FT REPORT – ENERGY IN THE AMERICAS: Smart money is riding on the next-generation fuels

By Ed Crooks, Financial Times
Published: May 08, 2007

The case for ethanol in the US was encapsulated, effectively if tactlessly, in a poster campaign by Missouri farmers last year.

Pictures of the late King Fahd of Saudi Arabia and a local farmer were juxtaposed, with the tagline: “Who would you rather buy your gas from?”

That same argument, in essence, was what lay behind president George W. Bush’s declaration in this year’s State of the Union speech: “For too long our nation has been dependent on foreign oil.”

Promoting energy independence has been a consistent theme of the his presidency, but in this year’s address he set an explicit target of cutting gasoline usage by 20 per cent over the next 10 years.

That would mean, by 2017, a market for renewables and other alternative road fuels of 35bn gallons, displacing 15 per cent of gasoline consumption, up from 3.5 per cent today.

That target, seemingly guaranteeing huge growth in the consumption of ethanol and other biofuels, has sustained the wave of interest in renewable transport fuels, and encouraged a surge in the planting of corn, the sole feed-stock for domestically produced ethanol.

It implies a six-fold rise in demand for biofuels – which was already set to rise sharply under the previous target of 7.5bn gallons by 2012.

That growth is under-pinned by several tax breaks, including a tax credit of 51 cents per gallon paid to blenders and retailers.

Domestic production is also protected against foreign competition such as Brazilian ethanol, produced from sugar at a much lower cost, by a 54 cent a gallon import duty.

Ethanol use is also being encouraged by the state-by-state switch away from methyl tertiary-butyl ether (MTBE), an oxygenate added to gasoline which has been found to cause toxic pollution, and is now being replaced by ethanol.

Even before president Bush set his new target, ethanol production in the US was soaring.

It rose by 22 per cent last year to 4.89bn gallons, pulling the US ahead of Brazil as the world’s biggest producer. Current production capacity is up a further 20 per cent, at 5.9bn gallons a year, and still rising fast.

There are currently 120 ethanol plants operating in the US; 75 more are under construction.

The industry is very diverse: small local and farmer-owned plants account for about 40 per cent of production, while Archer Daniels Midland, the large agri-business company, produces about 25 per cent. The remainder is accounted for by a range of other companies, including big names such as Cargill.

Peter Gaw, global head of power and utilities at ABN Amro, argues that further consolidation is likely.

“In all the markets that we have seen emerge, they start with a lot of players that have more of an entrepreneurial spirit, and then as they mature, the industry consolidates and larger groups take leading positions,” he says.

“I think we are seeing that with ethanol.

“One of the key elements of success is the ability to hedge the feed stock risk as well as the offtake. Ethanol when corn is $2 a bushel is a different business from when it is $4 a bushel. It also requires greater risk management skills, which tends to favour the bigger players.”

What will matter even more to the future of the industry, however, is technological change.

It is clear that the limits of the current model of corn-based ethanol production will be reached long before president Bush’s target is hit.

Last year, ethanol production took 20 per cent of US corn crop, up from 12 per cent in 2004, and the share is still rising.

Corn prices have been rising too; they have gone from about $2.50 a bushel to almost $4 in April, although the sharp increase in corn planting by US farmers has pulled the price back to about $3.50.

Demand from ethanol producers is not the only reason; increased demand from food manufacturers and poor harvests have also been to blame. But it is becoming an increasingly important factor.

The effect on the cost of food may not have been very obvious in the US, but it has been explosive south of the border.

In Mexico, the cost of flour tortillas went from 25 cents a pound to 50 cents in some areas. In April the government was forced to agree a price cap to last until August.

Competition between food and fuel threatens to become an ever more pressing constraint on the biofuel industry.

The real prize in biofuels is what are known as second-generation or third-generation fuels, such as cellulosic ethanol derived from plant fibres.

They would use as feedstocks not edible crops, but waste products that would normally be thrown away or burned, or plants that can grow on land not suitable for growing food.

There is huge interest in the next generation of fuels, both from the oil majors such as Royal Dutch Shell and BP – even ExxonMobil, traditionally the leading alternative energy sceptic, is funding research into new road fuels – and from a legion of new entrepreneurial companies.

President Bush also pledged $179m in the State of the Union speech for his biofuels initiative. The money is intended, the White House said, “to accelerate cost reduction and commercial development of cellulosic ethanol”.

“There have never been more dollars speculating on investment in clean energy technologies,” says Greg Curhan of Merriman Curhan Ford, a San Francisco-based investment bank.

“These technologies go down a cost curve similar to computers: as more investment goes in, the costs go down, and you get a virtuous circle.

“I think in a matter of two to five years we will see some of these next generation biofuels on the market: although my view is probably a bit more aggressive than the consensus.”

If he is right, the market for first-generation ethanol could disappear as rapidly as it has emerged.

This website and sisters royaldutchshellgroup.com, shellnazihistory.com, royaldutchshell.website, johndonovan.website, and shellnews.net, are owned by John Donovan. There is also a Wikipedia segment.