The reality we are living in now: Biofuels and the new DC, part II

In a two-part series, we look at the new DC in a $14 trillion debt environment: what’s up with loan guarantees, tax policy, the Renewable Fuel Standard, and the Defense Production Act.

In part I we looked at the latest on loan guarantees and at the Klobuchar-Thune-Feinstein compromise on ethanol tax policy.

Today, in part II, we look at the future of the RFS and take a fresh look at opportunities in the Defense Production Act.

When we look at the comprehensive — and either politically courageous or suicidal — carbon legislation introduced in Australia this past weekend, it provides a benchmark against which the chaotic US renewable energy policy debate is taking place. Australia’s goal: a way forward on carbon, and policy stability that will foster innovation that is the only path to bringing down the carbon price.

The Renewable Fuel Standard

By contrast, the US fell behind on renewables policy until 2005, recovered through 2008, and has fallen into a muddle since then.

In a swirling stew of change regarding US federal incentives, tariffs, tax credits and loan guarantees, the most consistent mechanism driving the expansion of renewable transport fuel has been the US Renewable Fuel Standard. Though the mix of fuels is changing, and volumetric mandates have changed each year, the RFS has, more or less, stayed on schedule and on course towards its ultimate goal, charted in 2005 and expanded in 2007, of replacing up to 25 percent of US gasoline usage with biofuels.

Had the US not taken the course it did in the mid-2000, inevitably the demand for gasoline would have risen, and the RFA is circulating an estimated impact of up to $0.90 cents per gallon on prices. We’ll never know, for sure.

But, in the absence of additional domestic production, even at current prices, the absence of biofuels would have added some $46 billion to the annual US trade deficit (at current RBOB prices and based on the 2012 RFS), and subtracted a bright spot in the US economy in the farm sector.

The RFS continues to be highly controversial – primarily because of the degree of dependence on corn ethanol, for which the mandated market will expand from 12.6 billion gallons in 2011 to 13.2 billion gallons in 2012. The heavy use of corn ethanol has drawn howls of protest, and well funded lobbying and PR campaigns, from an assortment of food and environmental groups – both more opposed to the use of corn than ethanol.

The oil industry is conflicted when it comes to biofuels – institutionally, through groups such as the National Association of Petroleum Refiners and the American Petroleum Institute, they oppose biofuels mandates.

Many of them have acquired ethanol producing capacity – Valero, Sunoco, Koch among them – with carrying degrees of happiness at being in the ethanol business. Companies such as BP and Shell have projected a sharp increase in the long-term market for biofuels and have invested in building up capability and capacity.

The promise of advanced biofuels

For the long-term, investors of all stripes, and environmental groups, focus on the promise of advanced biofuels.
There is widespread support of the fuels in the Congress, conceptually, with their 50 percent (minimum threshold) reductions in carbon emissions compared to straight gasoline – except, perhaps, in oil-patch states.

There are, generally speaking, no major hurdles expected in the downstream distribution of advanced biofuels – especially for drop-in fuels, which, once certified, are easier to distribute than ethanol or biodiesel. The processing technologies are coming along quickly – with numerous commercial-scale demonstrations scheduled to commence operation over the next three years.

So, what’s problem? Well, there are two.<

The corn ethanol problem

First, the RFS is a mixed standard that includes targets for biomass-based diesel, cellulosic biofuels, advanced biofuels, and convention starch-based biofuels such as corn ethanol – all in one package. Opponents of corn ethanol, for example, want to re-open the Renewable Fuel Standard and ratchet down those 15 billion gallon volumetric mandates.

And, the National Association of Petroleum Refiners, we are told, wants to re-open the RFS to eliminate the pool of advanced biofuels altogether.

So that’s problem number one, which has caused the biofuels industry to unite under a “don’t mess with the RFS” banner. Their belief: the certainty that the RFS affords to the investment community, as well as the incentive to obligated parties to buy or build capacity, is the most powerful driver of biofuels adoption.

The feedstock problem

Which beings us to the second problem: the availability of qualified feedstocks.

Generally speaking, support is virtually universal for biofuels made from low-impact residues such as waste greases, fats and veggie oils, municipal solid waste, or volumes of agricultural waste such as corn stover, or forest slash. The problem in these markets is that they are small.

The big, established markets for biomass are, invariably in the food crops – but opposition to expanded use of food crops for biofuels is strong and growing, as noted above.

Which leaves advanced biofuels between a rock and a hard place, when it comes to tapping feedstocks. One solution is dedicated energy crops, such as switchgrass or miscanthus, and they are expected to scale relatively rapidly in the 2010s. Jatropha is making a comeback based in better farming practices and improved genetics.

