The Signs: Good news for the Aces of Bio-Based may spell trouble for the Renewable Fuel Standard

“I saw the sign and it opened up my eyes, I saw the sign.” Ace of Base, The Sign

The Signs. In Washington, the courts yesterday denied a challenge to the Renewable Fuel Standard from the oil industry. LS9 raised $30 million in Series D financing and is headed for Brazil. Noble Group announced a $950M pair of acquisitions in sugarcane and ethanol processing in Brazil. Elevance yesterday closed its Series C financing and raised $100 million in the process.

It’s been a great month for bio.

But the events of this month should give anyone a few good reasons to question whether the signs are pointing to the industry standing up, at commercial scale, in ways that fulfill the US 36 billion gallon renewable fuel mandate for 2022.

“A lot of us, in developing our companies, based it on this document, the Renewable Fuel Standard, but its lying to you.” That’s what Eric McAfee, CEO of AE Biofuels, told us at Advanced Biofuels Markets last month in San Francisco. Not everyone was thrilled. But is he right?

Will the industry make a lot of ethanol? It already does, and will make a lot more. Will there be military biofuels, and aviation biofuels, and renewable chemicals, and plenty of other-bio-based materials from bioprocessing? Surely for sure. 36 billion gallons of renewable biofuel by 2022, for the US market? Not as currently organized.

Why?

“No one’s gonna drag you up, to get into the light where you belong,” go the lyrics to “The Sign”, Ace of Base’s monster pop hit from 1994, and it’s cautionary advice for the industry. The USDA’s Sarah Bittleman speaks in terms of “standing up a biofuels industry” like a pop-up children’s book, in that all the pieces have to rise up, in the right way, all at once.

Let’s look at the signs from this week, as we seek to discern the drivers and stoppers that are are defining winners and losers in biofuels over the next few years, and see if they open up our eyes. Is the industry standing up? Yes indeed it is. Is it standing up in a way that encourages us to believe there will be the grower community, the aggregated biomass, the biorefineries, and the downstream distribution in place by 2022? That’s a tall order – there are a lot of signs that that may not, in fact, be happening.

Capital flight to chems. Yesterday, Elevance Renewable Sciences announced that it has raised $100 million in its Series C financing round. Using a technology called olefin metathesis, the company creates high performance ingredients for use in personal care products, detergents, fuels, lubricants and other specialty chemicals markets, from renewable feedstocks. Naxos Capital Partners led the round with additional new investors, including Total Energy Ventures International, joining TPG Biotech and TPG Growth in the financing.

Also yesterday, LS9 released the details of its $30 million Series D financing round – and announced a clearly accelerated focus on Brazil and on the development of chemical products. Plus, we’ve seen Amyris gaining more and more attention from investors with its “chems + fuels + Brazil = Love” strategy. It’s share price is up 41 percent since its IPO just a few months ago.

What does that mean? In the near term, Elevance and LS9 are headed for Tractionville, leaving behind a lot of companies still in the Valley of Death, all of whom are looking at their magic bugs and catalysts right now to see how they can participate in the capital flows that are starting to rain down on companies that have renewable chemicals in their crosshairs.

The trouble with E15. “While some government agencies may believe differently, Tesoro isn’t convinced that E15 is ready for prime time,” a Tesoro spokesman told the Wall Street Journal this week, as Tesoro, Valero and Marathon announced they would not sell E15 ethanol at their gas stations.

These are not just a bunch of fossil-fuel loving old-line oil refiners. Tesoro is partnered with UOP in a DOE-funded project to produce drop-in fuels in Hawaii, and partnered with AltAir in a project to produce drop-in aviation fuels in Washington state. Marathon is an investor in cellulosic ethanol via Mascoma. Valero, for goodness sakes, is the third-largest producer of ethanol in the US, after ADM and POET. Their concerns may be short-term in nature – we’re not quite sure if they are worried about late-model cars as much as the older-model cars, and opportunities for misfueling — but they are troubling.

