Vinod Khosla on Biofuel Feedstocks

Market Dynamics

Every biomass source and crop will have different market dynamics, and it is unclear how the ecosystem will evolve, especially given the expansive options laid out in the previous section.  Valuable co-products or synergistic technology pairings are another important part of the economics and may be key to scaling some biofuels cost-effectively (those that cannot use the whole plant).  For example, cane and energy crops produce lignin-rich residue with more than enough energy content to power the fuel production facility, creating additional value. Only co-products with markets proportional in size to the liquid fuel market – i.e. commodity animal feed and energy – can realistically be sold to support a biofuels business.  One could also co-locate cane sugar-based specialty chemicals production (such as Amyris or LS9), with renewable crude oil production using the underutilized bagasse.  Bagasse to oil conversion would create far more value than burning bagasse for electricity, though well-meaning local policies can change that equation completely.

Feedstock price volatility will be mitigated by feedstock flexible technologies, and reinforces the value of using non-food feedstock.  As can be seen in the charts below, over similar time periods, corn and sugar have had high volatility (though oil has been worse), while wood products have been stable. The profitability of the corn and sugar-based biofuels companies are very much affected by the price of corn and sugar, depending on the value of their co-products. Thus the ability to use biomass such as wood and wood waste, or agricultural waste, is a huge advantage in the uncertain market ahead.

If interest in biofuels sustains and feedstock production becomes a focus, crop varieties and scaled processes will be optimized (e.g., efficient collection and use of agriculture co-feeds and waste, tree bark, saw dust, leaves, energy cane  etc), driving down costs in the coming decades. In the short run, collection of sugarcane field waste (often burned in place today), corn stover, corn cobs and other waste could reduce the biomass costs for many processes well below going rates for paper-grade wood chips. When it comes to new plant breeds, the feedstock innovation cycle is likely to be slow, and lag biofuels technology development by 5 to 10 years after the first biofuels plants prove their economics (or oil hits $150- a likely phenomenon). Using corn yield improvements in the past half century as a guide (38 bushels per acre in 1950 to over 160 bushels today), the upside potential in cellulosic feedstock development is substantial.

Not only that, biomass to sugars conversion technologies can open up sugar fermentation technologies to the whole world of cellulosic sources by cheaply producing fermentable sugars from cellulosic materials.  Sugar and cellulosic feedstock prices will drop as the ecosystem expands and matures.  Sugars, as high as $0.20 to $0.30 per pound in the US today (versus 15 to 20 cents per pound internationally),[13]will drop to $0.12 per pound and eventually to $0.08 per pound over the next decade or two from cellulosic sources.  These improvements will be driven by crop productivity, sugar conversion technologies, specialized transport and processing equipment, competition and improved logistics efficiency as well as new crops. The flexibility to move from wood to agricultural waste to specialized energy crops and beyond will help stabilize and commoditize the “price per btu” on the open market.  If this ecosystem develops, I predict that additional traded markets will appear in the next 10 years for agricultural waste, energy cane, miscanthus, grasses, fermentable hydrolyzed sugars of various grades and “mixed biomass,” among many others.

Conclusion

Looking at it from the point of view of the “hype” cycle, we are long past the peak of inflated expectations and have just passed the trough of disillusionment.  We are currently on slope of enlightenment on our way to advanced biofuels becoming a significant and positive part of the economy and the energy picture.[14]

Many biofuels technologies have made significant progress over the last few years; there have been some surprises, some partnerships and some clear winners and losers.  Some have failed for real technology reasons, but many others for business reasons, market/investor biases or technology-exclusive regulation. Many technologies are as yet unclear and some seem to be promising. There are many positive surprises to come. However, we believe that cellulosic feedstock, regardless of the processing technology and end-product, is the likely winner at scale in the fuels market. Still, sugars will work in the chemicals market.

Over the last few years the industry has seen a tremendous number of strategic and technical iterations coupled with new discoveries.  Novel business plans have been developed, to exploit capital light opportunities, as well as to branch out into high value specialty chemicals. It is critical to continue nurturing the next generation biofuel landscape. Though it may appear like a lot of capex is required for many of these projects, there is less market risk and more upside compared to a battery effort like A123 (which has raised roughly $1 billion).  The fuels market is huge and established, and all it takes is to be below the market price of this increasingly scarce commodity.

