Solazyme (NASDAQ:SZYM) feeds sugar from plant material to specially engineered heterotrophic algae in large fermentation tanks. The algae in turn produce triglycerides (oils) for use in numerous industrial and nutritional applications. The potential for Solazyme rests in the performance advantage of its oils compared to those manufactured by competing companies and those found in nature. Solazyme's main development partners that have been announced publicly are Dow Chemical, Unilever, Mitsui, Akzo Nobel, Bunge and Archer Daniels Midland.
Straight Path Through a Crooked Crowd
A year ago, Solazyme found itself caught in the nasty political crossfire of the 2012 Presidential election. President Obama had taken a strong stance in favor of alternative energy and expressly referenced the potential for fuel from algae. That put a bullseye squarely on Solazyme for the people whose job it was to stir up as much anger as possible heading into November. The favorite smear tactic was to repeat as often as possible the high price-per-gallon paid to Solazyme by the U.S. Navy for test quantities of oils to power ships and aircraft. The insinuation was that Obama's liberal love of all things green had enabled Solazyme to fleece the government. One such piece made its way into Forbes Magazine (found here).
Of course, just as the prototype of a drone aircraft or stealthy fighter jet is many multiples the price for future models off a factory assembly line, the fuel purchased by the Navy from Solazyme included the cost of research and development and reflected the high cost of small demonstration scale production. As noted by Fortune Magazine (found here), Navy Secretary Ray Mabus had clearly stated that the Navy would not buy any biofuels in large quantities if the prices were not competitive. That the ultimate price per gallon contemplated by the Navy in its development agreement with Solazyme would be competitive with market prices for diesel was an inconvenient truth that the political hacks made sure to leave out of their editorials. The bloggers and neocon news outlets ate it up and sat back with glowing satisfaction, waiting for their surefire win of the White House.
Fast forward one year. With Obama still President and the stock market reaching all-time highs, Solazyme finds itself roughly six months away from total nameplate production of approximately 127,000 metric tons (~40 million gallons) of triglyceride oils on three different continents. However, very little of that oil will find its way into a fuel tank. Why? Anyone reading a recent article on Seeking Alpha by Durwood Dugger (found here) might think it's because government researchers finally called out algal fuel as a pipe dream.
Dugger writes that "a string of recent high profile companies and government science researchers have announced withdrawals (partial or complete) from algae biofuel development. This has left many would-be algae biofuel developers desperately trying to come up with a plan B…." Dugger asserts that Solazyme "switched" to other markets when the economic realities of fuel caught up to it.
Well, the election may be over, but misrepresentations of Solazyme's history and its business aspirations are still very much with us. The clear implication of Dugger's piece is that Solazyme stubbornly but inevitably had to give up its hopes of helping Americans win their independence from foreign oil at the gas pump. Dugger is not the first person to push this inaccurate take on the situation. As discussed by Seeking Alpha contributor Maxx Chatsko (found here), Solazyme figured out the realities of algae and fuel long ago. The company has said time and again, since before the company's initial public offering in 2011, that they have no intention of trying to compete with gasoline.
It doesn't take someone as smart Solazyme's founders to do the basic math. Solazyme plans to have capacity agreements in place for around 175 million gallons of oil by 2016 (550K metric tons). That wouldn't be enough to satisfy California drivers for one week, let alone put America on the path to energy independence. Solazyme's officers have always acknowledged that they could never play anything other than a minor role in the National fuel equation. Instead, their express ambition in fuels is limited to the much smaller markets of sweeteners and blends for diesel and jet fuel, where the margins are more promising. Furthermore, and more important from the perspective of shareholders, the company made it very clear in its S-1 filing (found here) more than two years ago that the initial focus would be on the higher margin opportunities in chemicals, nutrition and personal care markets, with fuel products perhaps coming later. Contrary to what others would have you believe, Solazyme is still very much working and making rapid progress on its Plan A.
Dugger goes on to assert in his editorial that Solazyme finds itself joining a crowded market for fatty acid oils with products that belie its reputation as an environmentally friendly company. Let's divide this up into two issues:
There's Always Room for Innovation
Talk of price suppression caused by too much capacity misses the most important point of all. Solazyme's goal is not just to join the oleochemical party, but to grab share away from others through dramatic performance advantages. There are indications that Solazyme is manufacturing oils with capabilities never before seen (see here). For example, if McDonald's can save a lot of money with Solazyme's frying oil, and Dow can offer its customers both a performance and cost benefit with Solazyme's transformer oil, then that capacity isn't really being added to the market; it's supplanting competitors' production capabilities and forcing them to peddle their lesser oils elsewhere. By way of analogy, there might be all sorts of manufacturing capacity for cell phones, pharmaceuticals or jet engines. But if someone comes along with a unique product that clearly outperforms, existing capacity for lesser products won't preclude a company from doing blockbuster business.
