The Biofuels Pricing Pickle

Low-price biofuels are coming, but what about now? Price ’em low to please the public, or price ’em high to please investors?

Many were the worthy subjects taught at Sydney Grammar in the late 1970s and early 80s, but those who attended in those days generally acquired an education of, in order: girls, debating or surfing (pick one of two), Monty Python, Pink Floyd, and for a section of our group, in our time, the cadences of The Economic Theory of the Location of Railways.

The Economic Theory, an 800-page 19th century tome by Arthur Mellen Wellington, was taken off some dusty shelf as a joke. Who could write so much about such a ridiculously obscure subject, we wondered? But when Chris Kelly read from it, you listened. Today, you can hear Chris on History Channel documentaries from time to time, but even then he could read a laundry list and make it sound like The Ascent of Man, and several of the group took turns making The Economic Theory sound like Monty Python.

Wellington’s masterpiece was then, and remains today a classic – pioneering, for example, the principle of the discounted cash flow, which we use to measure the value of companies, even now.

And it had acid-wit passages, such as:

“There is no field of professional labor in which a limited amount of modest incompetency, at $150 per month, can set so many picks and shovels and locomotives at work to no purpose whatever.‎”

or:

“Engineering is the art of doing that well for one dollar which any bungler can do with two.”

It is the pitchfork of that last point, the doing of $2 tasks for $1, upon which the biofuels industry is lately impaled. Which is to say, there’s an awful lot of talk about $18 per gallon biofuels and $26 biofuels going around. When mentioned, it is invariably presented as a sign that the industry is run by bunglers, swindlers, the criminally insane, or graduates of the Madoff School of Fiscal Management.

It is being slung around like political hash, as a sign of wasteful spending, and as proof positive that the biofuels industry is a permanent, noisy, and greedy snout at the public trough.

Test-scale cost vs commercial-scale cost

Now, there is no doubt that the fuels in question are priced either in testing and certification quantities, or include funds for research and development. Tempting some desperate opponent-of-all-things-biofuel to libelously present the test-quantity cost as a cost-at-scale.

But they play hardball in Washington, believe you me. And those who seek public support had better learn something they don’t teach in the labs in Berkeley: how to hit the nasty DC slider that friends of incumbent energy platforms throw at all the rookies.

Take for example, an order for 100,000 gallons of renewable fuel. Priced at $18 per gallon, that’s around $1.8 million in revenue. Priced at $4 per gallon, that’s $400,000. Not a small difference for an early stage company, trying to limit its cash burn, and show progress to the shareholders. And, thoughtful counsel has probably opined that military contractors survived the $435 claw hammer, the $640 toilet seat and the $7600 coffee maker. “First comes the feeding thing, then comes the right thing,” as Berthold Brecht wrote in The Threepenny Opera.

So, why not an $18 per gallon biofuel?

But, consider the problem of the 99-Cent store. I am pretty sure that the Easter Gumball Machine, on sale there this past week, cost more than 99.99 cents at prototype stage. I mean, there’s design, there’s the mould, there’s the manufacturing plan, the gumball manufacturing. Maybe the first one cost $5,000, maybe $7,000. But you don’t sell gumball machines in the 99-Cent Store for $5,000. It’s a violation of the brand.

The loss leader

There’s another way. Over at the 99-Cent Store, they call it the loss leader – for example, those TVs that are sold for 99 cents to the first 9 customers. They generate a rush for the front door, as “85-cent per gallon” days do for E85 ethanol.

Why is that relevant? Well, here’s how it works, in the court of public opinion, by and large. Fuel that costs $2 per gallon makes a world of happy. Fuel that costs $5 a gallon makes people irate. Fuel that costs $18 per gallon? My guess? It gets an industry shoved where the sun don’t shine.

Accordingly, a dialogue on pricing is overdue – because pricing now by the few affects the future of the many.

The debate over taxes and spending

You see, there’s this fundamental dialogue going on, in real time, about how much the public is willing to subsidize public sector activities through federal taxation power. There’s a whole bunch of people over at the GSA getting a lesson in that right now, over an $825,000 budget for a departmental training event that included, I kid you not, a $160,000 budget for site selection.

In tough times, people are pretty resentful of flashy spending orgies, even in the private sector – corporate jets, executive retreats, and so on. In the government sector, they expect public servants to pick up nickels in parking lots, and they nuke anything that stinks of unbridled excess. Taxpayers are mad as hell over public spending, and apt to swing at easy targets rather than solving the problems of, say, Medicare. They are armed with email, fax machines, ballots, and high dosages of DC anger, and woe betide the biofuel developer who earns a prominent mention in the Mitt Romney stump speech, in the upcoming election season.

Sure, the ordinary citizen may have unsophisticated views about the pricing of sub-scale fuels – but it is their money being spent, and they are harried and hassled just paying their own bills these days. You can either pay a zillion to educate them, or pay a million to pacify them by subsidizing your own pre-scale cost challenges. Charging full price, plus a margin, on items manufactured at sub-scale? It’s hopeless to assume that everything will be jake.

The rise of the social media griper

Ah, the times we find ourselves living in. The good news, we have the iPad; the bad news, everyone’s a griper armed with a Twitter account.

In these nefarious days, for early-stage companies, it is worth the effort for boards of directors to carefully weigh the pricing pickle.

It is inevitable that fuels ordered in minuscule quantities from companies still in pilot or demonstration stage are going to cost far more than they will eventually cost at scale. The question becomes, who should pick up the difference? The sore-as-hell public, via a cost-plus model? Or the venture itself, as a cost of building a business?

Sure, all companies are hard-pressed for cash. But the ultimate goal, for all, is a big market, and market-making is a fair activity for investors to be making room for, in their estimates of the cost to reach scale.

It’s right there in print, in the first pages of The Economic Theory of the Location of Railways, though it is lifted from the Gospel of Luke. It is a question that passed the test of time, oh, about a millennium ago. It haunts biofuels. “Which of you, intending to build a tower, sitteth not down first, and counteth the cost, whether he have sufficient to finish it?”