Clean Energy Fuels Corp. Q3 FY2021 Earnings Call

Good afternoon, and welcome to the Clean Energy Third Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Robert Vreeland, CFO. Please go ahead.

Thank you, operator. Earlier this afternoon, Clean Energy released financial results for the third quarter ending September 30, 2021. If you did not receive the release, it is available on the Investor Relations section of the company’s website at www.cleanenergyfuels.com where the call is also being webcast. There will be a replay available on the website for 30 days. Before we begin, we'd like to remind you that some of the information contained in the news release and on this conference call contains forward-looking statements that involve risks, uncertainties and assumptions that are difficult to predict. Words of expression reflecting optimism, satisfaction with current prospects as well as words such as believe, intend, expect, plan, should, anticipate and similar variations identify forward-looking statements, but their absence does not mean that the statement is not forward-looking. Such forward-looking statements are not a guarantee of performance and the company’s actual results could differ materially from those contained in such statements. Several factors that could cause or contribute to such differences are described in detail in the Risk Factors section of Clean Energy’s Form 10-Q filed today. These forward-looking statements speak only as of the date of this release. The company undertakes no obligation to publicly update any forward-looking statements or supply new information regarding the circumstances after the date of this release. The company’s non-GAAP EPS and adjusted EBITDA will be reviewed on this call and exclude certain expenses that the company’s management does not believe are indicative of the company’s core business operating results. Non-GAAP financial measures should be considered in addition to results prepared in accordance with GAAP and should not be considered as a substitute for or superior to GAAP results. The directly comparable GAAP information, reasons why management uses non-GAAP information, a definition of non-GAAP EPS and adjusted EBITDA and a reconciliation between those non-GAAP and GAAP figures is provided in the company’s press release, which has been furnished to the SEC on Form 8-K today. With that, I will turn the call over to our President and Chief Executive Officer, Andrew Littlefair.

