While the housing crisis has taken center stage in the nation’s economic dialog (as it should), the ethanol discussion has died down a bit. While all the negative press wasn’t that great for producers, the broader economic environment will have a tremendous effect on the prospects of this industry. So it begs the question, where is the U.S. biofuels industry headed?
Where are we now?
Well, without going too deep into it, let’s look at a few bullets:
- new plant construction projects are being cancelled.
- construction costs have increased due to a lack of available resources to build
- high corn prices have impacted the industry’s profitability
- low ethanol prices due to increased production (and questionably lower/flat demand) have squeezed producers
- transportation options have higher costs
The news over the last few months, I think, paints a pretty clear picture of the challenges the industry is facing. I think we can, then, assert what the future outlook of this industry might be.
There are three elements that I think will shape the short-term outlook on the biofuels market:
Cost Management
Lets face it, the biofuels industry is a crappy one. When you’re buying and selling a commodity with fluctuating prices, you’re sure to get squeezed. So the viability of large producers comes in their ability to manage the risk involved with pricing through hedging practices.
Further, this current crop of production plants have to improve their efficiencies from all angles. This impacts product yield, energy consumption (and co-generation), and overhead costs.
Demand
It’s not clear that the actual demand for ethanol will continue to grow. Even though the government is pushing for it, the market still needs to adopt it. The sharp reduction in ethanol prices in recent months seems to indicate an imbalance of supply and demand. In particular, it could mean that demand is increasing more slowly than capacity is increasing (so it would support recent plant construction pull-backs). It could also mean that demand is waning. It’s not quite clear which. But the impact, then, is that while each company is jockeying for market supremacy, they must also manage their expansion plans to coincide with the real market demand.
Technology Development
It’s already evident that the ethanol industry will not continue without a breakthrough in cellulosic ethanol. It’s gotta happen or we’re done.
What isn’t well discussed is an innovation on ethanol refining technology. No matter what the upstream process technology is, ethanol must be separated from water. Currently, distillation is the method of choice. But it’s energy intensive. Huge strides could be made with a low-cost means of separating ethanol from water.
So where are we headed?
Problems with financing
The problems affecting the commercial banks will affect this industry. Equity money is fairly available, although not necessarily easily gotten given the prospects of this market. But these types of projects usually don’t go forward without some level of debt financing. And the debt markets are in the dumps at the moment. So everything I say for the rest of this post should be prefaced by saying “..if they can get financing…”.
A day of reconning
It’s clear that there will be a period of consolidation. While we have already seen some acquisitions, most likely, the smaller, less efficient facilities (say, less than 60 Million gal/yr) will go out of business. This business can only be survived on scale and these facilities won’t be able to manage. According to the RFA’s list of biorefineries, this assertion would implicate around 70 different facilities with around 2 Billion+ gallons/yr of capacity. Pacific Ethanol’s story, then, doesn’t look very compelling. And POET’s looks a little dangerous (they have lots of smaller facilities).
New Players
The big boys in the ethanol (and even the biodiesel industry, although we’re not quite there yet) will end up being ok if it keeps playing smart: VeraSun, POET, ADM, and Biofuel Energy. But the weakness of many of its other competitors could be a great opportunity for a new, technology-focused startup to emerge. Verenium would be an interesting opportunity. If their work with developing an enzyme solution for a cellulosic format, then they could do well. If Range Fuels’ first plant does well, it could be poised to scale rather quickly.
New Fuels
For all the hype, ethanol is just a fuel additive at this point (and biodiesel is just a lark, albeit one with a lot of potential). But ethanol’s life could end right here. It certainly has detractions as a fuel and with its compatibility with current transportation methods. But other chemicals could emerge as fuels in coming years. Biobutanol is getting good uptake and has some interesting prospects. Dimethylfuran has some potential as well. Synthetic fuels (gasoline produced from non-oil feedstocks like coal or plants) also have some interesting elements as well.
End of Round 1
In short, I’d predict that we’re looking at the calm before the storm. While I wouldn’t use the word “bubble”, we are certainly looking at a potential shake-out of weak competitors (it’s healthy though – we shouldn’t look at it the same way we look at the first internet bubble bursting).
What we should really be preparing for – and perhaps investing in if given the opportunity – is Biofuels Gen 2.0. Gen 1.0 – corn ethanol, and soy bean biodiesel – may be reaching its feasibility limits. While it might not be completely down hill from here, it could be quite rough until some new opportunities come online. Get your checkbooks ready though.
I’ll bring up some topics for Biofuels Gen 2.0 (or Fuels 3.0).
