Sustainable development blog : ecology and humanitarian aid

Biofuel, based on fuel derived from organic biomass from recently living animals or plants or their byproducts, has transformed from a niche alternative to fossil fuels (e.g., gasoline, diesel) to become a booming industry. Driven by a unique cocktail of energy security fears, rising oil prices, low barriers to entry, and government support, the biofuels sector has taken off over the past ten years. Any liquid that stores energy, which is typically utilized by an engine or generator, can be called a “fuel.” The term “biofuels” encompasses a wide range of fuels, including vegetable oils, animal fats, ethanol, biodiesel (any oil or fat that undergoes transesterification to more closely resemble mineral-based fuel), and synfuel (fuel made from gasified organic matter, thenliquefied to form fuel). The main common trait of all these fuels is that they are derived from organic biomass, rather than minerals.

Biofuels are made using a fairly simple process that typically involves harvesting feedstock, or the raw materials (e.g., soybeans, sugarcane), crushing the feedstock, separating the dry matter from the oil, then re-crushing and/or further processing to extract as much oil as possible. The resulting oil can then either be directly consumed (e.g., by vehicles with specially designed engines), further processed (e.g., into biodiesel), or blended with mineral-based fuel before being delivered to the end user at gas stations and depots around the world (the most common blends in the U.S. are E10 (10% percent ethanol blend) and E85 (85% ethanol blend).

Only some biofuels, most notably biodiesel, can be used in traditional internal combustion engines. Other biofuels, such as ethanol, must be blended with mineral-based fuel in order to be used in existing engines. The most common inputs into biofuels vary by country. In the U.S., corn and soybeans are most prevalent, while Europe tends to use flaxseed and rapeseed, Brazil sugarcane, and Asia palm oil. Brazil is in many ways the pioneer of the biofuels industry, having introduced ethanol from sugarcane (and flexfuel vehicles capable of running on ethanol) over 25 years ago as method to reduce dependence on oil imports. In 2008, biofuels were worth $34.8 billion on the global market.^[1]

Trends and Forces

Break-even oil prices for various alternative fuel sources, courtesy of the White House Report of the President

New Research Shows that Bioelectricity is More Efficient than Biofuels

New research done at UC Merced and published in the journal Science in May 2009 presents evidence that crops yield 81% more energy per unit area of land when it is burned to make electricity to power cars than when it is refined into ethanol.^[2] Furthermore, greenhouse gas emissions from this "bioelectricity" are 100% lower per unit area of land than cellulosic ethanol.^[3] Though this is one of the first studies supporting this idea, if future research continues to present such results, there is the potential for the validity of the entire biofuels industry to come into question.

Governments Support Biofuels, but Production May Not Meet Mandates

Governments around the world, for reasons that combine environmental friendliness, concerns over energy security, and a desire to support local farmers, have offered a wide variety of subsidies to biofuels. Typical subsidies include forgiveness of the consumption tax typically placed on fuel for vehicles, a tax credit for blenders who blend in biofuels with mineral-based fuels, and research subsidies and programs to develop new technologies for biofuels production. Beyond these subsidies, governments around the world have virtually guaranteed a market for biofuels by mandating biofuels usage to be blended with renewable fuels (e.g., the 2005 Energy Policy Act in the U.S. requires 4 billion gallons of biofuels consumption in 2006 and 7.5 billion gallons by 2012).

Congress later passed the Energy Independence and Security Act of 2007, which mandates that renewable fuels production in the U.S. had to increase from 2007 levels of around 4.7 billion gallons per year to 36 billion gallons per year by 2022 - 21 billion gallons per year of which need to come from cellulosic ethanol and other "advanced biofuels"^[4]In part thanks to mandates like these, demand for biofuels were expected to grow by 20% annually, to 92 million metric tons per year in 2011.^[5] A report released by the Energy Information Administration in December 2008, however, stated that the industry will not be able to meet these levels of production in time, given the price of oil and declining demand caused by the 2008 Financial Crisis.^[6]

To counter these fears of low production, the U.S. Department of Energy announced in May 2009 that it would make available $800 million in funding for new biofuels research projects - right about the same time as the Environmental Protection Agency announced that it would support higher biofuels production levels under the condition that producers cut greenhouse gas emissions of their refineries - including the emissions that are created during farming, transportation, blending, and consumption.^[7]

All of this despite the hard facts that biofuel production removes food stock from the food chain for human and animal consumption requirements, increases demands upon soil, atmosphere and water and has a higher incidence of cost that any petroleum based fuel source. Food availability and farming directives worldwide have seen significant change in the past decade as a result of these diversions to biofuels. As a result, it is estimated that 100 million more people around the world have been forced into starvation status. The removal of food stock from their pantry has had an enormous impact upon the poorest of the poor, all of whom live in the third world. From a fuel productivity viewpoint, biofuels are far less efficient than any petroleum based fuel source: compute the toal cost of seed supply, irrigation requirements (water, pesticide, waste and runoff), manufacturing processes and distributon and consumption effects and one realizes how incredibly inefficient the concept of producing fuel from food truly is. It takes 34% mor energy to produce a comparable BTU from foodstock than from petroleum and 61% more than from natural gas. Only because of tax rents, political gains and legislative fiat can these devices creak along in some seblance of replacement technology.

