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The Biofuel Bubble


A horde of startups have smart ideas. But the challenges are many, and the winners likely will be Shell, BP, DuPont, and other majors

It's a bold vision: Replace billions of gallons of gasoline not with ethanol from corn or other food crops but with biofuels made from plants, such as prairie grass in Tennessee pastures or algae percolating in Florida. Such a move would slash dependence on oil, create thousands of jobs, and reduce emissions that contribute to global warming. In the U.S., the idea has powerful political support. Congress has decreed that the country must be using 21 billion gallons of "advanced" biofuels a year by 2022. Washington is backing that goal with tax breaks, loan guarantees, and scores of millions of dollars in grants, with more support expected in upcoming energy bills. These inducements and the vast potential market have stimulated investments of more than $3 billion and spawned a new industry.

More than 200 companies, from 12-person startups to oil giants, are developing next-generation biofuels using a bewildering array of technologies. Pilot and demonstration plants are operating or are under construction from Florida to California. "We can have it all: more fuel, more food, and fewer carbon emissions," says John B. Howe, vice-president of Verenium (VRNM), a Cambridge (Mass.) company that makes ethanol from sugarcane waste at a demonstration plant in Jennings, La.

Yet behind the very real innovations and investments, the brash claims and the breathless headlines, lies an inconvenient truth. Replacing petroleum with biofuels is a tough business. Even as the industry develops, many of the companies—probably most—will not survive. "We've seen a venture capital-led bubble," says Alan Shaw, CEO of Codexis, a Redwood City (Calif.) manufacturer of enzymes used to make drugs, chemicals, and biofuels. "I cannot see how the small companies can build a business and still get a return to their original investors. The numbers just don't add up."

Nor will many Americans soon be filling their gas tanks with these next-generation fuels. Industry executives concede they'll fall far short of the mandated 2010 level of 100 million gallons of biofuels made from cellulosic materials such as prairie grass or cornstalks. Meeting the 2022 goal is also unlikely. It would require not only building hundreds of fuel factories—at a cost of $500 million or more each—but also surrounding each one with thousands of acres of land planted with energy crops such as prairie grass. "We're talking about a fairly substantial transformation of the rural economic landscape," says Jack Huttner, vice-president of DuPont Danisco Cellulosic Ethanol, a joint venture of Danisco and DuPont (DD) that is building a demonstration plant in Tennessee.

These difficulties don't mean advanced biofuels aren't coming, or that they won't play a crucial role in fighting climate change. But everything will happen more slowly than many venture capitalists say. And the probable winners will be those with deep pockets and patience, such as Royal Dutch Shell (RDS), BP (BP), DuPont, agriculture giant Archer Daniels Midland (ADM), or the rare startup with revenues from another business, such as making drugs. For the rest, the demonstration biorefineries now being built are more like high-stakes auditions than a step in the process of becoming commercial biofuels producers. "The business model that makes sense for most of us is demonstrating the technology and getting it into the hands of those who have balance sheets," says Bill Roe, CEO of biofuel producer Coskata in Warrenville, Ill.

Yet even with this strategy, there's a problem for individual companies: There could be a glut of innovative biofuel technologies, from clever microbes to processes using heat and chemicals. As startups stumble, big companies should be able to snap up technologies on the cheap, when and where they need them.

For the companies that do succeed in building a business, the irony is that their success will only increase the challenges. Right now the feedstocks of plant or waste materials needed for biofuels are cheap. BlueFire Ethanol Fuels (BFRE) hopes soon to break ground on a facility in Lancaster, Calif., that will use paper trash and other municipal waste. CEO Arnold R. Klann figures he'll make ethanol for $1 per gallon by getting the waste he needs for free—or better. "If communities are paying Waste Management (WMI) to take their waste away, they can pay me to take it, too," he says. Trouble is, the economics will change. Rising biofuel production, or the burning of biomass to generate electricity, will drive up demand and prices for the raw material, just as production of corn ethanol helped raise the price of that crop. "Biomass is cheap right now because no one wants it. As people want it, it will become more expensive," says Robert Chess, chairman of OPX Biotechnologies in Boulder, Colo., which is engineering microbes to make chemicals and fuels.

More important, the laws of supply and demand mean that replacing a significant amount of gasoline with biofuels would drastically lower the demand for gas. That, in turn, would cause the price of gas to plunge, making biofuels less competitive. The 5% drop in gasoline use in the second half of 2008 (compared with the previous year) helped push down the average price at the pump from $4.14 per gallon to $1.74, dampening enthusiasm for biofuels. "Low oil prices have a numbing effect on consumers and their interest in this area," says David C. Aldous, CEO of Colorado's Range Fuels, which is building a plant in Soperton, Ga. Imagine what would happen if tens of billions of gallons of biofuel were to become available. The world could be awash in cheap oil and gas.