Bottom line: a recent EPA ruling that E15 meets Clean Air Act regulations for 2007 through 2009 model years is nothing that obligates refiners to blend and distribute E15.

A titanic battle can be foreseen – if the corn-ethanol industry, for example, can change provisions in the RFS and qualify corn ethanol as an advanced biofuel (opening up a market beyond the 15 billion gallon corn ethanol maximum) – will the EPA obligate refiners to blend, say 18 billion gallons of corn ethanol even if they can only distribute 13 billion gallons via E10?

If mandated, where will the gallons go? Under RFS rules, qualifying fuels must be mandated if there is available production – the RFS is pretty silent on the question of what you do if there is production, but no market.

The threat to BCAP, and loan guarantee programs. The $1.3 trillion Senate Omnibus bill proposed last week would have zeroed out transitional assistance to farmers under the Biomass Crop Assisitance Program which encourages them to grow, say, switchgrass and other cellulosic feedstocks. It would have also zeroed out loan guarantee funds.

As Mike McAdams, president of the Advanced Biofuels Association, suggested in looking at why the bill died, “we just went through an election where the voters said they didn’t want business as usual on the Hill, and then we got business as usual on the Hill.” But if the structure of the “take it or leave it” pork-stuffed, “no time to read it” legislation caused it to die a mercy death, there’s no reason to suppose that a cash-strapped Congress won’t come back and try to claw back unspent funds from the Farm Bill and other energy legislation to do some deficit-reduction.

The Boys from Brazil. Noble Group is acquiring two projects in Brazil for $950 million. Cosan is merging with Shell in a $14B deal. Acucar Guarani acquired Mandu for $327 million. Petrobras is investing $920 million in Guarani. Good news for biofuels, but that’s tying up a lot of capital and attention in Brazil, far away from the US and the financing needs of the Renewable Fuel Standard. We see a lot of M&A financing starting to become available for existing capacity, but not too many signs of a reviving project finance market which aims to finance new capacity.

Military biofuels. The US Navy is doing everything it can to signify a minimum of 336 million gallons of annual advanced biofuels demand by 2020. We say minimum, because the Navy and the USDA have not completed all their work in terms of defining opportunities beyond the supply of biofuels to tactical forces and the Navy’s Hawaii-based installations. Plus, the Army and Air Force have yet to weigh in, in terms of their specific biofuels requirements through 2020, though indications are that they will buy a-plenty. That’s good news for biofuels – but none of that gallonage applies to the RFS, because it will not be distributed to the road transportation market via obligated fuel blenders.

One refinery per week. We’re hearing a lot of companies talking about 2013 or 2014 as the time frame for a number of advanced biofuels companies to complete their first commercial-scale plants, that will compete on an unsubsidized basis with fossil petroleum. That’s good news for biofuels – but what does it mean for the RFS?

Generally speaking, the USDA is looking at 40-50 million gallon biorefineries for advanced biofuels. Starting in 2014 with, say, 15 billion in first generation capacity, there will need to be 420 new bio-refineries built by 2022 to provide the market with enough capacity to meet the RFS. That’s one bio-refinery per week. The industry has never built more than about 15-20 new plants in a year – and those were comparatively standardized corn ethanol projects, at the height of the ethanol boom.

Put another way, that’s the 50 Hottest Companies in Bioenergy each building one new project per year from 2014 through 2022. Using the USDA’s $8 per gallon capital costs, that would mean raising around $16 billion in project finance per year. Do-able? It’s mighty tight, though not impossible – but the later the industry starts scaling, the more trouble for the RFS.

Conclusions. “No one’s gonna drag you up, to get into the light where you belong,” indeed. As 2010 draws to a close, we see lots of good trends for biofuels as a whole, but much of it is ominous for the US Renewable Fuel Standard. We don’t hear much enthusiasm for revising the RFS in 2011 – too many people view it as a complete can of worms.

But when it gets opened, and there is talk of revising RFS in 2012 – look out, there’s a brouhaha brewing.