Financial Trends: Evaluating Investments in Advanced Biofuels Projects in the U.S.

The recent passage of Renewable Fuel Standards 2 (RFS2) by the U.S. Environmental Protection Agency (EPA) has increased interest in deploying advanced biofuels projects, including biomass-based diesel and cellulosic biofuels such as ethanol and drop-in fuels (e.g., gasoline and jet fuel). These advanced fuels could be produced from multiple feedstocks such as soy and vegetable oils, forest and agricultural waste, and cellulosic components of municipal solid waste, as well as used fats, oils and algae-based oils.

According to the EPA, the volume requirements prescribed in RFS2 for advanced biofuels are significant at nearly 21 billion gallons per year by 2022, compared to a modest 1 billion gallons per year currently. According to U.S. Economic Impact of Advanced Biofuels Production: Perspectives to 2030, a report released by Bio-Era Research Chemicals Ltd. in 2009, capital costs for a 200 million-gallon per year project would be between $3.50/gallon to $4.50/gallon. If an average of $4 per gallon (at maturity) is assumed for these advanced facilities, achieving the 2022 target will require nearly $80 billion in capital investment over the next 10 years.

Investment in advanced biofuels development will only achieve this level if several risks are significantly reduced.

Risks Associated with Investments

The current technology maturity-level for several advanced biofuels concepts is too low and therefore poses a significant investment risk. There is a potential for large changes in fuel yields and capital and operational costs once designs are scaled up but without an understanding of the variability in these parameters, evaluating the return on investment is very difficult.

The fact that many companies are unable to follow a well-structured development process (sometimes imposed by investor groups), is also a significant risk. For example, companies may jump directly from a simulation model to pilot facilities that cost tens of millions of dollars to implement, or fail to accumulate sufficient operational hours to establish process viability and operational economics. Failure to follow a structured approach not only damages the reputation of the company but also the reputation of its peers by creating a negative image of advanced biofuels as an investment opportunity.

Furthermore, there is significant market uncertainty regarding forecasted feedstock costs, which can result in large deviations in operational costs. There is also limited operational knowledge for large-scale, advanced biofuels facilities (in the hundreds of millions of gallons per year range), which impacts operating costs as well as revenues (i.e., fuel yields may be lower than what has been calculated in simulation models or pilot plants).

Some companies are unable to estimate the true project cost — one that includes all of the “hidden” costs for deploying the infrastructure needed for a large-scale facility — and that also poses significant risks. Issues that can result in higher costs include access to utilities and to infrastructure for feedstock and product transport, permitting constraints, and lead times (local, state and federal).

All of these risks make it difficult for investors to create robust pro formas for advanced biofuel plants and businesses, especially in light of the significant uncertainties in capital and operating costs, and development costs and revenues.

Guiding Principles for Managing Investments

As with all high-risk technology development initiatives, there are some guiding principles that can help reduce some of these risks. First and foremost, developing a disciplined technology maturation plan for scale-up (lab pilot demonstration commercial) is critical in managing investment risks. This approach should also include very concrete go/no-go decision points so that investment dollars are not spent in trying to make uneconomical ideas work. Even if decisions are made to continue to invest in and improve on pathways that did not perform well at the pilot level, the net present value for the full investment must be continuously monitored so that the decision to invest is based on sound economic rationale.

In addition, defining realistic expectations on when returns on investment will be realized prior to making investments is critical. Advanced biofuels deployment initiatives are likely to take several years of research and development before revenues and returns can be realized. Investors with low risk tolerance (e.g., those comfortable with power generation projects with fixed off-take prices and proven technology) may be better off investing in an advanced biofuels company once it has demonstrated that a project is cash-flow positive. Investors who are more risk tolerant will need to be patient and manage investments based on clear development milestones.

Exploring opportunities for capital cost reduction by leveraging existing “steel on the ground” can help reduce up-front capital and development costs. Decommissioned facilities and refineries running below capacity may be preferred to “greenfield” development, because many of these facilities are likely to have the requisite utility and transportation infrastructure, which removes some of the uncertainty of “hidden costs.”

Spending time selecting sites and estimating deployment costs up front is highly advisable for “greenfield” deployment. Over the past few years, there have been significant advances made in Geographic Information System tools that can be used to study all aspects of project deployment, including procurement and pricing of utilities for the site, adequacy of infrastructure for transporting capital equipment, feedstock and products, land costs, and permitting constraints. Conducting these studies up front is extremely valuable in selecting sites and providing reasonable estimates for project deployment costs.

Developing process designs that are feedstock flexible can also be an effective way to hedge against the risk of large price fluctuations in any one specific feedstock, especially when considering that realizing solid project returns requires an operational life of 20 years or longer. Developing processes that can generate multiple products (i.e., an integrated biorefinery that can produce fuels, chemicals and/or power) can also hedge against low-end revenue scenarios.

Oftentimes, as evidenced by the development initiatives at many algae companies, it may be better for a process to focus on developing an intermediate, high-value chemical. Generating revenues and positive cash flow from a pilot-scale or demonstration-scale operation can provide investors with confidence that the company can execute projects at the commercial scale.

Investment Outlook

Although it is clear that significant challenges remain in achieving RFS2, there is growing evidence that investment in biofuels is likely to remain robust over the next few years. There have been many initial public offerings in advanced biofuels over the past year, including Amyris, Solazyme and Codexis. A key feature of many of these companies is that while drop-in fuels appear to be one of the products they are aiming for in the long term, they have interests in specialty chemicals that have the potential to provide revenue streams (and hopefully positive cash flow) in the near term.

A guaranteed fuel off-taker in the marketplace can also provide impetus for several of the other market participants who are in the startup stages and looking to raise capital. The recently announced joint U.S. Department of Agriculture, U.S. Department of Energy, and U.S. Navy initiative is a step in the right direction.

Similar procurement initiatives at the state and federal levels can also help the advanced biofuels industry. Further, when creating these initiatives, there should be equal focus on displacing specialty chemicals produced from petroleum using bio-based alternatives. These initiatives, if implemented, can help the advanced biofuels industry raise capital to support development and deployment initiatives that can not only meet the goals set by RFS2, but also contribute to increased economic growth and energy security.


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