Assessment of financial risk in renewable biodiesel firms

Abstract: Energy consumption in the transport sector is expected to increase substantially over the coming decades. The uncertainty in the forecasts are relatively high regarding the size of the increase but reports from the US Energy Information Administration (EIA) points to an increase of 56 percent between 2010 and 2040 (IEO2013, 2013, p. 9). World Energy Council forecasts an increase between 30 and 85 percent, depending on the impact of various factors such as market regulation, population growth, urbanization, and the availability of fossil energy (Global Transportation Scenarios 2050 (TSG 2050), 2011, p. 4-5). Some of this energy could come from advanced renewable fuels such as advanced renewable biodiesel. The commercialization of advanced renewable biofuels has however been slow even though the technology has long been considered mature for large scale production. External market factors that are frequently blamed for the lack of commercialization are lack of political support, low crude oil prices, high raw material prices, and notable profitability for producers of first generation biofuels. Previous studies further suggest that advanced biofuels are expensive to produce (Demirbas, 2010; Milbrandt et al., 2013) and that the companies operating in the industry hold high financial risks (Miller et al., 2013). This study examines the systemic financial risks as well as the estimated returns that the market places on companies active in the emerging advanced biodiesel industry. The results from the study indicate, contrary to previous studies and current external market factors that the systematic risks are not considerable higher for the advanced biodiesel industry than the market average or the established biofuel industry. This is despite the fact that oil prices have been low, raw materials prices high and that the uncertainty surrounding the political forms of support for the industry during the studied period have increased. This should have resulted in increasing rather than decreasing financial risk in relation to the previous studies of the advanced biofuel sector. Important factors that contribute to the results obtained in this study are circumstances that previous studies have completely disregarded, factors that may be beneficial for the studied companies. The studied firms are showing noteworthy profitability, access to substantial working capital, relatively low ratios between stock prices and cash flows. Furthermore, the analyzed companies have a business structure that other studies so far have completely ignored, e.g. they are structured as "biorefineries". This means the studied firms, similarly to conventional petroleum refineries, are producing and trading various products produced from the same raw material. The difference being that the analyzed firms use renewable raw materials rather than crude oil to produce the commodities. The firms thus possess an "option-based" diversification strategy which may be perceived by the market as a future real option. In contrast to focused firms these firms may simply change their business focus based on changes in prevailing external market factors or decreasing profitability in any part of the company. In accordance with the theories of the effective market hypothesis theory and random walk the market has access to all this available knowledge regarding these firms’ specific factors, pricing the risks on this knowledge these as well as prevailing external market factors. The results of the study suggest that the firm-specific factors in the studied companies may be more important than some of the considered external market factors in the pricing of financial systemic risks.