Will the Gas Bubble Burst? More projects struggle for GTL finance

July 7, 2016 | Jim Lane

The boom

Remember how natural gas was the no-brainer of all time. Gas-to-Liquids was the rage, and a gold rush of companies popped up such as Siluria Technologies, Calysta, and Mango Materials. Fuels, chems, materials and more. The world had discovered new technologies for making a chemical building block out of methane, instead of a runaway combustion train suitable only for power generation.

Market entries came from all over. Intrexon jumped into the fray with a gas fermentation play with an aim of producing low-cost isobutanol. Meanwhile, companies like Coskata and Primus Green Energy opted for natural gas in hopes of making the leap to commercial projects with a lower base cost of carbon.

And Velocys went agnostic — developing for the low-carbon markets via its customer relationship with Red Rock Biofuels and Red Rock’s syngas feed, and the ENVIA project with NRG and Waste Management in Oklahoma. But Velocys bought out a 5000 barrel per day project in the Marcellus shale that would plant will convert natural gas to diesel fuel and other liquids.

The trough

Over the past 12 months we have passed from what is some circles is described as “the peak of inflated expectations” to the “trough of disillusionment” in the natgas-to-liquids space.

Siluria has not been able to put a project together, and went through another CEO change in the past year. Coskata disappeared and the technology re-emered (in stealth mode) as Synata Bio. Primus Green Energy went through a CEO chnage and has announced a first commercial methanol project starting in 2017, but we don’t have visibility on the actual site excepting that the manufacturing site is ties to Marcellus shale.

Calysta, and Mango Materials remain at earlier stages of development and are aiming at higher value niche nutrition and materials applications — so it will be some time before we can expect to have any definitive commercial visibility on those. They remain as tantalyzing and promising as ever.

Velocys and its first commercial

Which brings us to Velocys, which reports that “Construction of the ENVIA Energy GTL plant in Oklahoma City, which will act as the commercial reference plant for Velocys’ technology, is progressing well.”

Velocys’ first commercial under development in Oklahoma

Specifically, All modular process units, including those incorporating the Velocys reactors, and all other major packaged equipment skids, including the steam methane reformer, cooling towers, landfill gas inlet and syngas compression units have been set in place on site. System integration, piping and electrical work is ongoing; 140-150 personnel are currently working on-site.

But Velocys have just put their Ashtabula Marcellus GTL project on hold, citing financing conditions.

The company reports:

“In the first half of 2016, the Company carried out further analysis of the wax market in North America, which confirmed that the projected plant economics remain attractive for Ashtabula GTL, the 5,000 barrel per day plant that Velocys has been developing in Ohio, focused on the production of waxes and other speciality products. Given the challenges in raising equity for capital projects of this nature at present and in order to defer costs, Velocys has put its development of Ashtabula on hold, pending reassessment as part of the broad review of the strategy of the business that the Company is currently undertaking.”

Let’s look at that, starting with the way that Velocys positions itself vis-a-via narural gas: “Velocys works flexibly to unlock gas resources of 15,000 to 150,000 mmbtu per day, allowing more companies to take advantage of more opportunities.”

The Velocys core tech

For sure, a big market. They note that “Velocys’ smaller scale GTL adds value to shale gas and bio-waste, and makes stranded or flared gas economic – an untapped market of up to 25 million barrels per day.”

Now, natgas continues to be impressively cheap in the US, and nothing has changed with the progress of the company on a technical front, except that the technology gets more de-risked every day as the ENVIA project heads towards completion.

Conclusion? The delta between natgas prices and fuel prices has narrowed enough to put projects on the shelf, and the forward view is pessimistic that the new relationship will fundamentally change any time soon.

Natgas vs crude prices

It’s been a rollercoaster, crude-vs-gas, as this graphic shows. A quick upward jolt around the 2010-2012 period as the floor fell out of natural gas prices, and a big correction in the past two years as oil prices also crashed.

The natgas-crude price ratio, down to 16 from a high of more than 60 in 2012.

It’s still pretty good. The EIA reports that the ratio betweem natgas and crude oil prices is 16.15, up from 6.4 back in the 1990s when the agency first started releasing data on this topic.

