Should biofuels have its own reserve accounting system and accompanying balance sheet booster, just as the oil & gas industry has?
Ceres CEO Richard Hamilton says “yes”, and explains why, and how.
At the Advanced Biofuels Markets conference earlier this month in San Francisco. Richard Hamilton, CEO of Ceres, advanced the remarkable proposition that biofuels companies – on the “level playing field” theory advanced by opponents of government mandates and subsidies, should have the right to book their reserves of crude renewable oil production, in a parallel to the reserve accounting system which forms the bulk of the oil & gas industry balance sheet.
About proved reserves and balance sheets
Most investors understand proved reserves. Under specific (and generally conservative) SEC rules, proved reserves (that is, which have a 90% or higher probability of being feasibly extracted) can be added to the balance sheet.
These reserves currently total 44 billion barrels for the top six oil exploration companies (ExxonMobil, BP, Shell, Total, ConocoPhillips and Chevron), and when we speak about the massive oil company balance sheets, this is very much in the mind of the investors when they value each company, especially in terms of their predicted future ability to produce revenues.
The complete Hamilton presentation
Hamilton’s presentation can be viewed here, and it contains a call to action on the final slide which is well worth considering. (But, please note, the call to action email should be sent to [email protected] – make sure you have that spelling correct).
Why have what Hamilton calls “renewable reserve accounting”? For one, it creates a system for valuing biofuels companies that parallels the way we value oil companies, which helps make them inherently more fungible, more comparable, more apples to apples.
Transitioning from an agriculture model to an energy model
Especially if we are to decouple biofuels from the agricultural model, which in all regions is heavily subsidized and in which government plays a heavy-handed role – and instead move biofuels over into the less regulated, more market-based system that underlies energy trading.
Hamilton notes in his remarkable presentation that a system for renewable reserves could, in fact be developed. He based his illustration on the tonnage of biomass per acre, the conversion yields in gallons per ton, and a contract term for which the underlying land would be dedicated to energy production.
Think of it, then, as an above-ground oil or gas field.
Hamilton points out that, over time, despite technological innovations, the cost of finding and developing new oil reserves is increasing, and this is a metric by which energy (bio or fossil-based) should be measured in a standard way. Hamilton notes that the three-year average Finding & Discovery (F&D) investment by the six largest independent oil companies is $20 per barrel, rising to $34 per barrel in 2010, and that the six IOC’s spent an aggregate of $100 billion on exploration & production last year.
What does $100 billion buy you?
What does $100 billion buy you? he asks. On the fossil side, about 3 billion barrels in reserves. On the bio side, if the goal is to produce a crude oil equivalent (rather than a finished fuel or chemical), the costs aren’t much higher for, say, the first stage of pyrolysis (before upgrading to finished fuel). In terms of reserves, you would end up with, say, somewhere between 2.5 and 3 billion barrels of oil equivalent.
Now, what would you rather have, goes the thinking – 3 billion barrels of crude (ready for refining) – and lord knows where the next 3 billion will come from or at what cost. Or 3 billion barrels of renewable crude (ready for refining), and you know exactly where the replacement is going to come from. And you have a pretty good idea that , because of technological innovation, costs of finding, developing and producing biomass reserves is likely to decrease.
That’s one of the nuggets in Hamilton’s system – the argument that biofuels companies ought to be able to acquire and manage reserves and be valued as companies for that potential – and not strictly for their production today.
Why is reserve accounting valuable?
For example, if oil demand dips, oil company reserves don’t – they still have the benefit, from an investment point of view – of being valued on their reserves as well as on day-to-day demand in the market.
Now, agriculture is not generally valued this way. In ag, reserve accounting does not generally exist, and companies are to a great extent valued based on market demand, margin and actual stockpiles (for example, processed grain held in silos). You don’t get bennies from the market just because there is a 90% or higher potential that you can get more production out of a given field, at a later date.
But, to protect agriculture from the mad price swings that accompany commodity grain markets, there is a lot of government protection built into the agricultural system – floor payments, mandated government purchases, price controls, subsidized food, and so on. No one wants a return to the market conditions of, say, the Great Depression, or the global commodity collapse of the 1890s.
But Hamilton argues, if biofuels are asked to transition out of system by which global agriculture is valued and protected, as opponents of mandates and subsidies would demand, why shouldn’t biofuels have access to a parallel system by which global energy is valued and protected?
A fair go
It’s a fair question. Shouldn’t biofuels get a fair go?
Now, Hamilton’s outlook is, essentially, a conversation-starter rather than a complete system. Whether a biomass field should be valued over, say, a 15-year or 100-year period, should be debated. Tonnage per acre, whether than is 2 or 15, should be agreed and understood.
Crucially, a cost would need to be established that parallels the technology cost associated with production & exploration. For the purpose of establishing a reserve, for example, should all the costs of growing, extracting and refining fuel molecules be included? Likely, not – after all, the total cost of refining fuels is not applied to oil & gas reserves. But what cost should be applied to “prove the reserve”? The cost of leasing land, or above that the cost of growing the biomass, or above that some limited refining cost to turn it into, at least, a barrel of crude oil equivalent?
Here at the Digest, the latter case strikes us as the most comparable – something like the lowest cost of growing, and then converting carbs into a biocrude.
Moving from conversation-starter to system
For sure, the devil is in the details. But the focus for today, is on a startling idea that deserves a wider conversation.
As Hamilton himself says, the world of carb-derived fuels features no to low carbon, low discovery risk, declining E&P costs per barrel, and fields that don’t peak and decline.
Why shouldn’t such a system have a parallel to the hydrocarb-derived fuel – one that fits the current accounting system and business model?
If biofuels, in short, are expected to live without agriculture’s USDA shelter, shouldn’t it have the SEC’s oil & gas shelter?