It has happened before. In the early 1980s, higher-mileage cars and an economic downturn sent petroleum prices swooning, killing off many renewable-energy efforts, including those supported by Big Oil. Avoiding that scenario today requires an additional policy step: raising the cost of using fossil fuels through taxes or limits on carbon dioxide emissions. "The major thing holding us back is the lack of a price on carbon," says Jim McMillan, a biofuels expert at the National Renewal Energy Laboratory (NREL) in Golden, Colo.

The crucial need for putting a price on carbon emissions is also a reminder that the industry is still pretty much a government creation. "The reason why renewable fuels exist at all is because politicians have decided they meet policy objectives. The whole market is 100% political," says Jeff Passmore, executive vice-president of Ottawa-based Iogen, the first company to make ethanol from a cellulosic feedstock—in this case, wheat straw. Those policy objectives: reducing energy dependence, fighting climate change, helping farmers, and creating jobs. But government policy can be fickle. Philip New, head of biofuels for BP, isn't so much worried that advanced biofuel technology won't pan out as he is that "the world might lose its enthusiasm for supporting these technologies through the difficult interim years," he says.

Even if the political winds do blow steady, however, the carnage on the path to the future's billions of gallons of advanced biofuels is likely to be great, with many companies and technologies losing out in the competition or being gobbled up by a few deep-pocketed survivors. Here's why:

COLOSSAL QUANTITIES

The first challenge is growing enough green plant material. The numbers are daunting. Producing 30 billion gallons of fuel takes 300 million or more tons of plant material. That's more than the total weight of cars and light trucks sold in the U.S. over the past 10 years. Growing this much cellulose would take at least 30 million acres of land. "I think the biggest problem for everybody is how are we going to grow, gather, store, and treat the biomass," says Brent Erickson, lobbyist for the Biotechnology Industry Organization.

Some industry executives doubt it's possible to grow that much plant biomass. "You can't make 16 billion gallons a year from cellulose," says Paul Woods, CEO of Algenol Biofuels in Naples, Fla. Woods is opting for algae instead. His plan: put "bioreactors" containing saltwater and blue-green algae out in the sun, and add CO2 and nutrients. Out comes ethanol.

Scores of other companies are also jumping into algae. For most, though, the bubble will burst. "There's a huge amount of hype in algae," warns NREL's McMillan. Experts at BP have looked over the entire field of algae competitors and found none they deemed worth investing in. "If they can make it work, it would be fabulous," says BP's New. "But I think there are still fundamental issues with algae." Not least, it's challenging to grow it in open ponds and troughs, where it's exposed to bird droppings, fungi, bacteria, and voracious microbes that feed on algae "like a pack of jackals at a buffet," says Fred Tennant, vice-president of business development at PetroAlgae (PALG) in Melbourne, Fla.

As a result, some biofuel players are looking at other sources of nonfood material. One of the cheapest sources now is garbage, such as the municipal waste that BlueFire Ethanol plans to use. Corn ethanol producer POET aims to make ethanol from corncobs. Weyerhaeuser (WY) is exploring growing energy crops in its forests, along with using wood waste. Range Fuels will tap into forests in the Southeast for its Georgia facility.

The problem is that making 21 billion or more gallons, the 2022 mandate, is likely to be far beyond the capacity of the startup companies—even if the recession eases and financing becomes more available. Jack Huttner, overseeing portions of the DuPont Danisco cellulosic ethanol plant in Vonore, Tenn., argues that the task requires a vast new agricultural enterprise. Biofuels companies will have to organize farmers to grow millions of acres of a dedicated energy crop like switchgrass or "energy cane," a low-sugar cane. "I'm concerned about organizing basically a new economy," Huttner says. The big players have a better shot at this than the startups.

Large financial resources and patience will also be essential when it comes to turning these enormous amounts of cellulose into liquid fuel. It's a far more complex process than fermenting starch or sugar into alcohol, which humans figured out how to do millennia ago, and there are a number of possible technologies. Typically, the cellulose must first be broken down into sugars, which are then fermented. To do this, some companies, including Range, use what NREL's McMillan calls "a big sledgehammer"—heat. BlueFire breaks up the cellulose with acid. Others employ man-made enzymes or microbes to convert it to sugar—or in some cases, directly into ethanol or other fuels. Still others, such as Virent Energy Systems, use mineral catalysts to turn feedstock into fuels.