At least half a dozen technologies will be competitive with oil, with some more profitable than others. The critical point is that for the next 10 years at least, there will be an unbounded demand for biofuels, the quantities required by the current mandates both in the US and in many other countries will be an achievable stretch with all the technological innovation. US and worldwide demand of oil will be such that biofuels will not compete with each other, they all compete far more with oil.  Each technology is suited to particular local conditions, and with the expected demand, there is lots of room for all these and even more technologies. Within a decade after beginning to scale (2012?), advanced biofuels will become material in the oil supply equation, and will be a significant market force within twenty years. I firmly believe that in 30 years, the price of oil will be more dependent on the marginal cost of land than anything to do with exploration, drilling, OPEC, or Middle East instability.

To those who accuse me of believing because I’ve invested in these technologies; I continue to invest because I continue to believe. 

APPENDIX A:

So what makes a good biofuels investment?  Before investing, I evaluate a company on the following checklist. A word of caution; new technologies can change some of these questions or render them irrelevant, and the questions don't apply equally to every technology approach. Consider them guidelines of the kind of questions I ask rather than “mandatory” questions. There are also questions that are missing here that would be appropriate for particular technologies.

I’ll be using some math in this section, here are the rough numbers:

Gallon of ethanol equivalent (GEE) = 76,000 BTU per gallon

Gallon of transportation hydrocarbon equivalent (GTHE)[15] = a proxy for “transportation fuels”, has the same heating value as a 50 percent gasoline, 50 percent diesel blend – around 122,000 BTU per gallon

Barrel of oil equivalent (BOE) = 42 gallons of crude oil, containing roughly 5.8 million BTU, 48 GTHE, and 76 GEE

1.     The first breakeven plant or retrofit for fuels should cost no more than roughly ~$100 million to allow for rapid implementation and easier access to boot-up capital. Boot-up for the first plant is a critical issue and often results in large time delays in projects. Though there are no absolutes here, risk aversion increases exponentially as risk size increases. It also increases exponentially with the size of the organization (think Exxon, Shell, BP) that must take the risk.

2.     In part I, I mentioned $5 to $6 capex per GEE for low opex processes, which will pencil out to a good IRR.  I also stated that an ideal target would be $3 per gallon of hydrocarbons, or GTHE (which is roughly $1.90 per GEE) for fuels after the first few plants, for the most competitive cellulosic fuels at mid-term maturity. For high value chemicals, targeting $0.25 of gross margin per $1.00 in capex may be a better metric.  Capex calculations should be based on true costs, including cost of capital.  The most important metric may be a 3 to 5 year payback on the investment which might trump the above metrics as it substantially lowers risk in volatile commodities markets.

3.     Feedstocks for fuels should be non-food–based and globally scalable. One off feedstocks reduce a company’s ability to scale rapidly. Historical feedstock price stability is very desirable, and processes that accept mixed feedstocks will have a large (availability and cost) competitive advantage.  

4.     For example, take my hopes for Kior as a likely benchmark for total cash opex. I would expect, with a bit of luck and at $55 per dry ton feedstock costs, to get below cash costs of $1.25 GEE ($ 2.00 GTHE) in a full size 2,500 barrels per day facility by late 2012. By 2015 I expect cash costs to be $0.80 GEE ($1.25 GTHE) with about an equal cost for feedstock and other cash operating costs. This corresponds to a feedstock cost of $0.50 GEE dropping to below $0.40 GEE over time, which is under the target I mentioned in Part I, of $60 BOE (just under $0.80 GEE or $1.25 GTHE) near term, as well as the “safe” target of $40 BOE (around $0.55 GEE or $0.85 GTHE) by 2015 in a mature facility. Any biofuels company should aspire to beat these metrics.