Thank you, Bob. Good afternoon everyone and thank you for joining us. The country continued to climb out of the pandemic-induced economic slowdown this last quarter, which helped the ongoing recovery of the transportation sector and our fuel volumes. We also added new customers to our roster of those fueling with our ultra-clean renewable natural gas, or RNG. And we made significant advancements in securing future supplies of RNG. All-in-all, a very good quarter. Our fuel volumes exceeded 100 million gallons for a second straight quarter coming in at over 104 million gallons, an increase of about 7% from the third quarter of last year. Our revenue was up a very healthy 21% to $86 million for the third quarter, even after the non-cash charge for the Amazon warrant. Without that charge, revenue would have been $88 million, a 24% increase over the third quarter of last year. Our RNG volumes of 42 million gallons grew 5% from a year ago, demonstrating the increasing demand for the negative carbon intensity fuel and Clean Energy's ability to deliver large volumes of RNG. Adjusted EBITDA for the quarter was $13.4 million, a 22% increase over the same quarter a year ago. We ended the quarter with $260 million in cash and investments, leaving us in a strong financial position as we continue to invest in future RNG supply and further expand our fueling infrastructure for our large new customer, Amazon and other fleets. We communicated to you earlier in the year that we pivoted our business to focus on the expansion of our RNG offering and to begin to control more of our own destiny by investing in the production of new RNG supply. All fleets are looking to decarbonize, which is why a fuel that can be rated negative carbon intensity is so appealing. Fleets, including some of our longtime customers like the transit agencies in LA, Dallas and New York, easily and quickly switched to RNG because their buses were already equipped with natural gas engines, and the existing fueling infrastructure could immediately deliver our organic renewable fuel. Other customers like Amazon are deploying their first alternative fleets and they are choosing RNG. The risk for them is negligible, because the heavy duty trucks are equipped with a proven Cummins engine and immediately have access to a national existing fueling infrastructure. Amazon began rolling out their fleet of heavy duty RNG trucks less than a year ago and Amazon trucks have already fueled at over 85 Clean Energy network stations in 21 states around the country. That number does not include the additional stations we announced we would be building to accommodate the deployment of the Amazon fleet as the new anchor customer. We expect those new stations to begin coming online starting in early 2022, as Amazon continues to expand its fleet. RNG is a drop-in fuel and can be directed to any of our stations for any customer that has contracted for the ultra-clean fuel. Speaking of Cummins engines, I hope you saw the very important announcement that was made last month about a new 15-liter natural gas engine for heavy duty trucks. As the President of Cummins engine business said at the announcement, “This natural gas option is a game changer as a cost competitive power option to existing diesel power trains and heavy duty trucking, making it a great complement to reduce CO2 emissions.” This new engine should make the switch by heavy duty trucking companies to RNG all that more compelling because many of their trucks need the extra power. Cummins has communicated recently that they've never been more bullish on the adoption of RNG. Besides the announcement of the new 15-liter engine, Cummins also recently acquired a 50% stake in Momentum Fuel Technologies, which manufactures CNG fuel delivery systems. Cummins also announced that their entire RNG product line of engines has received 2022 certifications from the California Air Resources Board, rating them 90% cleaner than a new diesel engine. It's great to have one of the most respected and trusted manufacturers of engines and power trains continuing to make investments in advancements in the future of RNG. The growth of RNG continues to come from a variety of customers. For example, our longtime customer Republic Services recently awarded us a contract to build new stations in Boise, Idaho and Fremont, California that will flow RNG provided by us. The transit agency Santa Monica Big Blue Bus re-upped its contract and we added new customers, Sacramento Regional Transit and Gold Coast Transit in Ventura, California, all representing about 5 million gallons of fuel a year. Big Blue Bus was one of our first agencies to see the long-term greenhouse gas reduction benefits of operating their bus fleet on RNG and has been a loyal customer for many years. Another longtime customer Foothill Transit, which serves a large portion of the LA basin, expressed their loyalty in a different way, by awarding Clean Energy a contract to build Foothill's first hydrogen fueling station. The station design, construction and maintenance agreement as well as the hydrogen fuel supply is a tremendous confirmation of our strategy to give customers what they want, as they explore ways to decarbonize their fleets. Not only did we have the best overall proposal in the competitive solicitation process, but Foothill also recognized Clean Energy's past performance over the last two decades of providing exceptional service keeping their large fleet of buses operating on CNG initially, and RNG more recently. The CEO of the agency that provides an average of 14 million rides a year cited our long successful track record of building alternative fuel stations, and said Foothill looks forward to continuing to work with Clean Energy as they expand into hydrogen fuel cell technology. This won't be the first hydrogen station that Clean Energy has built, but it is the first since OEMs of large vehicles have recently agreed to test their new fuel cell technologies. Foothill Transit has placed an initial order of 30 fuel cell buses that will operate on hydrogen. And I'd like to note that a third of the feedstock to create the hydrogen will be low carbon RNG. As I mentioned, following customers to where their alternative fuel plans take them is a long-term strategy for us. We acknowledge that there will be multiple alternatives going forward. Fortunately, by being the pioneer in building alternative fueling stations and our 25 plus years of maintaining those stations, combined with our access to the cleanest fuel in the world that can be used directly as a fuel or as a feedstock, we believe we are in the best position in this evolving market. But for any alternative to get a low carbon intensity rating, the fuel must either be low CI itself or its feedstock must be low CI. As everyone knows, it makes no sense to power a vehicle with electricity that was produced from a coal power plant. Most hydrogen produced today is not green. That is the beauty of RNG and why we are making significant investments in its production. Fortunately, we have two partners, TotalEnergies and BP, that not only bring financial resources, but have centuries of experience in the energy business as well. I know there has been a lot of interest by many of you to hear more details about our progress in RNG production, and let me assure you it's going very well. For instance, I'm traveling to the Texas Panhandle in a few weeks to participate in a groundbreaking of a new RNG facility at a large dairy. The project is one of the first that will be financed through our joint venture with TotalEnergies. That same week, we will be breaking ground at our fourth dairy in the Upper Midwest, all of which are funded through our BP joint venture. And just last week, we signed a contract with one of the country's largest dairies, which is in Idaho to develop a new RNG production facility, which when operational will produce millions of gallons of negative carbon RNG per year. Details of these deals will be forthcoming. But please understand the RNG produced at these dairies I just mentioned will be coming online in 2023, after the facilities are built, CARB certifies the carbon intensity of the RNG and the pathways of the fuel are locked in. But in the meantime, we continue to secure additional RNG from dozens of third party suppliers to meet growing demand in our downstream station network. Some of that demand is coming from our Adopt-a-Port finance program with Chevron that you've heard me speak about. Over 680 RNG heavy duty trucks have either received grants, been purchased or are in the process of being financed through the program. Trucks will operate in the very busy ports of LA and Long Beach, and most are owned by small companies or owner-operators, and benefited from grants administered by California state agencies that Clean Energy helped secure. In fact, I'm proud to say that our hard working grants division recently surpassed the $0.5 billion mark in securing grants to purchase new RNG trucks for our customers. I must brag about our entire Clean Energy team. They have continued to perform above and beyond expectations under difficult circumstances during these past 18 months, while at the same time taking the company to a new level. The sales team brought in our biggest customer in the company's history, Amazon, which was sold on the idea of fueling their new fleet of heavy duty trucks with our RNG. The team also signed our first LNG bunkering contract with World Fuel Services for two cargo ships operated by Pasha out of the Port of Long Beach. When the ships begin their regular routes back and forth from Hawaii, they're expected to operate on LNG that reduces nitrous oxide emissions by 90% and carbon dioxide by 25% compared to the incumbent shipping fuel. The contract is for five years and we anticipate volumes to be at least 78 million LNG gallons. Our engineering and construction group continues to expand our fueling footprint around the continent, with 66 different station projects in progress. And our superior maintenance team of men and women, which keep our customers happy and asking for more. Since the beginning of the year, we've made some significant pivots with our focus on offering a renewable fuel that can make a huge difference in the effort to combat climate change, and I'm pleased to say the Clean Energy team has risen to the occasion. And with that, I'll hand the call over to Bob.

