Thursday, August 18, 2011

Navy Green Energy Moves One Step Forward

The nation appears to finally be thinking seriously about energy. As blog readers know, I thought the biggest mistake of the Obama administration early on was the focus on health care instead of focusing on renewable energy resources. Most folks disagreed with my opinion, which is fine, but I still believe energy is a strategic issue that government must be focused on, and I do not believe the same is true of health care. The BP spill and the final HCR bill that is more focused on health insurance than health care are two of many factors that have not helped the energy sector move forward in the United States. Refinery issues, nuclear concerns, and the environmental emphasis over drilling are among several other issues. I admit up front I have close ties to the green energy sector that heavily influence my opinions, and my opinions may not be congruent with others or some specific expert that is highly respected. Honestly, the biofuel industry doesn't have legitimate experts yet, just very intelligent theorists and observers, because if it had legitimate experts those folks would be putting Exxon Mobile out of business already.

There is no investment for biofuels in quantities necessary to move the sector forward in any serious way. There is plenty of interest and money, but everyone willing to spend wants to take the technology out of the United States. Startups across California are being offered hundreds of millions of dollars - to leave California and the United States and set up shop elsewhere, including China. It is going to take big regulation changes and incentives just to restore more interest in private sector investment in biofuel technologies in the US, and because green energy is polarized politically, that may not happen. The promise that green energy can grow the US economy in the future is slowly becoming less likely to ever happen. Part of green energy is manufacturing, like solar panels, and those jobs are already following the trend of all manufacturing in the United States and being shipped overseas.

The Obama administration is going to give energy policy a shot. With all due respect to Dr. Steven Chu, many leaders in the green energy industry think you are terrible and so do I, and to his credit the real leader on green energy issues in the United States under the Obama administration has been Secretary of the Navy Ray Mabus.

This is the generic news statement by Reuters of the President's new $510 million plan if you want the summary. Below are some of my thoughts.

The President’s plan is looking to build four biorefineries as a first step. What I appreciate about the plan is that not only does it focus on the energy side of biofuels, but it also involves the USDA on the output side of livestock feed. For algae fuels there are two main products produced from the algae, biofuel mass and livestock feed. Because the price of livestock feed has shot through the roof with the higher cost of corn over the last decade, it has ultimately led to higher costs of just about everything in the food sector. If livestock feed byproduct of biofuel generation can be produced at scale and sold USDA approved for safety, it could legitimate impact market feedstock price and have broad impacts across the food sector. This is particularly appealing not just in the US, where we have a lot of growers, but also in third world nations where high demand for reliable feed exists, but less quality feed is often used because of high costs of quality feed.

The key questions heading forward is whether biofuel companies can, in any way, attract investment money to the US startups that have struggled under the current economy, and if/when the money does come - will the technology (particularly that of the algae growers) scale and work as advertised. There are several algae companies that have working products, but cost and scale are still largely unknowns. The Navy currently buys biofuel from a company called Solazyme, which produces biomass by cooking it. While these are R&D contracts and consist of more than just the fuel, the Navy is still probably paying somewhere between $50 - $150 a gallon for biofuel with these early contracts. For me, I still don't see how a company that has such high costs to cook biomass in a lab is ever going to be competitive on the market, but right now Solazyme is one of the few companies that can produce relatively large quantities of biofuels reliably, so they are getting all the early testing and R&D contracts. Good for them.

I still believe the pond algae companies will be the green energy companies that have the biggest impact to biofuel in the next decade, even though pond algae companies are also the companies US investors are most skeptical of. As I see it, there are a handful of private companies with legitimate human talent and small working ponds currently producing small quantities can demonstrate affordable biomass and feed, and while they are working with limited capital, some of these companies do seem to be on the right track. The clue they probably have a good product? Those pond algae companies with mature strain development processes and established collection technologies are the ones being offered the most money from overseas investors to take their technology out of the US. I have been told more than once from folks at the Department of Energy that there is legitimate concern that the most successful biofuel (specifically algae) technologies that can produce at scale will ultimately be US technologies with ponds developed and established in other countries.

Jim Lane at Biofuels Digest has one of the best detailed looks and analysis of how the President's new plan impacts the Navy.

Finally, there’s the financial program itself, which will provide a strong equity infusion – something on the order, minimally, of $127 million per biorefinery (if in fact four are built, as per the President’s plan). With industry providing a minimum of $127 million per project from their side via the 1:1 match – about the proceeds from one of the several IPOs that have been brought forward (and about what Total, for example, invested in Amyris), that’s between $4 and $6 per gallon of capacity for the equity side of the capital requirements for constructing the plants (based on a 40-60 million gallon capacity).

If the average first commercial advanced biofuels plants cost $8 per gallon of capacity, as the USDA has forecasted, that could mean that either there will be a low debt requirement (reducing the fuel cost, perhaps dramatically), or a desire by the USDA to commission more than four plants

This initiative should produce somewhere between half and two-thirds of the Navy’s 336 million gallon needs, and given program start (after the RFP process) in 2013, look for capacity to become available by 2015 or 2016 – that’s well in time for the Navy’s Green Strike Fleet, and leaves plenty of time for the construction of additional plants to meet future capacity needs.
Jim goes on to advise that the administration should not try to go bigger or faster than 4 biorefinery's, that the nation needs to see that biofuels are legitimate, viable, and can work in the market.

Total annual investment in biofuel industry this year only just recently totaled $10 billion, and that was a global total. In the scheme of our nations energy use, the nation needs to hit 10x that number by ourselves in a single year before we start seeing any impact to the market, and even then investment in all this new technology doesn't guarantee the prices will be better than traditional carbon based fuels. There is certainly the potential, but potential has yet to be proven reality. This plan, even with only $510 million, may in fact be a very smart approach to developing momentum towards biofuels grown in the US. Time will tell, but with the Pentagon now locked into paying $165 per barrel in fuel according to recent Congressional testimony in the House, it is easy to see why just getting a $5 a gallon price in the short term would be a legitimate cost saver to the DoD both now and into the future as quantity would presumably drive costs down further.

If green energy is something you are interested in but don't really know a lot about, I encourage you to subscribe to Jim Lane's daily email newsletter. I've been following it for years, and FYI of the dozen or so biofuel companies I have interviewed and interacted with from an investor perspective, the management of every single one of those companies follows Jim Lane too (it's one of the questions I ask, and I always get a yes).

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