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The Allure of Rerefining

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Investors seem to be showering rerefining projects with boundless enthusiasm and bottomless funds. But they may be creating a bubble that will pop, warn some.

The private equity community is flush with dry powder that its eager to invest, said Effram Kaplan, managing director of investment bankers Brown Gibbons Lang Inc. in Cleveland. He added that used oil collectors, processors and rerefiners have become a frequent target for cash-laden investors, and the competition for quality assets is driving aggressive buying. Overall, theres a very healthy corporate buyer community, and transaction activity is back up to historic levels, back to where it was before 2009.

Speaking on Nov. 9 to the annual meeting of NORA, the Association of Responsible Recyclers, Kaplan noted that the environmental services sector is even more attractive since other investments stalled during the recession. Publicly held specialty waste companies are outperforming the broader Standard & Poors market. They include companies such as Vertex Energy, Newalta and Safety-Kleen.

In fact, the environmental services market is not ticking down like the general services market – its ticking up, he said. There are significantly more transactions being done in specialty waste, and a lot of capital is being invested in this sector.

Dan Cowart, CEO of used oil collector and recycler Aaron Oil, in Mobile, Ala., is also watching this gold rush, but more uneasily. We need to maintain all our options and viable uses for used oil, and that includes burning it as fuel, he states. Yet he sees many rerefiners targeting used crankcase lubricants and avoiding the more difficult waste streams, like industrial lubes and bunkers. He fears they could leave traditional used oil collectors with a less-valuable product, and undermine their profitability.

He also wonders if rerefiners have bitten off more than they can chew. When it comes to rerefining, we hear lots of announcements about plants going up, mergers and acquisitions, and rollups, Cowart told the NORA event, one day before Kaplan spoke. Some of these plants will make base oil, some will make vacuum gas oil. But North America now has about a 23 percent base oil oversupply, versus current demand, which suggests that more rerefined oil will be a drag on an already glutted market.

Nevertheless, the ranks of rerefined base oil suppliers continue to fill out, with newcomer Heritage-Crystal Clean opening last year, and this year to bring NexLube in Tampa, FCC in Baltimore, and Universal Environmental Services in Peachtree City, Ga. Beyond that, Newalta promises to expand its operation in British Columbia, and Safety-Kleen and others also are teeing up new rerefining schemes.

Aaron Oils Jeff Gross also visited this theme during the NORA meeting. There are lots of new investors and private equity groups in rerefining, he said, including many first-time funds. Often they use a hook to attract partners, chasing what is fashionable at the time. So during the George W. Bush Administration, we saw lots of investment in homeland security and defense. Under Obama, the push is for green and clean technologies.

BGLs Kaplan, who advises on mergers and acquisitions, strategies and company valuations, is more bullish. In our view, the macro issues seem to be aligned to favor rerefining. First, theres sustainability. U.S. culture has changed to be accepting of recycled motor oil. We see zero-waste efforts at corporations, and strategic initiatives on recycling. Still, will customers be willing to pay on a par with virgin motor oil, or pay a $3 premium, or $2 more for recycled motor oil? Thats to be determined.

He did concede that North America is experiencing a land grab by rerefiners, with companies announcing projects in choice geographic areas long before theyre actually ready to build. Folks hear whats announced and must wonder, will all this get built? Well, we dont believe there is overcapacity now, Kaplan said. And we believe that a 10 million gallon a year rerefining facility can be a great investment – always depending on the location. The ability to build capital and get margin benefits, and to take share from big oil – I think its all there.

Scott Parker, executive director of NORA, highlighted another challenge for the used oil industry: volume. As he reminded the ICIS Pan American Base Oils & Lubricants Conference in late November, the supply of used oil isnt getting bigger. Quite the contrary.

Used oil is finite, and thats the number one limiting factor to our marketplace. At the most, you can only collect the amount that is generated, Parker said. Whats more, the supply of used oil will continue to shrink because of longer drain intervals, fewer miles driven by consumers, and tapering sales of virgin lubricants.

On the other hand, large volumes of used oil are still not being collected, and channeling that volume into safe uses is one of NORAs principal goals, Parker said. By some estimates, uncollected used oil in the U.S. is about 400 million gallons a year. To be honest, these will be hard to collect. Every gallon that is collected now has value, but much of the rest does not.

NORA has been involved in used oil for more than 30 years, and now has more than 340 member companies who collect and process over 1 billion gallons of used oil and related materials a year. Members include used oil collectors, processors, burners, equipment and engineering firms and rerefiners. And thanks to Wall Streets interest, investors and bankers are also joining NORA.