Thank you, Andrew, and good afternoon, everyone. Our third quarter financial results were highlighted by continued volume growth, increased natural gas pricing helping drive revenues higher and year-over-year improvements in our effective margin per gallon. We also improved our cash and investment position to $260 million at the end of the third quarter compared to $254 million at the end of the second quarter. We're maintaining our guidance for 2021 of a GAAP net loss of $86 million and adjusted EBITDA in the range of $60 million to $62 million, as we described in more detail in our press release. Continuing with my third quarter comments, our volume increases compared to a year ago third quarter largely came from across all sectors with some variability around where our RNG flowed, and if those volumes were incremental or already counted alongside maintenance gallons. Our RNG volume grew 5% to 42.2 million gallons in the quarter, up from 40.1 million RNG gallons in the third quarter last year. We're looking forward to continued RNG growth as supply continues to grow. Our effective price per gallon in the third quarter of 2021 was $0.77 per gallon compared to $0.59 a gallon a year ago, or an $0.18 per gallon increase. This increase reflects higher prices at the pump, principally from higher underlying natural gas costs as well as higher rent and LCFS revenue. Our alternative fuel tax credit revenues of $5.3 million for the third quarter were in line with trends. While our station construction sales of $2.6 million were less than a year ago and lower than more recent trends, the construction revenues can be a bit lumpy due to the timing of the underlying construction processes, particularly in today's environment. We're anticipating fourth quarter construction revenues to be more in line with recent construction sale trends in the $5 million to $6 million range. Our overall gross profit margin improved in the third quarter of 2021 compared to 2020, exclusive of a non-cash contra-revenue charge of $2.2 million related to the Amazon warrants and a non-cash fair value gain in our ZeroNow fuel hedge of $300,000. Exclusive of these non-cash items, our gross margin was $32.2 million in the third quarter of 2021 compared to $25.7 million in the third quarter of 2020, or a 25% improvement. Increased volumes together with a rise in our margin per gallon from a year ago were the primary drivers of this year-over-year improvement in gross profit margin. Our effective margin per gallon for the third quarter of 2021 was $0.26 per gallon compared to $0.21 a year ago. This $0.05 per gallon improvement reflects the difference between a rise in our effective price per gallon of $0.18 and an increase in our effective cost per gallon of only $0.13. With the cost of natural gas being at some of the highest levels we've seen, exceeding $5 per MMBtu, I thought I would take a moment to make the point that this significant rise in the cost of natural gas did not translate to a degradation in our margin. As you've seen in this third quarter, our effective cost per gallon was up $0.13 per gallon from a year ago, but we managed an increase in revenue per gallon of $0.18, helping to drive higher overall revenues. This dynamic of the change in natural gas cost is key to understanding that a rise in the cost of natural gas is not automatically a bad scenario for us as we are generally able to increase our pump prices and we have contracts that call for commodity costs to be passed through to our customers. Our SG&A was $22.3 million in the third quarter of 2021 compared to $16.6 million a year ago, an increase of $5.7 million, of which $2.7 million or 48% of the increase relates to an increase in stock compensation, as expected. We have seen some cost increases in connection with our rebranding and RNG activities, which could take us to around $86 million in SG&A for 2021, including about $13 million of stock compensation. Our GAAP net loss for the third quarter of 2021 was $3.9 million, which includes the effects of the non-cash warrant contra-revenue charges and the ZeroNow hedge gain. Our non-GAAP net income for the third quarter was $1.6 million, or $0.01 per share, which we believe is more indicative of our operating results. Our adjusted EBITDA of $13.4 million for the third quarter of 2021 compares to $11 million a year ago, which again highlighted the benefit of increased volumes and improved margins, principally associated with our RNG deliveries. Our cash flow provided from operations amounted to $19.9 million for the third quarter of 2021 compared to $3.4 million in the third quarter of 2020. Exclusive of changes in operating assets and liabilities, cash flow from operations was $15.3 million in the third quarter of 2021 versus $10.2 million in the third quarter of 2020. CapEx spending for Clean Energy's downstream business was $7.6 million for the third quarter of 2021, which is up from $4.6 million last quarter and likely will increase again in the fourth quarter, as our station building continues to ramp up. Our debt was $42 million at the end of September 2021. On the RNG upstream supply business, we've begun spending in each of the joint ventures on equipment purchases and development expenses as we get projects moving. In the joint venture with BP, approximately $22.3 million has been spent on dairy project CapEx as of September. In the joint venture arrangement with TotalEnergies, approximately $4.7 million has been spent on dairy project CapEx through September. The $4.7 million was reflected in our consolidated statement of cash flow as purchases of equipment in the third quarter as the dairy project JV with TotalEnergies was not formed until October, at which time those assets were moved into the 50-50 joint venture with TotalEnergies. And we will continue to report on the capital spend and other progress on our dairy projects as we move forward. With that, operator, we can open the call to questions.

