Although current efforts to produce cellulosic ethanol are frequently referred to as being near fruition, considerable uncertainty remains about the speed with which cellulosic ethanol will become commercially viable. So far, no company has been able to produce cellulosic ethanol in mass quantities at a cost that can compete with starch- or sugar-based ethanol.
The RFS requires that fuels produced from non-corn feedstocks that have 50% lower lifecycle greenhouse gas emission than petroleum fuels – called “advanced biofuels” – beginning in 2009 and fuels produced from cellulose, hemicellulose or lignin that have 60% lower lifecycle greenhouse gas emissions than petroleum fuels – called “cellulosic biofuels” – beginning in 2010, form an increasing percentage of the RFS. As a result of these increases, by 2022, advanced biofuels are scheduled to represent 58.3% of the RFS, and cellulosic biofuels are scheduled to represent 76.2% of the advanced biofuels, the balance of the RFS being met by earlier generation ethanol and biodiesel fuels.
However, the U.S. Energy Information Administration recently released a report projecting that renewable fuels will not be able to meet the 36 billion gallon federal mandate by 2022. Yet, because cellulosic ethanol has the potential to improve the environmental benefits of using biofuels significantly, efforts to achieve its commercialization continue.
Developers of cellulosic ethanol facilities, however, have found it difficult to commercialize their new technologies due to what has been termed the “valley of death.” The valley of death is a period in the development of a new technology when it is susceptible to failure due to the developer’s difficulty in raising additional cash to fund its commercialization. During this period, a developer faces an increasing demand on existing cash, as cash is spent on development, and a decreasing ability to raise additional cash, due to the project’s lack of demonstrable positive future cash flow.
Venture capital investors tend to provide financing to developers once the technology has been shown to be commercially viable, just before the upturn in cash flow is experienced. Private equity investors are typically interested in investing in companies that are already operating and established in the market, rather than developers that have an as-yet unproven technology.
One way of moving a technology through the valley of death is for a developer to enter into a strategic joint venture with an established company. By doing this, the developer can use the cash flow of the established company in order to raise additional cash for commercialization of the new technology.
However, using a strategic joint venture requires identifying companies that are willing to accept the risk associated with the new technology and have access to sufficient cash to support additional development costs or can guarantee debt financing for the developer. Several oil companies have invested recently in cellulosic ethanol, including BP in a strategic alliance with Verenium, Marathon Oil in Mascoma, Royal Dutch Shell in Iogen and Valero Energy in ZeaChem.
In addition, developers have increasing access to loans and guarantees from the U.S. government, which is another possible route through the valley of death. For example, the Department of Energy has provided funding for nine small-scale projects and four commercial-scale projects, including an additional $76.3 million (after an initial $3.7 million investment) for POET to develop a cellulosic facility. Also, the Department of Agriculture recently announced that it provided its first loan guarantee of $80 million to Range Fuels under the $250 million biorefinery assistance program to support commercial-scale advanced biofuel facilities
Another possible hurdle to the commercialization of cellulosic ethanol is the uncertainty surrounding access to feedstocks. Although the Department of Agriculture administers programs to promote the production of biomass crops, it is unclear whether these programs will convince farmers that a market for biomass crops will develop. Many of these crops may take several years to establish before a marketable crop is available for production, and until such time, it may be difficult to predict whether these crops will be commercially viable.
Without knowing whether biomass crops can be produced at commercial yields and prices, and in the absence of a market for these crops, it may be difficult for developers of cellulosic ethanol facilities to procure binding feedstock agreements.
In addition to market certainty for feedstocks, the production and transportation costs for feedstocks (residual non-food parts of agricultural crops, residual parts of forestry and waste products and biomass crops) on a commercial scale are largely unknown. Feedstocks that contain significant amounts of lignocellulose tend to be bulky, which may present difficulties and additional costs in terms of harvesting, collecting, transporting and storing these feedstocks.
Much of the marginal land that has been identified as being a major source of feedstocks for cellulosic ethanol production lacks access to populated areas where ethanol would be used, which may further increase transportation costs. Projections of the amount of available feedstocks are based on the assumption that feedstocks can be harvested at increased per-acre yields, which in certain instances would require additional spending on new harvesting machinery. Also, the projections do not necessarily take into account the impact that such harvesting may have on continued increases in per-acre yields for agricultural crops, due to the removal of harvest residue that would otherwise fertilize the next year’s crops.
All of these additional costs will remain difficult to quantify until cellulosic ethanol facilities enter commercial production.
Another risk to large-scale commercial production is what has been termed the “blend wall.” Currently, most ethanol gasoline fuel blends contain no more than 10% ethanol (a fuel known as E10). Blenders stop at 10% because the automakers take the position that using higher percentages of ethanol will void most vehicle warranties. Given that current U.S. consumption of gasoline is estimated at 142 billion gallons a year, absent an increase in the percentage of ethanol that can be blended with gasoline, the total annual market for ethanol in the U.S. is expected to reach the blend wall at a maximum of 14 billion gallons of ethanol. The RFS is scheduled to increase beyond the current blend wall in 2012 and provides an incentive to increase ethanol production even though there may be no one to buy the additional ethanol in practice.
Unless the percentage of ethanol that can be blended with gasoline is increased, through a change in either the types of vehicles sold in the U.S. or the automaker’s warranty position, additional production of commercial cellulosic ethanol will be difficult to absorb into the motor vehicle fuels pool. This concern is heightened by the fact that most, if not all, cost projections for producing cellulosic ethanol using current technology show that the fuel is not cost competitive with starch- and sugar-based ethanol.
Todd Alexander is a partner at Chadbourne & Parke LLP based in its New York office. His practice includes representing developers, private equity groups and lenders in project financings, including the financing of wind farms, utility-scale solar projects, gasification facilities, 2nd generation biofuels projects, biomass and landfill gas facilities, and smart grid applications.
Lee Gordon is an associate at Chadbourne & Parke LLP based in its New York office. His practice includes representing developers, private equity groups and lenders in a variety of renewable energy, biofuels and conventional energy projects.