Why are small businesses interested in Biodiesel?
Improving profitability and deregulation of diesel prices (the subsidy on diesel prices was removed in 2015 and diesel price has been linked to its international price) is fuelling the interest of small businesses in biodiesel. Currently, the small manufacturers of biodiesel are able to make profit margins of over 10%, provided they are able to source raw materials efficiently. Their profitability has somewhat improved due to a reduction in input palm oil imported prices following GOI’s directive to waive import duty on crude palm stearin.
The biodiesel industry has two type of players, large refineries with a capacity of 50-500 tpd (tonnes per day) or more and small players with lower economies of scale who manufacture 5-10 tonnes per day.The large corporations supply bio diesel to Oil Marketing Companies (such as HPCL,BPCL) and bulk customers such as Indian Railways. Smaller players sell their biodiesel to farmers (as fuel for their tractors), and local industries where inherent customer credit risk is high. Their product typically gets sold at a discount of Rs. 3-4 from the retail price of diesel.
Given the policy incentives and government push to promote greener fuels, lot of small businesses have started manufacturing biodiesel. But the moot question is- is this sustainable? We believe that these businesses are not equipped to manage the risks inherent in biodiesel manufacturing, arising out of lack of any linkage between biodiesel prices and its feedstock palm oil prices.
What is the risk?
Selling price of biodiesel is not linked to its raw material price
The selling price of biodiesel is linked to the retail price of diesel, and it varies depending on international prices of crude oil and duty structure. However cost of manufacturing biodiesel is linked to palm oil, a vegetable oil, prices of which is not dependent on crude oil. Thus biodiesel manufacturers inadvertently take on input commodity price risk, which they neither understand nor have capability to manage.. Also, unlike large corporates who can diversify their risks across different businesses/products, small businesses often only have only one revenue stream, thus have limited risk appetite and are impacted by concentrated business risk profile.
Biodiesel price movement is difficult to predict
For someone in the .business of manufacturing biodiesel, understanding drivers of diesel including international price movement of diesel and government policy on excise duty is critical. As can be seen in the table, excise duties, taxes contribute up to almost 50 per cent of diesel price.
Build-up of diesel prices
What else can go wrong?
Further, one needs to be able to anticipate the trend in palm oil price also, as a fall in diesel prices coupled with increase in palm oil prices can erode the profitability of biodiesel operations.
Given so many domestic and international variables that impact the biodiesel business, it would be difficult for a small business to manage the inherent risk, and therefore it may be advisable for them to not enter biodiesel manufacturing.
FineTrain (www.finetrain.com), an advisory firm for small businesses. FineTrain provides independent, comprehensive and real time information on new business opportunities.
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