We will now begin the question-and-answer session. The first question comes from Mr. Rob Brown with Lake Street Capital Markets.

Good afternoon.

Hi, Rob.

Hi, Rob.

Just wanted to follow up on the JV and sort of the upstream activity that you're doing. How is that sort of supply situation right now and how much sort of supply you expect to come online over the next couple of years? I’m sorry, your own supply over the next couple of years.

Right. Well, one way to look at is a lot of ways to slice all that. But our own supply, let me speak to it in a second. This year, we brought on about 50 million gallons of third party supply coming from other suppliers. So that's an important component to this. And as I look out over the next couple years too, I think it's really important for everyone to understand these projects take 18 months to two years to come online and begin to really monetize the credits and contribute. We've got about 80 million gallons of projects in the pipeline at present, but these things are coming on all the time. So that number likely will go up over time. But since we've been at this in earnest this year, I think that's pretty good progress.

Okay, great. And then maybe on the Cummins 15-liter engine that you talked about, how do you sort of see the market expanding with that engine coming in? What kind of customer growth do you think that can help drive? And how do you view that engine?

Rob, you've looked at this a long time and the current 11.9-liter engine is really very adequate for the day cabs. A lot of our customers at this point are regional day cabs, and the 12-liter is good for them. However, I think it's important to recognize that approximately 75% of diesels that are being purchased are more like the 15-liter diesels. So in order to run the routes, terrain and sleeper cabs and be able to take care of the full breadth of what an over-the-road truck needs to do and to give the driver that torque and horsepower, the 11.9 is around 1,450 in terms of torque, and this engine will be variable but can go up to 1,650. So you're going to have more horsepower and more torque. It's going to be able to handle the heaviest loads, and it's going to be able to give that driver the power that they really like. One of the things that these trucking companies need to do is keep their drivers happy. Keeping drivers is really key. I think this 15-liter is going to be a ground-up engine. It's been on the road in China. It's going to be manufactured and assembled with American parts and American labor here, which should get it to the market faster. It's going to have increased fuel efficiency as well. We've always had a little bit of an efficiency penalty, sometimes ranging a bit higher; I think this engine should be able to cut that penalty in half. Increased fuel efficiency, increased torque and horsepower—it will really be able to do everything that you would want an over-the-road truck to do. So we're very excited about it. I think it really fits out the entire offering that Cummins now will have: the 6.7, the 9, the 12-liter and now the 15. I imagine over time, the 15 will end up being the workhorse and replace the 12.

