The hits keep coming for Renewable Energy Group (NASDAQ:REGI). After a promising year of operations in 2018, the producer of renewable fuels has been faced with lower average selling prices and higher input costs this year. Political gridlock in Washington has tabled hopes among investors that an important tax credit will be reinstated anytime soon. Shares have been cut in half since the beginning of 2019 as a result, which has reinforced the negative stigma of investing in biofuels stocks.

The well-managed company has done its best to navigate the headwinds. Rather than refinance maturing debt, it recently used cash on hand to retire the liability and maintain flexibility on the balance sheet. But Renewable Energy Group exited June with just $61 million in cash. Mounting operating cash outflows will chip away at that balance in the second half of 2019.

The return of operating volatility has eroded investor optimism, especially after the company appeared to outgrow the uncertainty of biofuels markets in 2018. But there is one potential path to sustainable, long-term operations: renewable diesel. Renewable Energy Group just has to figure out how to finance the needed investments.

Biodiesel vs. renewable diesel

Renewable Energy Group is North America's largest producer of advanced biofuels, boasting an effective production capacity of 514 million gallons per year (mmgy) on the continent. Roughly 80% of that commercial footprint is spread across 12 facilities pumping out biodiesel, while the remaining 20% comes from a single facility manufacturing renewable diesel. There's a subtle, yet significant, difference between the two products.

Biodiesel is counted as an advanced biofuel thanks to the way regulations are written, and Renewable Energy Group uses low-carbon and non-food feedstocks to manufacture it, but it's technically a first-generation biofuel. It sports a different chemical structure from petroleum-based diesel, which limits blending potential and can cause it to gel in colder temperatures. While the United States has the capacity to consume vastly more biodiesel than it does today, there are better-performing renewable fuels that can displace petroleum-based diesel.

For instance, renewable diesel is chemically similar to petroleum-based diesel, which allows for seamless blending potential and much better performance in cold temperatures. That value is reflected in higher average selling prices for renewable diesel compared to biodiesel. It also generates 13% more federal compliance credits per gallon (in the form of Renewable Identification Numbers, or RINs) than biodiesel and is the lowest-carbon fuel listed in California's Low-Carbon Fuel Standard (LCFS) program -- lower than even electric vehicles.

All of those benefits have added up for Renewable Energy Group. While renewable diesel accounts for just 20% of its total effective production footprint, it generated more than half of the company's total adjusted EBITDA in 2018. That's why the business must go all-in on the renewable fuel.

Prioritizing renewable diesel is a must

To be fair, Renewable Energy Group wants to expand its renewable diesel footprint and better leverage its proprietary BioSynfining production technology. The company is exploring a large-scale expansion of its existing 100 mmgy renewable diesel facility in Louisiana and a possible joint venture with Phillips 66 to build a 250 mmgy facility in Washington state. The obstacle is financing.

Large-scale expansions will be expensive and would ideally be financed with both cash and debt. With just $61 million in cash at the end of June, that's not an option. The wild card -- and perhaps what management is waiting for -- is whether or not Congress retroactively reinstates the blenders tax credit (BTC) for biodiesel producers. If it does, then Renewable Energy Group will receive a $370 million payment from Uncle Sam for production in the last six quarters.

That windfall could fund a significant expansion of renewable diesel production capacity and position the business for the future. It might also be required to remain competitive in the renewable diesel space as companies race to claim market share in the growing list of states and provinces signing up for California's LCFS program.

Company Renewable Diesel Production Capacity LCFS Significance World Energy Plans to increase from 45 mmgy to 300 mmgy Facility based in Los Angeles Diamond Green Diesel (joint venture between Valero and Darling Ingredients) Plans to increase from 275 mmgy to 400 mmgy Largest U.S. producer of renewable diesel (based in Louisiana) Neste Plans to increase from 845 mmgy to 1,190 mmgy Largest global producer of renewable diesel, exports most production from Singapore to U.S. West Coast

There are risks to going all-in on renewable diesel. In addition to the well-funded peers in the table above, a number of petroleum refiners are beginning to explore producing co-processed renewable diesel (CPRD) at existing refineries. CPRD could be the lowest-cost source of renewable diesel, although it may not qualify for all federal and state incentives. Additionally, as the market and competition grows, demand for limited feedstocks could outpace supply, causing feedstock prices to spike and margins to fall.

That said, those risks are similar to what Renewable Energy Group has managed through its ascension to the top of the biodiesel market. As the proposed joint venture with Phillips 66 demonstrates, the business is also open to partnering with petroleum refiners by opening up its proprietary production technology. Besides, considering biodiesel's future is limited by economics, investors might be willing to accept the competitive risks of renewable diesel.

Management faces difficult choices

Renewable Energy Group is in a tough position. On the one hand, doing nothing isn't an option. Biodiesel alone isn't going to deliver the business to sustainably profitable operations, and it has to act relatively soon so as not to be steamrolled by competitors with more financial resources.

On the other hand, it has to determine how to finance renewable diesel expansion projects in a way that's acceptable for shareholders. It sports a relatively manageable debt load, but it doesn't seem wise to fund expansion solely with debt. It could give up more control of the joint venture to Phillips 66 or license its BioSynfining technology to other refiners, but that would leave significant value on the table.

The ideal course of action would be for Congress to retroactively reinstate the BTC and hand Renewable Energy Group a $370 million check. As Congress reconvenes this month, investors will know what to watch for, but must keep expectations in check.