5.     In part I, I mentioned targeting non-feedstock opex of $20 to $25 BOE, (roughly $0.30 to $0.35 GEE) for a mature and competitive technology by 2015, with an ideal target of $15 BOE. Building on that, near term, non-feedstock opex costs should be no more than ~$0.75 GEE (this is $50 BOE, $1.10 GTHE) for fuels in the first few commercial plants, not including feedstock (production costs simply need to be in line with target markets, so pathways targeting high value chemicals can be higher). By 2015, the target should be below $0.40 GEE, though I would like to see numbers below $0.25 per GEE (near $15 per BOE) eventually.  This would get us to costs that are profitable at $50 per BOE (for example: $15 per BOE opex, $25 BOE feedstock, plus depreciation and return on capital)

6.     For fuels the guideline I use, the cost of the final product cost should be such that feedstock accounts for 50 percent of the total cost, even initially (assuming inexpensive and stable feedstocks). The best will get to where feedstock is 60 to 70 percent of total opex costs (very cheap “other” opex), though technologies like solar fuels (algae) will be exceptions if they can be economic. This comment is generally true of cultivated feedstocks.

7.     Feedstocks for specialty chemicals markets can be sugars-based as sufficient scale exists for sugars and starches for the chemicals business but not for a large fuels business.

8.     Cost effective boot-up tactics are a critical consideration because a technology that can’t get started in at least one market will never reach its full theoretical potential. Amyris has found some very high value markets.  Retrofit/bolt-on approaches like those of Kior, LS9, LanzaTech, Gevo and Amyris are examples of clever boot-up strategy.

9.     A demonstration plant or leased capacity should be at least 100,000 gallons per year, and have a clear path to commercial scale. In the end, the only reason for a demo plant is to a) produce samples and b) to verify engineering data.  Without this scale a technology cannot be reasonably assessed. Similarly costs for a process that is more than 2 to 3 years to first commercial unit is no better than speculation. Though the appropriate scale can vary and is hotly debated, I use either annual capacity scale or, depending upon the technology, the size of the vessel or fermenter as a guideline to assess the reliability of the costs numbers and scalability of the process. 200 to 300 percent variations from estimates are not abnormal from naïve estimates when technologies are early or technologists inexperienced in large scale projects.

10.  The lifecycle carbon emissions should be at least 50 percent less than conventional fuel, even initially, and the technology should have a path to 80 percent carbon reductions. If one gets to 50 percent initially, an 80 percent reduction target as the technology and ecosystem matures is likely.

Table: Representative base, benchmark and ideal targets for cellulosic biofuels production by 2015

Other questions to ask:

1.     What is their feedstock cost, availability and flexibility? This in the principle operating cost of most processes.  We believe cellulosic sources will be the most scalable in the long-term and most cost effective, for fuels. Broad availability provides relative feedstock cost stability, as primary feedstock  production variable costs (like fertilizer or delivery) are linked to and thus hedged by the price by oil.

a.     What feedstocks does the process require now versus possible in the future?  Does it use specialty oils or require food-based sugars?  If so, is it compatible with hydrolyzed cellulosic sugars like HCL?  Can it exploit Waste gases? Does it use Cellulosic materials directly? (We believe the latter two are the best here).  Are the prices they project reasonable when scale increases dramatically?

b.     Have they locked up significant feedstock in contracts, or is the feedstock relatively available in the US or globally?  Is there anticipated competition for biomass in the locations a company has picked? How replicable is the site? 

c.     What has the company proven with current and anticipated feedstocks?  Yields, continuous production, costs? At what scale? Have they shown it with industrialized microbes or just lab microbes?  Point yields on a small scale, with special conditions, without separation or post-processing can all be used to make claims.  Only the 100,000 gallon per year scale demo or larger vessel scale for production verification with industrial feedstocks and microbes should be used to estimate true yields of end products. Most people don't recognize the difficulty in industrializing microbes, waste management, safety issues and start/stop of processes.

d.     Is the feedstock ecosystem on a declining or improving yield and cost trajectory. Trajectory matters critically in all new technologies.