Okay, great. Thank you for the overview. I'll turn it over.

Your next question comes from Eric Stine with Craig-Hallum.

Hi, Andrew. Hi, Bob.

Hi.

Hi.

So obviously volume recovery underway. I'd love it if you could maybe just drill down in your various end markets. And then curious whether you're willing to give kind of an early view of what you think volumes might be in light of this recovery in 2022?

Yes. Bob's got some of the numbers there. We've seen participation in all of our segments. We're bringing on—let me just—and Bob will speak to that. The airports are not back fully. We all have been in airports, so you know that they're not quite firing on all cylinders, but we've seen tremendous recovery there. Our refuse is ahead of plan as is our transit. We like where we stand on that now. Trucking, because of Amazon, we're bringing on a lot of new trucks. So we are very excited about the growth rates that we'll see in the trucking business. But we're making our job difficult because we want to ship more and more of it to RNG. That's what our customers want. And we obviously want that. But at the same time, we're really putting pressure on adoption, which is what we've always tried to do. So it just puts more strain on us to bring more RNG on faster certainly as we bring on Amazon and some of the other big customers like them that want this RNG. Bob, you may be able to get into some specifics there.

Yes. We continue to see year-over-year growth in refuse. Transit was in double digits. The airports were actually positive growth in the fleet area, which has taken a while to really start to come out of the recovery, but we're now seeing year-over-year growth there. And then as well as trucking, considering the RNG optimization and that sort of thing. So it's across the board. As we look at next year, we've preliminarily said we're looking at kind of a 10%-ish number on the volume, but more to come on that.

Got it. Fair enough on that. Maybe would the RNG—Andrew, I know you mentioned that you got the pedal down and you need to keep up with that. And I know these projects don't come on overnight. Do you feel like what you see in the market, given the investment for the whole market, that you will be able to satisfy that demand? I know you will, once you have all of your projects up and running. But in the interim, while those are in development, do you think you're able to keep up with the volume growth you may see from Amazon and others?

Well, I think realistically, Eric, there will be challenging quarters in this next year or so until we get some of our projects on line. The projects I've talked about—the 80 million gallons in the pipeline—need to be significantly larger than that. I would like to think there's time; one of the fleets we've talked about today could take that much RNG—twice that much RNG, just one fleet. So we're just in the very early innings of the RNG supply game. To review, the supply resource when you look at landfill, wastewater and manure from livestock is on the order of somewhere between 25 billion and 30 billion gallons annually. Now that's many years from now, but that's a long bridge that could take 10, 15, 20 years to develop. So there's a lot of room here. I think the lowest hanging fruit is in the dairy space. There's still plenty of large dairies to come and medium-sized dairies. That's on the order of 3 billion to 4 billion gallons. But remember, the industry is at 400 million gallons. So we're just getting started as an industry. There's a lot of money pouring in. We're well positioned because it won't all be our own supply, but we are able to avail ourselves to third party supply because we have the network. So yes, I like the position where we are, but there will be quarters next year, especially if we do a good job on the demand side with some of these large fleets, where it will be nip and tuck whether or not we have exactly all the RNG we'd like to have and the commitments that we made. All of our customers want the lowest CI RNG they can have. I think over time, we'll be able to supply that. But I think 2022 could have periods where it will be a challenge to get all that we'd like to have. Does that make sense, Eric?