As an investor, how would one judge these choices? Is the cost inefficiency of biofuels, as previously stated, worth the supposed social and political result? Or, does it make more sense as an investor to own stocks and bonds in companies that make best use of modern technology, exploit market variances and provide a product or service in response to real - rather than perceived - need? Do you want to own a company that earns a dividend from the tariff on pipeline transportation of natural gas, or do you want to own a tax subsidized firm with no actual profits, entirely dependent upon the future largess of a polity with enormous vested interests, none of which generate a profit, much less a dividend? To add insult to injury see the following: ===== The European Union is imposing protectionist measures against U.S. biofuels ===== From 2006 to 2008, biodiesel imports to the European Union from the U.S. increased from 60,000 tonnes to 1.5 million tonnes; to support regional biofuels producers, of which 15 have gone bankrupt in the last two years, the European Union is adding tariffs on imported biofuels worth €29-41 per 100 kgs.^[8] This is meant to raise the price of imported biofuels in Europe, encouraging the use of fuels from local companies and reducing the use of American biofuels.

Price of Oil is Directly Correlated with Demand for Biofuels

Biofuels still represent a tiny fraction of total fuel consumption (to put it in perspective, total gasoline and diesel consumption in the U.S. is roughly 180 billion gallons, versus 4 billion gallons of biofuels consumption in 2006), and as a result, the price of biofuel is driven by the price of it’s nearest substitute, oil. As oil prices rise, it becomes increasingly attractive to produce biofuels, and more feedstocks for biofuels become economically viable.

The Drop in Oil Prices and Contraction of Credit Markets Resulting from the 2008 Financial Crisis and Ensuing Recession Mean Reducing Demand for and Investment in Biofuels

From 2007 through June of 2008, oil prices experienced a strong increase, surging up past $145 on July 3rd^[9] before plummeting to below $50 in December^[10] - right after the NBER announced an economic recession. The decline in oil prices has done tremendous damage to the biofuels industry by making gasoline much more economically friendly. Furthermore, the credit crunch that preceded and, indeed, strengthened during the Financial Crisis means that biofuels companies are going to find it harder to raise capital, as investors no longer want to take risks, which is exactly what biofuels companies are doing in trying to supplant gasoline.

Price/availability of feedstock

The majority of the production cost of biofuels comes from the cost of the raw materials, or feedstock, used to produce them. Therefore, as feedstock prices increase, producing biofuels becomes less profitable. As a result, biofuels producers are constantly considering alternative feedstocks— for example, the recent run-up in corn prices and wheat prices (see chart below), both of which can be used for biofuels, has led several major biofuels players to diversify into other biofuels technologies. Utlimately, biofuels may even drive up the prices of other fruits and vegetables, as farmers convert more land to biofuels feedstock. Algal biofuels are changing the biofuel space in respect to the fact that the "feedstock" for an algal biofuel is primarily carbon dioxide gas. Large quantities of carbon dioxide will be necessary to scale up algal biofuels production and will necessitate the placement of algal biofuels plants in close proximity to sources of carbon dioxide, such as coal burning and natural gas burning power plants where the effluent can be tapped as the feedstock for the algae.

However, the potential of algal biofuels is enormous; existing strains of algae can produce 2000 gallons of fuel per acre, compared to 250 gallons per acre for corn. However, the cost of producing algal biofuels stands at $33/gallon, versus $2/barrel for Saudi crude, necessitating further development before it is fully competitive.^[11] Many ethanol companies, ironically, are also exposed to falling corn prices, because of hedging against price cuts. VeraSun Energy went bankrupt in October 2008 because the company placed bets on rising corn prices once they hit $8 in June 2008. During the financial crisis of 2008, however, when commodities prices fell and the value of corn dropped by half, the company was left illiquid, unable to pay off its derivatives.^[12]

Second-generation biofuels use non-food feedstocks like grass and reeds to make biofuels, which would make the cost of the fuel independent of food prices. These feedstocks are lauded for growing well on land that wouldn't support food, freeing up land capacity, but environmentalists are skeptical because many of the plants that are expected to be used are categorized as "invasive species". The have a high likelihood of spreading outside of the growing land and using resources, thereby killing native plants as well as food crops on adjoining lands.^[13] Because of this, environmentalists have appealed to the United Nations to ban or limit using such feedstocks to refine biofuels.