Despite these diverse interests, Parker says NORA members share the common goal of preventing used oils classification as hazardous waste, so they can continue to collect and recycle it responsibly.

Used oil has value and if it does, youll see collection and appropriate segregation and recycling, because theres an economic incentive to do so. Generally, companies in this industry are privately held, entrepreneurial and smaller. Theyre also regional, because all those working in the recycling industry have to be close to where the material is generated, Parker explained.

The average volume collected is just 322 gallons per stop. It takes a lot of energy to go get this oil, so you can imagine what it takes to amass the millions of gallons NORA members collect each year. Most of it comes from quick lubes, dealerships, some industrial sites. The streams include used crankcase oil, industrial lubricants, oily wastewater, and spent antifreeze.

What happens next to these millions of gallons is whats sparking excitement in the investment community. Kaplan pointed to a rash of news involving recyclers and rerefiners.

Used oil collector and rerefiner Safety-Kleen was purchased by Clean Harbors in late October for $1.25 billion. Safety-Kleen is the worlds largest rerefiner, with base oil plants in Breslau, Ontario, East Chicago, Ind., and a third promised for the U.S. Gulf Coast region.

Universal Lubricants, which owns one rerefinery in Wichita, Kans., and plans to build another, bought Texas-based used oil collector Midstate Environmental Services in order to secure raw material. Universal has been in Pegasus Capital Advisors portfolio since 2007.

Private equity firm CIVC Partners sold used motor oil collector Thermo Fluids to Heckmann Corp. for $245 million in March. The companies convert used oil into reprocessed fuel oil, among other environmental services. Increasingly, their material is sold to rerefiners as feedstock.

In 2011, Germanys Avista Group became the majority owner of Universal Environmental Services, which is building a $52 mil-lion rerefinery in Peachtree City, Ga. UES then acquired the used oil collection business of The McPherson Companies, while McPherson took a stake in Avista, which counts private equity firm MidMark Capital among its owners. Last October, the investment firm SKion GmbH became Avistas largest shareholder.

Publicly held Heritage-Crystal Clean opened its rerefinery in Indianapolis and began base oil production in early 2012. Feeding this facility is its growing network of used oil collection branches, which total more than 70.

The glow from investors is burning bright, Kaplan said. Heritage-Crystal Clean is trading now at 25 times its EBITDA, he pointed out excitedly. Likewise, Heckmann paid handsomely for Thermo. That was a landmark deal that will push more merger and acquisition activity. Its now owned by a publicly held company and run by a guy who built his company on making deals; theyll do more deals. He also suggested that Universal Lubricants has the potential to become a mini-Clean Harbors/Safety-Kleen.

Given the momentum, Parker of NORA expects North America to have 500 million gallons of rerefined base oil capacity and 200 million gallons of rerefined VGO capacity in five years time. But just because a future plant is announced, doesnt mean it will be built, he said.

Its possible that with all this construction, rerefiners will start to compete with each other for feedstock instead of with industrial burners, Parker added. However, after the next two to five years I expect well see growth plateau. Beyond that, the number one growth sector for used oil collection and rerefining is likely to be South and Central America.

Oil recycling is ripe with opportunity. The small oil collection business owner has an opportunity to merge, to raise capital, to build a rerefinery (and smaller can be OK), Kaplan advised. But if youre a collector, you need to protect your feedstock because those with rerefineries could come and take your feedstock. You need to protect yourself from that disruption or volatility. The biggest opportunity, if you are a rerefiner, is to go get your own feedstock.

There is rapid change ahead, were moving fast and the speed will go even faster, predicted Aaron Oils Cowart. But we need to ask ourselves a lot of questions as we move in this direction. Why are some refiners closing virgin base oil capacity in North America? Most concerning, the market is shifting to API Group III, but rerefiners only make API Group I and Group II.

Well, that too can change, according to Safety-Kleens Rodney Walker. He told the ICIS Pan American meeting that used oil rerefiners are continually improving their processes to create higher performing base oils. Right now, his companys 4.6 cSt base oil meets API Group II standards, and delivers even lower Noack volatility than is needed for ILSAC GF-5 engine oils. And each time a new engine oil upgrade is introduced to the market, its quality eventually percolates into the used oil stream.

We are what we eat. Walker said simply. And now were eating a lot of Group III.

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