But the ratio is down 25.6% from one year ago, and in fact has dropped nearly 30% in Q2 alone.Down from a peak of 63.04 in 2012. Meaning that you get one-quarter the revenue for the same project cost as four years ago, for a natgas GTL project, more or less. Why? For one, “Record Heat [is] Wiping Out U.S. Gas Glut” says this Bloomberg report.

One caveat: crude oil prices fell far faster than gasoline prices in the past two years — making gasoline refining margins pretty good, and making for good times at refining companies like Tesoro or Valero. So, crude movements do not always correlate perfectly with fuel prices. And, fuel molecules with attractive properties (e.g. octane) can have premium prices.

Still, 16 to 1 is not nothing, and companies like Intrexon still guide that their GTL projects are financially feasible in today’s market. But it does remind us that the market challenges in predicting commodity prices are immense, and upside down prices are a hallmark of commodities (where spot prices for end-proidyucts drop below the cost of production, or even the cost of the underlying feedstock).

Classic workarounds? There are 3.

1. Have a branded product that commands a premium price. Pennies matter, and you’d be surprised how much extra revenue something like “super unleaded” can bring in, sold to consumers who from an engine POV don’t really need the octane.

To use an example from outside of the advanced bioeconomy, consider Starbucks. Their pricing is so far above the production cost that they are affected but not sidelined by commodity price swings.

2. Own the feedstock. One sure way to anchor a project’s fundamentals is to own or have long-term fixed price contracts for feedstock, especially if it is a waste residue. One of the raesosn why MSW and forest-based projects are having a slightly easier (not easy) time in terms of finance — companies like Waste Management and forestry companies like UPM and Canfor are able to provide more assurance on feedstock costs.

3. Tap carbon markets. Now, most bankers say things like “we zero out the carbon credits, or subsidies” because “they are too unreliable”. Yet, carbon prices have been remarkabley more resilient than oil prices, that’s for sure. That financing attitude drove entire companies to abandon biomass for natgas, yet in the end they couldn’t get natgas going as easily as it was thought.

More on the Velocys first commercial: ENVIA

ENVIA uses biogas as a feedstock. That qualifies under the Renewable Fuel Standard, if the project and pathway go through the approval process — and under the California Low Carbon Fuel Standard as well. So, it can access RINs and other carbon-pricing mechanisms such as a cellulosic production tax credit, to make project economics work better.

But, even ENVIA is enough of a no-brainer that there have been financing constraints from the partners. Not long ago, Velocys reported that it made available “additional equity and debt funding” Velocys to ENVIA Energy earlier this year. The upside there is that “Velocys gained a greater influence in the commissioning, start-up and operations of the plant.”

The EPC contractor, Ventech, will spercifically lead the commissioning and start-up of the plant. But,

a secondment agreement has been signed by ENVIA and Velocys for a team of experienced Velocys operators and engineers to be on-site serving under the ENVIA Plant Manager during commissioning and start-up until the end of 2016.

The Velocys subcontract with Ventech for operations, commissioning and start-up planning and execution and the secondment agreement with ENVIA will generate a total of over $0.7 million of revenue for the Company in the current financial year.

Velocys, Red Rock and all that stranded gas

Red Rock Biofuels, which is developing a biomass-to-liquids plant using forestry waste as feedstock in Lakeview, Oregon, continues to make progress on permitting, financing and offtake agreements. All of the jet fuel that will be produced by the plant has been contracted to Southwest Airlines and FedEx. over in the stranded gas sector, Velocys has completed its part of the engineering study underway for a project being developed by a national gas company in Central Asia that is seeking to develop its stranded gas reserves. Elsewhere, the opportunity with a major fuels player in the US remains active. Progress continues to be made by the third-party project developer, and the air permit for the plant has recently been issued.

The Bottom Line

Tough times for natgas-to-fuels with a thermocatalytic approach? Seems like so. But the fermentation companies like Intrexon believe there’s enough power in biology to survive the market dip, while other fermenation players head for niche markets with higher prices. We don;t see the gas bubble as “burst” because we’re not entirely convinced there is a “gas bubble” — based on proved reserves, there’s enough extractable gas to keep prices under that of crude oil on an energy content basis.

However, more and more players are struggling and there is an inflection point ahead if the ratio for natgas-to-crude dips much below 10X.

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