Yes, it does. I guess it’s a good problem to have. But it's something—

Well, that's right. It is sort of a good problem to have. It's not a long-term problem. But it's one that I think we just have to recognize that when you bring on a customer like Amazon, and their sustainability report talked about 2,700 trucks, if you use that as a placeholder and multiply that to kind of an average number, you can see the annual number that you could see that alone would require 40 million gallons. As these other big fleets pay attention to that and want the RNG, and frankly, as we've discussed before, when they look at their other alternatives and availability of those alternatives—electric and fuel cell—RNG is what's here today, near term, and cost effective and available. So these other fleets are looking at what Amazon's doing, and there is a bit of an Amazon effect going on right now.

Okay. Thanks for the color.

The next question comes from Manav Gupta with Credit Suisse.

Hi, guys. Just one big—bear with me a little here. You said 80 million gallons of projects are kind of in development. Could you confirm all of them are dairy farm RNG or are there some landfills? Because in the past I think Bob indicated that for dairy farm RNG, it's about $15 million to $20 million per million gallons. So to hit that 80 million gallon number, we are looking at a capital deployment of $1.2 billion to $1.6 billion between you and your partner. Is that math right, or if it's wrong, can you help me out?

Okay. No, it's not wrong. But that reference is really more toward offtake from other partners, not ours. There are two pieces to our supply. It's what we get as an offtake partner, just taking gas, not producing it. That's what Andrew was referring to—we've already signed up 50 million gallons of supply contracts from others, and we've got another 80 million there, because we need that gas—our gas is not going to fulfill our needs for a few years.

So 50 is the partner, then 30 is yours?

What’s that?

So 50 is the other, then 30 is your—just trying to understand between you and your two JVs, what's the pipeline in million gallons? What's that number looking like right now?

Okay. The 50 that we've secured and the other 80 has nothing to do with our JVs. That's coming from other supply sources that's offtake. We refer to that as other offtake that we will secure. Then our JVs—Andrew spoke to that some with Rob's question in terms of like, what's our volume going to be in '23, '24 and beyond? We're still tallying that number. Our hope is that we'll provide more color in February when we do our year-end, because there's a lot going on where we've been checking out a lot of deals. We want to get those a little more tied up, and then we can start to say exactly what some of the numbers will be. But you're looking at double-digit volumes from our JVs in '23. I'm thinking certainly more than 10, and more on the way to 20s—somewhere above 20. And that's just a starting point right now from what I know and it's still moving.

Perfect. I won't press you on number of dairies or anything. My quick follow up here is, as you come across all these customers who want your RNG, are the customers pressing you specifically and saying, I want zero or below zero carbon RNG, or are they more or less agnostic and saying fine, deliver landfill RNG? Are the customers starting to make a distinction as to the carbon intensity of the RNG as you are interacting with them?

It depends. Customers are becoming more educated and it depends where they're located and how sophisticated they are. If you sat with a customer and showed them that they could have the lowest CI fuel available, they'd want it, but not all customers need that right now. Most customers understand that. As you bring on lower CI sources, that portfolio number comes down. For instance, our portfolio average CI is coming down from higher levels as we shift away from mostly landfill. In this quarter and the next, it's going to be very close to negative. We'll begin to share that with you over time. We're able to blend our portfolio and bring down the landfill with super negative CI gas. It will continue to go lower over time, and we'll be able to serve our customers more and more negative fuel over time. It's not that landfill gas isn't good—it already represents about 50% less carbon than diesel. But RNG can be even lower, and it will be lower as we go.

Perfect. My last question: we saw a deal where you're looking to supply some LNG to ships and I'm trying to understand—do you feel there's a possibility that more ships globally could switch to something cleaner than bunker fuel?

Yes. Bunker fuel is extremely dirty. There is an international compact that was sanctioned where bunker fuel is being phased out, and local jurisdictions, such as Singapore, Hong Kong and here at the Port of LA and Long Beach, have put in rules requiring cleaner fuels. You're seeing more LNG shipping at ports worldwide—Rotterdam and others. Carnival Cruises ordered LNG ships—maybe 9 to 11. This is a long-term trend. These are long-life assets and you'll see it happen more around the world. It takes time to build new kits or repower a ship—this isn't like buying a new truck.

Thank you for taking my questions.

You're welcome.

The next question comes from Craig Shere with Tuohy Brothers.

Good afternoon.

Hi, Craig. Good afternoon.

