Ask and Ye Shall Receive
Last week, The Economist posed the following question: “What happened to biofuels?” The biofuels in question are so-called second generation biofuels that are produced from trees, grasses, algae, — in general, feedstocks that don’t also have a use as food. The appeal is obvious to anyone concerned about the world’s dependence on petroleum, and further worried that a major shift to biofuels will cause food prices to rise. So let’s address that question.
Entrepreneurs Revive a Century-Old Idea
About a decade ago, a number of entrepreneurs began to use their political influence to convince the US government that the only things keeping the US from running our cars on advanced biofuels was lack of government support, and interference from oil companies. These advocates eventually won over enough political support that state and federal governments began to funnel large amounts of taxpayer dollars into advanced biofuel ventures. President Bush spoke of running cars on switchgrass in his 2006 State of the Union address.
The federal government sought to deal with supposed oil company intransigence with a mandate requiring gasoline blends to contain growing volumes of corn ethanol initially, but starting in 2010 advanced biofuels as well. The federal government mandated that by the year 2022 the fuel supply had to use 36 billion gallons of biofuels, with 21 billion gallons coming from advanced biofuels.
But the history of cellulosic fuels goes back much further than many of those entrepreneurs realized, and many set out to reinvent the wheel with tax dollars. It was nearly 200 years ago, in 1819, when French chemist Henri Braconnot discovered how to break cellulose down into component sugars, which can then be fermented to ethanol. The Germans first commercialized cellulosic ethanol production from wood in 1898, and the first commercial cellulosic ethanol plant in the US was built in 1910 to convert lumber mill waste into ethanol. Nevertheless, many budding biofuel entrepreneurs insisted that this was a field in its infancy, and therefore required generous government support until it could stand on its own.
Some attempted to produce fuel from wood via a different route. Wood (or natural gas or coal) can be partially burned to produce synthesis gas (syngas), which consists of hydrogen and carbon monoxide. That syngas can be converted into diesel (among other fuels) using the same process that Germany used to produce fuel in World War II. The problem is that this is a terribly expensive process, and so there are only a handful of commercial plants around the world that use either natural gas or coal (South Africa, which had its roots in their inability to secure petroleum because of sanctions resulting from their apartheid policies).
We do have a small trickle of advanced biofuels that are beginning to collect EPA credits. In other words, for the first time the EPA is officially approving batches of these fuels for sale into the market. This first took place last year with a batch of 20,069 gallons from a company that subsequently went bankrupt. And therein lies the challenge. Of course this stuff can be produced. But can it be produced economically? The answer to that is no, the approaches that have been taken to date are nowhere near that point regardless of the hype to the contrary.
Moore’s Law to the Rescue?
The high costs have never been a deterrent for Silicon Valley entrepreneurs who wielded Moore’s Law as the solution to every problem. In their minds, the advanced biofuel industry would mimic the process by which computer chips continually became faster and cheaper over time. But advanced biofuels amounted to a fundamentally different industrial process that was already over 100 years old. A decade into this experiment it is clear that Moore’s Law isn’t solving the cost problem.
In an interview with Wired Magazine in 2006 called My Big Bet on Biofuels, Vinod Khosla, one of the co-founders and the first CEO of Sun Microsystems, described his investment in Kergy (which later became Range Fuels). He wrote that to his knowledge, they had invented “the first anaerobic thermal conversion machine.” In fact at that time there were hundreds if not thousands of these gasifiers around the world, mostly used to produce power (a much lower cost proposition than biofuel production).
My experience touches on all of these areas: biomass conversion, gasification, and production of liquid fuels — and I wrote a number of articles critical of the claims coming from the Range Fuels/Khosla camp. Some referred to me as “Range Fuels’ Number 1 Critic.” But the mainstream press couldn’t say enough great things about the company, right up until they declared bankruptcy in 2011. Hundreds of millions of dollars of taxpayer and investor dollars had been wasted, and the company never produced a drop of qualifying renewable fuel.
Now some might say that failure is just a part of doing business and trying new things. That’s true, and I would never have criticized these companies and their promoters except they were influencing energy policy on the basis of inflated claims and collecting tax dollars as a result. If entrepreneurs try and fail on their own dime, then that’s their business. (I work for an energy entrepreneur). But if they take tax dollars, it’s my business as a taxpayer. And if they take investment dollars, it may become my business if I am advising investors.
Epic Analyst Fail
In fact I did give a fair bit of investment advice as some of the advanced biofuel firms began to take their companies public. Amyris (NSDQ: AMRS), Gevo (NSDQ: GEVO), and KiOR (NSDQ: KIOR) were three Vinod Khosla-backed companies that went public, and the value of his stakes has reportedly declined more than a billion dollars since (nearly a billion dollars at the time of that article, but the shares of all those companies continued to decline). I have been asked by investors about the prospects for each of these three companies (among others) since their IPOs, and every time I warned people away. That has proven to be good advice, because since their respective IPOs Amyris is down 85 percent, Gevo has fallen 89 percent, and KiOR is down 88 percent.
Yet one analyst after another recommended these firms to clients, and then continued to reiterate those recommendations. Take KiOR, for example. KiOR uses a process in which they rapidly heat up wood chips to form a bio-oil, which can then be upgraded with hydrogen in pretty standard refining equipment to produce diesel and gasoline. KiOR has their own spin on the process, but the basic process has been around for a long time. The problem has always been cost.
After the IPO, the market promptly bid KiOR’s value up to $2 billion. In response, I wrote an article arguing that KiOR was grossly overvalued. (I explained my decision not to short the company even though I felt they were grossly overvalued, but some investors contacted me to tell me they did short the company on the basis of my recommendations).
But analysts remained undeterred. After KiOR announced a net loss of $31.3 million for the first quarter of this year, several analysts reiterated ratings of “Overweight” or “Outperform” on the company. For instance, Pavel Molchanov from Raymond James reiterated the “Outperform” rating that he first made on August 15, 2011 when shares were at $11. When second quarter results came in far below projections, Molchanov reiterated the Outperform rating and $9 price target. Shares are now down under $2, a drop of more than 50 percent just since the Q2 results were released.
The point here is that this was totally predictable from the chemistry and low energy density of biomass, and of the science involved in trying to economically turn that into a low margin commodity like fuel. There is no magic catalyst or magic process that can overcome that. No matter how I sliced the numbers, I couldn’t see how any of these biomass to fuel companies were going to make any money other than through government largesse. (I am not saying that no scheme will ever work economically, but many in these space don’t understand the challenges and thus they fail by over-promising and under-delivering). So I advised investors to stay away, even as the analysts continued to believe the hype that many of these companies put out.
No Funeral Just Yet
KiOR isn’t dead yet though. In fact, I talked to a reporter on Monday, and advised that they would probably bounce off the bottom soon. There is probably one or two cycles of more positive news ahead, and they may very well get additional injections of cash from Mr. Khosla. As if on queue, shares were up 25% in trading on Tuesday. But even though the share price may see sharp gains at times, the road ahead will be very challenging for them, and the risk of bankruptcy is high in the long-term. So I would continue to avoid most companies in this space, unless you simply want to put some money down in lieu of a trip to Vegas.
I don’t feel the same way about the entire renewable energy space. Solar photovoltaic (PV) panels, for instance, benefit from Moore’s Law effects, but their manufacture is very different than the production of biofuels from biomass. And in fact, we are seeing not only exponential growth in the installation of solar PV panels, we see costs dropping exponentially. I have been reiterating my view for more than six years that I think the future belongs to solar power. The mistake from biofuel entrepreneurs, politicians, and investors in that space was that this is how things would play out for biofuels.