Biofuels 2.0

The rise of themochemical biofuels, the power of markets, and the anarchic essence of energy development

One of the most astute equity analysts in renewables, Pavel Molchanov of Raymond James, issued a recommendation on KiOR’s stock this week with an Outperform rating – despite the fact that KiOR already has a $1.5Bn market cap, and has not produced revenue to date.

It’s a remarkable step forward for a technology known as catalytic pyrolysis.

Factors in Molchanov’s call: “While Gen2 scale-up faces hurdles, the long-term growth potential is very real, especially against the backdrop of our long-term oil price forecast of $125/Bbl…KiOR’s thermochemical process creates immediate leverage to cellulosic biomass, enabling a target cash cost of $1.80/gal at full commercial scale, with the potential to reach $1.30/gal long term.

Molchanov added: “The first commercial production plant (~13 million gallons) is set to be completed in 2H12, and we assume four additional plants of ~40 million gallons each by 2015.  The first plant is fully funded.”

Bottom line, 200 million gallons of cellulosic biofuels production by 2015, with a fuel cost of $1.30 – $1.80 at the refinery gate – in the context of wholesale RBOB gasoline futures for 2014 trading on NYMEX in the $2.90 per gallon range.

The rise of drop-in fuels and the RFS

Back in the spring of 2007, when the Renewable Fuel Standard was being first shaped into a law that would eventually pass in December, there was hardly a word about drop-in fuels, much less pyrolysis oils, much less catalytic pyrolysis. There were research efforts underway – nascent companies like Dynamotive and US Sustainable Energy exploring the technology – and by November, Khosla Ventures formed KiOR as a JV with BIOeCON, a Netherlands-based research group, to commercialize BIOeCON’s Biomass Catalytic Cracking process.

The problem with traditional pyrolysis, in which biomass is rapidly heated in a vacuum to produce bio-oil, methane and char – is that the char was of generally low-value and the oils produced were highly acidic, unstable, and required substantial upgrading to be used as fuel. The BCC process lowered the temperature of the reaction, using a proprietary catalyst, and thereby transformed the yield and usability of the pyro oils.

But KiOR represents something even more important than a material contribution towards the US Renewable Fuel Standard, and a biofuels investment opportunity of note – it defines the essentially anarchic, dadaist, unpredictable nature of the development of advanced biofuels.

The failures of Biofuels 1.0

Yesterday, I had a lengthy conversation with a promising young biofuels analyst and researcher, Mackinnon Lawrence, about an upcoming report for Pike Research he is developing on the state of biofuels. In his reading, he said, he had detected a strong theme of discussion about the failure of cellulosic ethanol, and the EPA waiving down the mandate for 2010 and 2011. What’s up with that? he rightly asked. Is it the financing situation?

Partly, I said.

The “failure” of cellulosic ethanol is a failure of the policy framework, I said. It was suicidal to pass legislation that set mandates starting in 2009, when the EPA could not even issue the final RFS2 rules of the road until the summer of 2010 and began imposing the full mandate in January of this year.

Kirk Haney, the CEO of jatropha genetics developer SG Biofuels, said that  “jatropha 1.0 didn’t fail, the jatropha 1.0 business model failed.” And so it was with Biofuels 1.0 – the model failed.

That is to say, the prescriptive nature of the mandates, which focused on expectations that specific fuels would be developed (e.g. cellulosic ethanol), in specific timeframes (the RFS schedule), and would be distributed at precisely designed blend ratios (E10 and E85, and nothing in between).

That is to say, the prescriptive nature of the R&D investments by DOE, which focused on scaling cellulosic ethanol, with scant work on feedstock, engines, pumps, pipelines, new fuel certification, drop-in fuels, renewable chemicals, or higher alcohols. That’s changed now, and it’s great to see the focus on integrated biorefineries and replacing the entire barrel of oil. But the early years were lost to the locust.

The Soviet of Renewable Energy

Prescriptiveness? It reminds me of the old story, from the days of the Soviets, about the prize given by the USSR for the factory that produced the most nails. The first year, it was won by a factory that re-tooled its machines to spit out nails as small as sewing needles. The next year, the USSR changed the prize to reflect the highest tonnage of nails. The same factory won again, by retooling to produce rail spikes. Two awards, and a bunch of product that never found a market and was thrown away.

Did that really happen? It’s an apocryphal tale – but I saw worse, as a young journalist in the old USSR.

The prescriptive, Stalinist, big brother, politburo that pervades the renewable energy movement is, of course, its Achilles heel. Filled with its prescriptive mandates, tariffs, subsidies, incentives, modeling systems that never quite model the real world, and fraught with unintended consequences.

Hands on the hookah, eyes on the government dope

It’s nearly succeeded in convincing the general public that renewable energy is a set of technologies that survive exclusively on gigantic government hand-outs, designed to line the pockets of acolytes, and inevitably result in higher prices, more taxes, more regulation, and more government.