2.     Production cost (ex-feedstock) -- These are the costs that will make or break many technologies, and are only really known after the process reaches significant scale. The key question here is, what has been proven?

a.      Are their production costs compatible with their target markets? 

b.     What inputs does their process rely on (e.g., water, chemical additives, nutrients, catalyst, electricity), are those costs predictable and under control?

c.     What are their current yields, how close to theoretical?  What are the barriers to getting to ideal yields?

d.     Will they reach their projected costs and be market competitive within 5 to 7 years of their launch (without subsidies)? Ideal prices would be (and I believe can be) market competitive initially.

e.     What product separation/purification or post processing are they using, has it been proven at scale?  What purity of inputs is required?

3.     Environmental impact – using the CLAW framework at least qualitatively but preferably quantitatively.  Questions should be asked of the technology as a whole, but also for every deployment/site a company is planning.

a.     How do lifecycle carbon emissions compare to gasoline/diesel?

b.     Does the deployment plan involve minimal or beneficial land use changes?  (palm oil has been a huge concern due to clearing of rainforest in some regions). Does the technology or feedstock lead to encroachment of rain forest regions or other virgin land use? I would not take the political and environmental risks personally. Often other political risks exist.

c.     Are there issues associated with airborne emissions during processing or consumption?  What has been tested, and at what scale? What are process effluents and local environmental permitting complexity for the technology? Have they been properly accounted for in costs, both capex and opex?

d.     How much water is needed for the process, and how does it compare to gasoline production and refining?  Water use should be low, less than 5 gallons of water per gallon of fuel, preferably less than 1 gallon per gallon. Fuel production and refining uses anywhere from 1 to 40[16] gallons of water per gallon of fuel combined, with conventional oil refining claiming around 1 to 2.5 gallons water per gallon of fuel.[17]Water quality requirements if any are also important in these comparisons.

4.     Scale-up ability –Quick scaling will decrease adoption risk among competitors, and give a first mover advantage.  These questions are directed at the company’s end-product

a.     Has the technology been demonstrated at least 100,000 gallons per year scale to have reliable process estimates and cost estimates?

b.     Are the products approved or registered by the appropriate state and federal agencies? More importantly, since many companies are early and immediate registration is not required, I try and assess the risk in getting the products registered.

c.     Is the product fungible with existing infrastructure? Can it be mixed with fuel, oil, other biofuels directly? 

d.     Can existing biofuel production assets be leveraged?

e.     How experienced is the team in handling agricultural and petroleum supply chains?

f.      Time to market is critical if a technology hopes to take advantage of mandates and regulatory benefits like tax credits, RINS etc that may disappear within five years. The RFSII regulation in the US has created a huge but time sensitive opportunity. Economics will change over time.

g.     Can a facility be easily replicated exactly (“copy exact”) or is each site customized?  Is the process designed for remote operation and management so one does not need high level of skills in remote facilities? Customization is often required when a process has waste effluents or needs inputs that are local to a region. Customization increases the difficulty of rapid replication. Need for local skills (versus remote management) makes staffing, training and scaling difficult and more prone to disturbances.

5.     Business plan: Do they have a clever business plan in place, e.g., through strategic cost-sharing partnerships or distressed assets? Is there creativity in EBITDA sharing models? Has the company demonstrated the ability to collaborate with partners to reduce risk across the enterprise from feedstock supply to product offtake?  Risk management is often one of the larger issues in such projects.

6.     Value/Flexibility of end products– Ethanol is only one possible end-product – some technologies are able to produce a variety of chemicals in order to adjust to changing market demand.  Synthetic biology fermentation processes tend to effectively produce a single tailored product, while thermochemical systems create a mixture.

a.     How much product flexibility does the technology offer from the same capex? Can they supply the market at prices competitive with fossil alternatives? A one-off above market price contract (e.g., with government agencies) does not signal scalability of a company or help in making the technology a winning technology globally. We focus on unsubsidized market competitiveness in a company’s chosen markets. These markets should be worth at least billions of dollars initially and have potential for expansion.

7.     Financing: What will be the amount and timing of the financing needed to get to commercial scale and into a self financing mode?  What levels of government support (such as DOE or USDA loan guarantees) are included in the financing plan?