Companies who stand to benefit

Monthly corn prices from United States Department of Agriculture, in $ per bushel :

Companies with control of feedstocks and vertically integrated biofuels refiners (i.e., refiners with exclusive control over supply of feedstocks) will benefit from the rise in biofuels, as they can offer commercial-scale supply of an increasingly scare commodity. Archer Daniels Midland, with its dominance of the corn-based ethanol market in the U.S. and an increasingly diversified portfolio of biofuels feedstocks overseas, should continue to benefit. Cargill, another large feedstock player, is privately held. It is expected, however, that despite these companies' market strengths, they will only exert control over around 30% of the market for biofuels thanks to the rapid expansion of the market.^[14]

Suppliers to the biofuels sector, especially construction companies with refinery expertise and equipment suppliers, should benefit from a biofuels boom, regardless of which feedstocks or refiners end up on top. These would include Lurgi, the market leader in providing turnkey biofuels refineries, and Titan International, which manufactures wheels and tires for makers of farm machinery. Both will benefit from increased investment in biofuels. In addition, Caterpillar (CAT)'s role in agricultural equipment supply will also make them benefit from any drive towards increased farming activity.

Along the same lines, chemical companies and seed suppliers should benefit from a biofuels boom. Monsanto, in particular, would likely benefit, as concerns regarding the safety of its genetically modified (GM) seeds for human consumption would be nullified if they were used to produce biofuels. Dow Chemical has also been developing a robust chemicals program for use with biofuels. Diversa (DVSA) is another major producer of enzymes used to make biofuels from biomass and cellulosic feedstocks. A number of oil refining companies, including every one of the majors, are investing in biofuels production. Even Exxon, who had previously stayed out of the renewable energy industry, is entering the market. In July, 2009, the company entered a five-year, $600 million partnership with Synthetic Genomics Incorporated, to develop algae-based biofuels.^[15]

Companies who stand to lose

Contrary to popular belief, pure-play biofuels refineries may not necessarily benefit from a biofuels boom, as biofuels refining is not technically complicated, with relatively low capital expenditures. Capital, and new competitors, are flooding the market for biofuels refining, fueled at least in part by the current low interest environment. Rising feedstock costs, for those who are not vertically integrated, could ultimately eat into profit margins. Pure-play refiners such as Pacific Ethanol or Aventine would fall into this camp.

Companies who rely on biofuels feedstocks for alternate uses are also at risk, should a biofuels boom drive up the price of feedstocks. Tyson Foods, which is a major consumer of corn for its chicken feed, would be particularly negatively impacted— Credit Suisse First Boston estimates that every 10-cent increase in the price of a bushel of corn cuts 5 cents per share of profit from Tyson. This negative impact will ultimately depend on which feedstock for biofuels “wins”— corn and soybeans have benefited greatly in the short-term, but over the long-term, cellulosic ethanol or sugarcane could end up salvaging Tyson’s profitability. The rise in corn prices has already reportedly caused riots in Mexico over excessive tortilla prices.

Companies competing for acreage with biofuels companies may find themselves out of luck as a result of the biofuels boom. For example, breweries such as SAB Miller or Heineken will face the double challenge of struggling to find acreage for growing barley and rising cost of other commodity inputs into the brewing process. Either way, biofuels may be on the rise and a good thing to keep an eye out for.

References

1. SeekingAlpha: "Solar, Wind and Biofuels' Impressive Growth Surge in '08"
2. CNET: "Study: Bioelectricity bests biofuels on miles per acre"
3. CNET: "Study: Bioelectricity bests biofuels on miles per acre"
4. HR 6 Energy Bill Summary
5. SeekingAlpha: "World Market for Biofuels Expected to Double"
6. SeekingAlpha: "Biofuel Industry Won't Meet Government Production Targets After All"
7. SeekingAlpha: Feds Propose Controversial Biofuel Mandate, Offer $800M to Boost Production
8. FT: "EU slaps tariffs on US biodiesel"
9. The Industry Standard: "Oil prices spike to $150 a barrel by July 4"
10. Financial Times: "Crude oil prices tumble $100 in five months"
11. Hard Assets Investor: Exxon: A Biofuel Bet?
12. Financial Times: Lex: "Ethanol producers"
13. The New York Times: "New Trend in Biofuels Has New Risks"
14. SeekingAlpha: "World Market for Biofuels Expected to Double"
15. Hard Assets Investor: Exxon: A Biofuel Bet?