The rivalry is intense. "The biological processes are the winners," argues William Frey, CEO of Qteros, which is developing a microbe to turn cellulose directly into ethanol. Heat or chemicals can't be used economically, he believes. Range CEO David Aldous disagrees. Biology is too finicky to handle the variety of feedstocks that a biorefinery might see, he says. Who's right? BlueFire's Klann asserts that so far, "no one is bright enough to know which technology will rise to the top."

That's why Big Oil is hedging its bets. Shell is joining up with Iogen, which already has a pilot plant making cellulosic ethanol; with Codexis, a producer of man-made enzymes; with algae company HR BioPetroleum; and with Virent. "This advanced technology is risky stuff," says Graeme Sweeney, executive vice-president for future fuels and carbon dioxide at Shell. "I stay awake at night because tomorrow it could all be changed."

Processes that work well in the lab often run into problems when scaled up to commercial size. Iogen found that enzymes that effectively convert pure wheat straw to sugars fail when faced with 1,000-pound bales laced with dirt, dead mice, and stones. "We've been at this many years. We've learned that the more you know, the more you discover that you don't know," says Iogen's Passmore.

Among the major players, two of the most promising efforts are the DuPont Danisco joint venture in Tennessee and BP-backed Verenium, which plans a commercial cellulosic ethanol facility in Florida. Both of these already have expertise in every step of their complicated processes, putting them ahead of startups that only have some of the pieces. "The dilemma with all the [small] technology players is that in the end, they have to plug into someone else's system," explains BP's New.

A shift in power to Big Oil is already happening in the traditional corn ethanol business, where low prices have led to the idling of more than 20% of capacity. VeraSun Energy (VSUNQ), one of the largest U.S. ethanol companies, filed for Chapter 11 in October. Guess who bought seven VeraSun plants at bargain prices? Valero Energy (VLO), an oil refiner with a $119 billion in revenue.

But don't expect the giants always to be fans of ethanol. True, refiners need a certain amount of it to meet the federal mandates. But ethanol—whether from corn or new sources—is about to run head-on into something called the "blend wall." Right now much of the gasoline in the U.S. contains 10% ethanol, which works fine in today's cars and trucks. Automakers worry that higher levels will damage engine components. So they will void the warranties of most vehicles running on richer ethanol blends. With the U.S. now consuming 137 billion gallons of gasoline a year, the total market for any kind of ethanol—corn, algae, or cellulosic—hits a hard limit at about 13 billion gallons. Going beyond that requires a whole new infrastructure, from car fuel lines to gas pumps.

That's one reason for the growing interest in newer, non-ethanol biofuels. "Oil companies really don't want to invest a lot in ethanol infrastructure. They'd much rather develop a different molecule," says Nathanael Greene, biofuels expert at the Natural Resources Defense Council, an environmental group. Whether that molecule is a type of alcohol called butanol (which DuPont and BP are working on) or other hydrocarbons more similar to gasoline, these fuels are compatible with existing refineries, pipelines, and vehicles. So some startups are designing microbes that can turn sugar from any source into diesel, gasoline-like molecules, or jet fuel. Colorado's Gevo, for instance, has an innovative business plan to add technology to corn ethanol factories to change the end products into fuels that are closer to gasoline or diesel.

The future of biofuels, therefore, probably looks like this: Farmers will grow millions of acres of switchgrass and other energy crops on land not taken out of food production. Those crops will help fight global warming and improve soil quality by adding carbon to the soil, and they can be processed into low-carbon fuels that are seamlessly delivered to filling stations and pumped into the gas tanks of trucks and cars. In other words, over the long term, we're probably not talking about ethanol—nor about a triumph of tiny startups.

As for the rest of the companies, some of their technologies may find a role, but most are not likely to make it. For many people, this conjures up the bubbles that enveloped biotechnology and the Internet in the late 1990s, when many companies failed. Now in next-generation biofuels, predicts Codexis CEO Shaw, "the only people who are going to be able to survive this are the Big Oil companies."

Business Exchange: Read, save, and add content on BW's new Web 2.0 topic network

The Climate for Biofuels

Advanced biofuels will be important in the fight against global warming. But their economic viability hinges on whether Washington implements a climate policy that puts a price on CO2 emissions, thus raising the relative cost of gasoline compared with low-carbon biofuels. As The New York Times reported on Apr. 11, the Obama Administration is moving cautiously: "Addressing climate change appears to be slipping down the President's list of priorities." Obama is letting Congress take the lead for now, but his Environmental Protection Agency is preparing for climate regulation in case Congress doesn't act.

For this story and others on the topic, go to bx.businessweek.com/global-climate-change/reference/

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