Hi, Craig.

So the Idaho dairy project that you mentioned sounded really big. I was a little unclear if you were talking about something in the JVs, or if you're looking at anything outside of that?

It's in one of the JVs.

Got you.

So that's our production, our upstream for our account with our partner.

But that still can come online in 2023?

Yes, latter part. Probably not January.

Okay. And when something is that big, can it be ramping for a year or more after you start delivery when you have the CARB certification to reach theoretical capacity? Does it take a while to get to full capacity?

When you start production, it doesn't take the full two years to reach commercial production. I've always talked about 18 months to two years. You're on commercial production and you're producing RNG. There's a little ramp-up and shakeout period, but it comes on fairly robustly. You're producing it while you're waiting for some of the certificates on the CI, and you're storing it and then turning it loose after you get the CI. So you're actually in production during the startup phase. At this dairy specifically, there's a design to add tens of thousands more cows over time, which will increase volumes further. It's already about the second-largest facility and it's going to grow dramatically. There's been a lot of consolidation in dairies which helps bring them to scale. You'll also see infill clustering—gathering systems from several dairies wheeling into a central digester—which is starting to happen. This is a new industry with a lot of operational items to figure out, but not many technology risks.

Maybe I missed it, I apologize. It looked like there's a lot in the pipeline. Third quarter RNG was lower than second quarter. Did I see that correctly?

At 42 I think it was, yes, it may have been down a little from second quarter.

Is there anything specific around that, or over time will there be hiccups to this or will we get to a point where it is consistent—every quarter should be higher as all these investments start kicking in?

Like anything else, sometimes certain supply sources have a hiccup. Occasionally, one project doesn't get re-upped. Over time, as volume grows, you won't notice those individual hiccups. We did have some change because of weather events and a hurricane. But as we grow the projects I talked about earlier, volumes should trend up consistently.

Right. You're a little susceptible to seeing operational matters impact quarter-to-quarter right now. I will say, though, that we are pretty diverse and spread out on our supply sources, so we're in a much better position than others who may tie their supply into one or two projects.

My last question, picking up on Manav’s question about fleet customers’ CI demand—if I understood, it comes down to geography and function. Right now low CI nationwide fuel with a pathway is going to California because of LCFS, with a little in Oregon. Over time, as low CI supply grows faster than California's market, will suppliers start to push landfill gas out of California to fill tanks nationwide, because Amazon and other fleets across the country want some of that fuel outside California? And then over time, the other CNG will move to other markets like maritime bunkering where they aren't as focused on RNG. Am I saying that right?

I think you are. We already sell fuel where a significant portion is RNG. Fossil fuel will be replaced by RNG over time. Other markets—railroads, maritime—could use LNG or RNG; they consume a lot of fuel. Yes, you'll see other markets adopt cleaner fuels. Also, this isn't just a California story—New York is likely to adopt a low carbon fuel standard and if it does, other Northeast states may follow. States like Illinois, Pennsylvania, and Michigan are studying RNG. By 2024 you could have 10 or more low carbon fuel states, which would increase demand and broaden markets for low CI fuel.

I appreciate that. Thank you very much.

You bet.

The next question comes from Pavel Molchanov with Raymond James.

Thanks for taking the question. All right, I'm going to ask about our friends in Washington again. We got the Build Back Better draft published recently. There is an interesting low carbon fuel credit at the federal level. Do you know how that is going to work for your product in terms of will you be collecting the low carbon fuel credit or the natural gas fuel credit or both?

Pavel, I have the bill like you do—it's a long document and it's changing as we speak. I think the LNG credit you're speaking of appears to be on the producer side—it's a production tax credit. I don't see a new RNG fuel credit collected at the pump in the current draft. There is a five-year extension of the alternative fuel tax credit in the bill, which is important. But the new federal low carbon fuel credit you referenced looks like a producer tax credit, and I don't have clarity beyond that right now.

Okay, understood. Same topic—green hydrogen is scarce and expensive today. The reconciliation package contemplates subsidies up to roughly $3 per kilogram. Would that meaningfully help scale up green hydrogen supply?