Nothing could be further from the truth, but you can see how the public gets confused. They are stuffed with the debate over the ethanol tax credit, the biodiesel tax credit, farmer payments, the biomass crop assistance program, the blender pump incentive, the Brazilian ethanol tariff, and the various production and investment tax credits until they are just about to throw up.

And that’s just biofuels. Wind, solar, geothermal and small hydro all have their hands on the hookah, and their eyes on the government dope.

In the eyes of many, renewable energy has gone from the cute days of giggling baby companies, to 30-year old adult industries that are still wearing diapers, living off Mom’s cooking, and whose business plan is a plaintive “wipe me, Daddy.” Is it any wonder that people feel this way?

Australia’s Carbonageddon

As if to confirm everyone’s worst fears, Australia came out this week with a train wreck of a carbon tax – imposing a price of $23 per tonne on carbon. It will take effect after 12 glorious months for innovation in carbon remediation, be imposed on an arbitrary group of polluters, with an arbitrary, politicized group of opted-out industries. Featuring a redistribution of the proceeds so complex that it must have been pulled from a file in the Kremlin.

59 percent of economists say the Aussie model is a good idea, but the public is not composed of economists pouring over model data for a living.  68 percent of the public, surveyed, opposed the plan – and the government’s approval ratings have fallen into the electoral disaster range. The opposition is having such a field day with it that, should they ever gain power, carbon pricing will be annihilated.

The power of markets

Ranged against that experiment in public policy, are technologies like KiOR’s. By contrast, KiOR will sell $1.80 per gallon “drop in” fuel, received no major US government grants in the 2007-2011 period, do not benefit from the VEETC, do not require a blender pump, don’t need a new pipeline system, are not protected by the Brazilian ethanol tariff, and do not require growers incentivized by BCAP. They are going to make a fortune for their early-stage investors, and are building at scale right now.

That, readers, is the power of markets. The power of a more dadaist energy policy – that embraces the chaos and chance of markets in its policy. That uses government to set goals, not to prescribe ways and means.

Energy policy in a Dadaist world

That’s what government is good at – setting goals. Kennedy said we should reach the moon and safely return, before the end of the 1960s. He never said “in a Saturn V, using a lunar module, based on the Rocketdyne F-1 engine, burning an RP-1/LOX fuel, made by Boeing, North American Aviation and McDonnell Douglas.” None of that detail could have been known at the time the goal was set.

A good policy? A fuel, feedstock and technology-neutral Renewable Fuel Standard, based on carbon-miles (miles per gallon for the fuel, adjusted for carbon content compared to gasoline).

Keep it simple, stupid, as the old saw goes. A simpler, goal-directed energy policy liberates the power of innovation, and leverages the national investment in R&D.

That bets the future, alternatively, on the transformative, deconstructive work of carbon-based scientists like Lee Lynd, Sue Leschine, Kevin Gray, Jim Dumesic and Randy Cortright, George Huber, Robert Brown, George Church, Emil van Zyl, Shulin Chen, Chris Somerville, Neil Renninger, Steve del Cardayre, Craig Venter, Steve Mayfield, Peter Meinhold, Philip Steele, Sean Simpson, Rathin Datta, and Charlie Wyman. Just to name a handful.

Atomic energy: a cautionary tale

By contrast, prescriptive views of the future, based on foolish assumptions chanted by the collective, have landed us in the carbon mess we are in today.

To mention one, the prescriptive response to the rise of atomic power, and wrong-headed assumptions about nuclear energy.

It was the Eisenhower Administration’s assumption that everything atomic was, potentially, a force for good, that led them to assume that the world would be powered by nuclear energy in the distant future (i.e., now).

It was under Ike’s Atoms for Peace architecture that the US encouraged its Saudi allies (and Aramco, and the US companies south of the Red Line, exploring for petroleum in the Gulf) to build as much refining and pumping capacity as they could, on the assumption that the markets for oil would run out long before the oil would.

Ironically, it was under the Atoms for Peace program that the first nuclear programs were established in Iran and Pakistan. Good outcome for US investment, eh?

Conversely, it was David Brower’s prescriptive assumption that everything atomic was, potentially, a force for evil, that caused the 1967-68 split in the Sierra Club over the Diablo Canyon nuclear project. The split forced Brower out of the Sierra Club, and led to the foundation of the Friends of the Earth and the birth of the ‘no nukes’ movement. The US ultimately halted nuclear power construction, but did not halt the expansion of its economy.

Today, France has a lot of nuclear, the US has a lot of coal, and look where we are.

Biofuels 2.0

Ranged against all that – companies like KiOR, Solazyme, Amyris, and Gevo – based in the radical exploration of the potential in carbon-based molecules. I’ll take them any day and twice on Sunday.

What do they know that all the apparatchiks in the environmental Politburo can’t see? The enemy is not carbon, but a failure of imagination in how to handle carbon residue. In the name of building a paradise, we have built a Waste Land. The enemy is waste – wasted land, wasted people, wasted time, wasted carbon.

All we really need is a good set of goals, some continuing public investment in basic R&D, and policies that liberate the power of markets and the innovative spirit. KiOR is a pretty good example.

That’s Biofuels 2.0.