel fuel price  

Actual price differences vs. diesel fuel at all of these blends will depend on local conditions as well as plant size, its management, and other factors.  Our estimates likely understate the differential between biodiesel prices and wholesale diesel prices in markets where much of the product is blended, in part because of transport costs and merchandising margins. Note also that these break-even costs do not include an allowance for return on the plant investment or profit.

Other Feedstocks

Some biodiesel plants use yellow and/or brown grease as feedstocks along with or in place of soybean oil or other vegetable oils.  As we noted earlier, yellow grease is a term for used cooking oil.  Its main alternative market is for feed, and it typically costs much less than virgin soybean oil.  Brown grease is recovered cooking fat, which also is much lower cost than virgin soybean oil.  The blenders’ credit for biodiesel made from these feedstocks is one-half that of biodiesel made from virgin soybean oil. 

Although other vegetable oils can be used for biodiesel, soybean oil almost always is the lowest priced of all major vegetable oils except palm oil.  For that reason, soybean oil is the preferred biodiesel feedstock in the U.S.  Oil produced from algae is a possible biodiesel feedstock for the future.  It has the advantage that is does not require use of cropland, and recent research indicates algae can be produced in salt water.  However, additional research is needed before its use becomes widespread.  Ethanol plants -- with added technology to remove corn oil -- are another potential future source of increased feedstock supplies.  A few ethanol refineries currently are using this technology.

Glycerin: the Co-Product

There is a limited demand for glycerin for a number of food, beverage, personal care and oral products, as well as pharmaceutical and other industrial uses.  Based on demand estimates and estimated growth rates outlined from industry sources in a New York biodiesel study(8), it appears that the mandated future levels of U.S. biodiesel use could create substantial excess supplies of glycerin for these markets.  To deal with that potential problem and to create additional markets for the co-product of biodiesel, research at Iowa State University and elsewhere has found that glycerin can be used effectively in livestock rations.

Mandated U.S. Blending of Biodiesel in Motor Fuel

We noted last month that 2009 is the first year in which there were mandated levels of biodiesel blending in U.S. diesel fuel.  At this writing, it appears that the mandates will not be enforced until 2010, when 700 million gallons of biodiesel are to be blended with diesel fuel.  Although the current year’s biodiesel production estimates are still quite tentative, it appears that next year’s mandate would be nearly double the current year’s production – if enforced.  In the current year, a large number of RINs may be accumulated that can be used next year to substitute for actual blending. (See our previous article on RINs.) 

USDA economists project 2,200 million pounds of soybean oil will be used for biodiesel during the next marketing year.  This is less than half of the mandated 632 million gallons to be used during this period.

Some increase in biodiesel production and use is likely next year, but the exact amount is uncertain and total blending appears likely to be less than the mandate.  USDA’s World Agricultural Outlook Board on May 12, 2009 released its projection of the amount of soybean oil to be used in the U.S. for biodiesel in the September 1, 2009- August 31, 2010 production and marketing year.  USDA economists project 2,200 million pounds of soybean oil will be used for biodiesel during this period.  That’s about 293 million gallons of biodiesel, or less than half of the mandated 632 million gallons to be used for the marketing year.  It is apparent that USDA economists anticipate extensive use of RINs to keep production sharply below the mandated level.  Part of the difference between projected production and the mandated blending may come from biodiesel produced from other feedstocks.  Imports also may be a factor.

Renewable Diesel

Renewable diesel is a fuel made from biological feedstocks such as vegetable oil, animal fats, or yellow grease that is produced in a petroleum refining facility or other facility using the same type of process.  It does not qualify for a blenders’ tax credit if produced through co-production with petroleum-based diesel fuel. (9)

References

1 Energy Independence and Security Act of 2007 

2 Based on Judy Jarnefeld and John Urbanchuk,  Statewide Feasibility Study for a Potential New York State Biodiesel Industry, Final Report 04 -02, June 2003, New York State Energy Research and Development Authority,  pp. 41-46.

3 Anthony Radich, Biodiesel Performance, Costs, and Use, Energy Information Agency, U.S. Department of Energy, Washington, D.C., 2002

4 Jarnefeld, Op. Cit.

5 Christopher Strong, Charlie Erickson and Deepak Shukla, Evaluation of Biodiesel Fuel: Literature Review, Western Transportation Institute, College of Engineering, Montana State University, Bozeman, Montana, January 2004.

6 U.S. Department of Energy

7 Information on the blenders’ tax credit is available from the National Biodiesel Board

8 Jarnefeld, Op. Cit.

9 Internal Revenue Service, U.S. Department of Treasury, Fuel Tax Credits and Refunds