But, to expand capacity to something like 36 billion gallons in the US, a broader array of feedstocks are expected to be needed. Two sources – algae and forest hardwoods – are having trouble qualifying as advanced biofuels feedstocks because their availability was not generally well-understood when Congress established the RFS2.

“We went to the EPA with a really good Fortune 100 company,” said Mike McAdams, president of the Advanced Biofuels Association. “They are looking at gasification of hardwood into diesel, and jet fuel. Bottom line: they can’t use the hardwood – it won’t qualify as an advanced biofuels feedstock. What is approved under current rules are slash or commercial thinnings, but there are not enough.

“The restrictions on hardwood were pushed by the pulp & paper industry before the 2007 legislation – but now that the global paper market is so challenged, the hardwoods have opened up. Now, the pulp & paper industry really needs the softwoods, because they want to make diapers and tissue. But it requires a new statutory authority, and if we open up the RFS, the NAPR is right behind us, asking to eliminate the advanced biofuels pool.”

But it goes beyond hardwoods – even algal biofuels are not covered in the RFS – which, according to biofuels industry leaders, needs to better incorporate fuel and feedstock neutrality. But to do so, risks opening the RFS, and exposing the overall biofuels policy to a difficult debate at a difficult time.

The Defense Production Act

In recent months, there has been a brightening outlook on the military biofuels front. The Defense Department, through the Defense Logistics Agency, has released guidance on up to 500 million gallons of annual biofuels purchasing for renewable, drop-in diesel and aviation biofuels, that will be required by late in the decade.

The DoD has been buying test quantities of advanced biofuels to use for certification, and the Navy in particular has indicated that it will fuel a Green Strike Force, and up to half of fleet fuel requirements, through biofuels in the long term.

It was hoped, in military circles, that signaling advanced biofuels demand would combine with DOE funding of commercial demonstrations, and DOE loan guarantee authority, to create the conditions for private investors to move forward on building advanced biofuels capacity in sufficient quantity that the DoD would have an array of competing suppliers, at scale, to ensure that advanced biofuels would not only be available, but affordable.

The global financial crisis, and the loan guarantee dry-up

Then two things happened. The global financial crisis dried up the project financing market that had been expected to provide the scale-up financing for advanced biofuels. The bridge mechanism, DOE loan guarantees, ran into strong headwinds at the Office of Management and Budget.

Despite clear Congressional instruction for loan guarantees to fund new, not-yet-commercial technologies, OMB has been knocking back every biofuels package that offered better terms than commercial banks. Not one federal biofuels loan guarantee has closed since the authority was first established back in 2005. Even companies that had gained conditional commitments, such as the Diamond Green Diesel project, backed away from the DOE program after getting better terms in private financing.

No financing – no advanced biofuels at scale, or very little, at best. That concerned the military – not only in terms of having biofuels at all, but having so little supply that it would become a seller’s market.

Taite McDonald at Wilson Sonsini recalls, “We originally recommended to look into the Defense Production Act about 18 to 24 months ago. It came up on a loan guarantee for a strategic minerals technology. We didn’t go ahead on that project, but the White House, at the time, indicated that they were willing to talk about utilizing the DPA for cleantech projects.

What is the DPA?

DPA, if and as funded, permits the government to construct alternative energy projects to meet national security goals. Here’s our Digest primer: “GI Joe, Funding Man from Head to Toe.”

“When President Obama gave his March 30 speech at Georgetown,” McDonald added, referring to the speech in which he committed the Administration to building four advanced biofuels projects would be built, “there wasn’t funding at the time, even with the DPA. It was going to have to be put in there, in FY 12 or beyond. But conceptually, there was support for using the DPA.”

Is the money there, or sort of there?

“Oh, the White House has the money,” adds another Digest source familiar with the state of play, who declined to be indentified for the article. “They were going to announce it on July 4th as “Energy Independence Day”. They are talking about 5-6 plants, and are going to use the DPA to build the capacity, although they probably don’t really have enough to do that many.”

The hold up? “It’s the debt ceiling debate,” our source explained. “The White House is not going to ‘find money’ for advanced biofuels and announce it before the debt deal. Otherwise that will just go into play for deficit reduction.”

Taite McDonald is not so sure. “Ultimately, we need both the Congress and Executive to be on board, to make sure that funding is allocated to this effort and remains committed to it. The Executive Branch and Navy were working together, but what is needed is for industry to form a coalition and press hard with the Congress so that they understand how important this is to the scale-up of advanced biofuels.”