The Fog of Biofuels in the United States

June 29, 2012 |

After a nine-fold production increase in the 2000s, global annual investment in biofuels declined 20% between 2010 and 2011, and capacity expansion has slowed. What’s the mid-term growth outlook?

By Mackinnon Lawrence

In the world of finance, a market gray zone is a hazy realm of disillusioned bulls and restless bears.  The market neither gains nor loses, bumping along with only minor deviations that give speculators and investors little semblance of trading momentum.

Market gray zones are a function of uncertainty.  As competing indicators roil the global economy, a fog of uncertainty consumes capital markets and the industries they loosely track.  The challenge with gray zones is that investors often flee in droves, seeking shelter from risk.

For biofuels in the United States – an industry that increased production capacity nearly nine-fold in the 2000s – a similar fog has descended.  Facing a number of competing indicators, production capacity expansion has slowed, and according to a recently published UNEP report, global annual investment in biofuels declined 20% between 2010 and 2011, and has dropped off steadily since an ethanol-fueled high in the United States in 2006.

While the long-term prospects for biofuels remain bright, the following indicators are contributing to the current “Biofuels Fog.”

The New Era of Oil Volatility:

All discussions around biofuels begin and end with oil.  Oil scarcity, security, and price drive demand for biofuels, either up or down.  Just over a decade ago, the price of a barrel of crude started on a rapid ascent northward.  High prices precipitated a massive expansion of ethanol refining capacity, distributed biodiesel production, and a growing interest in “homegrown fuel.”

Fast-forward a decade and a new reality is beginning to settle in.  Oil production in the Western Hemisphere is on the rise, and some analysts believe that crude oil prices could drop to the $30-$40 per barrel range.  While biofuel price parity makes or breaks a business plan, oil volatility is unmanageable.  Regardless of whether we see $40 oil again, wild price swings on the global oil market are pummeling the biofuels industry with considerable uncertainty.

The Post-Stimulus Hangover:

The American Recovery and Reinvestment Act (ARRA) was a boon for cleantech.  For biofuels, it channeled more than $1 billion in investments and initiated the integrated biorefinery as the hub of future industry expansion.  Seeking to bridge the gap between promising research and commercial, large-scale production of advanced biofuels, ARRA was written to usher in the next generation of biofuel technologies targeting dedicated energy crops, municipal solid waste (MSW), algae, and other promising non-food feedstocks.

Today, that gap is still being bridged, but at a far slower pace than the general public and some exit-hungry investors would otherwise like.  Complex industrial projects take time, especially when they are the first of their kind.  The mismatch between long project timelines and ambitious near-term targets breeds frustration.  That frustration is reflected in polls, and policymakers are increasingly wary of spending outlandishly on projects that fail to yield near-term results.

Messing with the RFS:

The Renewable Fuel Standard, version 2.0 (RFS2) is the backbone of the United States biofuels industry, representing the only truly long-term policy currently in place for renewable fuels in an otherwise diffused energy policy landscape.  As tax incentives, loan programs, and federal grants come and go, RFS2 is seen as the last line of defense for an industry still clamoring for long-term viability.  In its present form, RFS2 extends to 2022.  But mounting calls to reduce, waive, or eliminate the mandate are eroding the stability it provides.  As uncertainty grows around whether RFS2 will survive in its present form, undergo further revisions, or be scrapped altogether, an already challenging financing environment is made even more so.

The Search for the Next Torchbearer:

The biofuels industry has been criticized for its purported role in causing indirect land use change (ILUC), contributing to rising food prices, and fueling land grabs.  The industry has consistently looked to torchbearers –ideas, events, and stakeholders that can move the discussion beyond negative consequences – to further a positive industry brand and attract continued investment.

In the early 2000s, when biofuels were hailed as an antidote to the United States’ addiction to imports of Middle Eastern oil, ethanol carried the torch.  When a public backlash erupted as food prices increased worldwide, next-generation cellulosic biofuels emerged as the long-term solution to sustainable biofuels production, followed shortly thereafter by a brief buzz around algae and waste-to-energy.

As it became clear that advanced biofuels would take much longer to scale up than many had envisioned, the U.S. military emerged as a thirsty potential customer.  With its sizeable demand and deep pockets, the Department of Defense aims to help build a domestic biofuels industry in the name of energy security.

Recently, the military has been forced to take a step back as a damaging RAND report and Congressional challenges have forced a recalculation of the cost-benefit of such a massive scale-up effort.  As a result, the current biofuels industry stands torch-less.  Such a vacuum allows doubt and uncertainty to take root, ultimately obscuring the positive storylines that can propel industry growth.

The Next Innovation Cycle

Although it faces significant uncertainty, the U.S. biofuels industry is clearly sitting at the bottom of its next innovation cycle.  A trend towards flexibility (enhanced by both feedstock and end-product diversification) and the integration of technology platforms is signaling a transition away from the one-track focus typical of the energy industry.

Through bolt-on technologies, upgrading of current ethanol infrastructure, and integrated greenfield facilities, the industry is pioneering a new generation of future biofuels refineries that are more flexible and financeable than the existing fleet.  Not only could such innovation lower the investment hurdle by optimizing profits and production processes, but it could ultimately help lift the fog for a still nascent industry.

Mackinnon Lawrence is a senior analyst contributing to Pike Research’s Smart Energy practice, with a focus on advanced biofuels and bioenergy.

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