It would help, of course, but hydrogen would still have a ways to go. The most cost-effective green hydrogen today is on the order of $11 per kilogram, so $3 would help but wouldn't make it a no-brainer. Infrastructure for hydrogen is very expensive. Vehicles are expensive too. So subsidies would assist development, but they don't immediately solve the economics or infrastructure challenges.

Right. Last question more big picture: we have not seen $80 oil for seven years, but we also have not seen $5 natural gas for probably about that long. How do you reconcile those two things pushing and pulling in opposite directions?

Yes, and refined product prices are high—the price of diesel at the Port of LA is around $4.76, near highs. I often refer to BTU equivalents—historically oil to gas traded around 6:1 to 7:1. At current prices, oil to gas is around 15:1 or 16:1, so natural gas is expensive but still relatively inexpensive on a BTU basis versus oil compared to some past periods. I still believe gas prices will come down at some point. Remember, you get about 7.2 gallons of diesel equivalent per MCF of gas, so a $2 increase in the price of natural gas translates to about $0.30 per gallon impact on feedstock. As Bob covered, we were able to pass through commodity costs to customers or absorb them depending on contract terms. Diesel also increased, so customers still have a meaningful discount to diesel on a per-gallon basis. Overall, we've been able to navigate the price environment without degrading our margins.

All right. Thank you very much, guys.

Okay. Thanks.

The next question comes from Jason Gabelman with Cowen.

Hi, guys. Good afternoon.

Hi, Jason.

Hi, Jason.

Thanks for providing the detail on the spend on these upstream joint ventures. That's helpful. Can you clarify—is that your share of equity spend or should I be thinking about that spend differently?

On that, that's the total spend at the JV.

Just acquisitions, excluding debt?

Exactly.

Okay.

Technically, I didn't clarify whether it's debt or equity. It's the CapEx spend at the JV as of the end of September. Technically, we're in for half of that. But just a reminder, the BP JV—we already have our money in there. That's off our balance sheet. So I'm just giving you what that JV has spent. And on the TotalEnergies JV, it's a little different because it's on a project-by-project basis.

And has that spend been ratable over the last six months, or is it really just ramping up and do you expect it to continue to ramp up?

It's ramping.

Yes, it's going quick.

And my other question on the downstream business—fourth quarter EBITDA guidance is implied to be pretty strong relative to the rest of the year. Could you provide context about that? And as RNG volumes ramp up and carbon intensity scores go down, do you expect gross margin per gallon to improve from the $0.22 to $0.26 per gallon range you've discussed?

On Q4, historically Q4 over the past four years has included some other income related to an earn-out from a 2017 transaction where we sold some upstream assets and contracts to BP. So that helps the Q4 EBITDA figure somewhat. That's cash we collect. Regarding margin, without giving full '22 guidance, I do expect that range to move up as we bring in more dairy and continue to grow higher-margin fuel gallons. So yes, I expect gross margin per gallon to improve moving forward.

Great. Thanks. I appreciate that.

Thank you.

The next question comes from Greg Wasikowski with Webber Research.

Hi. Good afternoon, Andrew and Bob. How are you doing?

Good. Hi, Greg.

Hi, Greg.

Nice to officially be on the call. I wanted to go back to your comments about additional LCFS programs in other states. How does that factor into the economics and your decision making when sourcing dairy farms? Are you considering locations on the East Coast or the Northeast based on that assumption?

We already consider locations broadly—we're taking projects where they come. We have projects in Wisconsin, upstate New York, North Carolina. In a perfect world you move the fuel to the closest LCFS state to maximize value, because moving it far to California can incur pathway costs and reduce value. But we won't be cherry-picking only for LCFS states; we're trying to bring on RNG wherever we can.

Got it. You also mentioned the Amazon effect. Any update on vendors or suppliers making the switch in response to Amazon's direction?

I can't provide specifics, but Amazon is fully engaged. Deployments are ongoing and we're providing fueling experience in 21 states. They have many trucks yet to come online. Amazon looks at scope 3 emissions and has a large vendor and supplier pool. We hope to design a program with them to address that, but nothing specific to report on this call.

Okay, fair enough. That's it for me. Thanks, guys.

All right. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Andrew Littlefair for any closing remarks.

Thank you, operator, and thank you everyone for joining us today. We look forward to updating you on our progress next quarter. Have a good day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.