Many Shades of Green
Dugger raises a valid and very important point that the plants fed to Solazyme's algae need fertilizer (or "NPK" as Durwood Dugger calls it), and fertilizer is dirty stuff. There was a time that Solazyme did a lot of talking about how much less impact its oils had on the environment and pointed to studies by third parties comparing the lifecycle carbon footprint of its oil vs. petroleum. At least some of the studies commissioned by Solazyme contemplated cellulosic (i.e. non-food) feedstock. Solazyme has shown the ability to use cellulosic feedstock instead of conventional plant sugars like corn and sugarcane, but has taken the position that until the logistics and infrastructure for hauling and processing cellulosic are ironed out, corn and sugarcane are a better bet for shareholders.
As noted in the S-1 filing referenced above, Solazyme expects to manufacture oils for less than $1,000 per metric ton. They expect to sell into the chemical and food markets at gross margins of 30-70% (see here). If this is indeed possible, then I can't say that I would be in a rush to use cellulosic feedstock either. Cellulosic material is cheap sitting in a field, but costly to gather, haul and process. Meanwhile, corn and sugarcane are going to be with us indefinitely, and Solazyme's needs are a drop in the bucket of those massive crops. Nevertheless, this has created the curious dichotomy of a company that points to the benefits of cellulosic feedstock but doesn't use it. Does this warrant criticism? Yes, I think it does. As a shareholder, I want the company to make the best return on capital, but they should not create a misleading impression about their operations. Basically, their officers' candid commentary on conference calls is at odds with the copy put out by their PR department. While they haven't aggressively pushed the environmental angle in recent months, there's still enough of it lingering on their website to confuse people about their current methods of production.
Could Solazyme's current process really be called green? I doubt anybody can really say exactly how green the oleochemicals will be because it's unclear what the performance of the company's products will mean in terms of usage. For example, petroleum based transformer oil performs well, but it's an environmental nightmare in terms of disposal, handling and other risks. Various natural oils can be used as friendlier substitutes, but don't hold up as well. If Solazyme offers a product that outperforms all current offerings by a wide margin, it might very well be that the life of the product more than mitigates the food crops used to make it. The same might be true for a 60% myristic acid oil (vs. 15% coconut oil) or a frying oil that lasts 10 times as long as the leading brand from oilseed crops. It's also unclear to what use the algal organisms themselves will be put after the oil is extracted. If they are used as animal feed or a source of electric power via gasification, then that too gets thrown into the green equation. Solazyme has not yet made the details of their production plans public, but the issue is clearly more complex than simply "food vs. fuel".
Not Your Father's Corn Syrup
Another aspect of Solazyme that must always be considered is the company's plan to focus on food production, not merely "nutraceuticals", but high quality fats and proteins that serve as the main ingredients in food products. In fact, a very large chunk of the Brazilian and future European capacity will be dedicated to edible oils and distributed by oil giant Bunge into the Brazilian market (see here) and starch giant Roquette in Europe (see here). Using corn to make ethanol in the United States may be ill advised, but what about converting corn and cane sugars into high quality nutrition? We pack our refrigerators with Coke filled with high fructose corn syrup, made from GMO corn, without blinking an eye. But a company that plans to use corn to make healthier frying oils should be a target for environmentalists?
Last but not least, you have the future of feedstock. I'd like to see Solazyme move to cellulosic feedstock as soon as it's feasible and cost effective. But it may be that the future holds something different altogether. Sugarcane feedstock used on-site at a mill is pretty cheap. By the time cellulosic catches up, there may be better alternatives. The company has worked extensively with low-grade waste glycerol as a source of sugars (see for example this patent application). Glycerol is a cheap and abundant by-product of biodiesel, which is used extensively all over Europe. Given their partnership with Bunge, one of the largest biodiesel companies, we could potentially see Solazyme dramatically alter the green equation of biodiesel production. Then there are the more exotic, futuristic possibilities such as Proterro's production of sugar in bacteria using carbon dioxide and small amounts of water. Although it is many years away, I would not bet against the ingenuity of scientists who are laser focused on making cheap sugars without the need for plant sugars.
Regardless of the production process, it is critical to differentiate between the potential size of Solazyme's environmental impact and the size it will need to make a lot of money for shareholders. The U.S. ethanol industry has a capacity of 14 billion gallons per year (see here). Even if all of Solazyme's capacity goals for chemical, food and fuel sweeteners are achieved over the next several years, they will be making fewer gallons of product in a year than the ethanol industry makes in a week. So no matter what feedstock the company uses, its environmental footprint in terms of feedstock use will be relatively small. But that same level of production would be sufficient to propel Solazyme's share price much higher.