Renewable hydrocarbon producer KiOR (NASDAQ:KIOR) had a rough week. Having closed at $20.53 last Friday (9/30), it proceeded to swan dive to $16.37 Wednesday (10/5) at close, a drop of 20% (it has rebounded a bit at the time of writing to $16.91). By contrast, the S&P 500 index was up 1.1% over the same period. So what happened?
The decline began when KiOR had its shares cut to underperform from neutral by Baird late Monday afternoon. Of much greater importance to KiOR's long-term valuation, however, was the release of a comprehensive report by the National Academy of Sciences on the economic feasibility of U.S. biofuels . Tucked in among the blue ribbon panel report's 650 pages is a short techno-economic analysis of KiOR's catalytic pyrolysis pathway, which calculates the optimal minimum selling price (MSP) of hydrocarbon fuels produced by KiOR to be $3.24/gallon. By contrast, the average pre-tax price of gasoline from 2011-2031 (as projected by the Energy Information Agency) is $2.84/gallon . If accurate, the National Academy report suggests that KiOR is unlikely to turn a sustained profit in the foreseeable future.
All is not lost for KiOR, however, despite this dire finding. First, a few words on KiOR's operations. The company produces hydrocarbons from biomass feedstocks via a thermochemical pathway called catalytic fast pyrolysis (CFP). The feedstock (Southern Yellow Pine chips, in KiOR's case) is rapidly heated to a very high temperature in the presence of a catalyst. This thermal decomposition transforms the feedstock into a liquid intermediate product called bio-oil. Further reaction of this bio-oil with hydrogen produces hydrocarbons such as aromatics and alkanes. Both are capable of serving as blendstocks for gasoline and diesel production in conventional petroleum refineries. This gives KiOR two significant advantages over starch-based ethanol producers (starch ethanol comprises the vast majority of the ethanol industry).
First, its final products can utilize the existing transportation fuel infrastructure (think pipelines and internal combustion engines), whereas blending ethanol with gasoline at a greater than 9:1 ratio can damage unmodified infrastructure. This ability to utilize the existing infrastructure allows KiOR's product to theoretically be substituted for all of U.S. petroleum-based gasoline and diesel consumption, whereas ethanol is limited to 10% substitution (15% if recent EPA regs survive Congressional challenges), barring significant infrastructure modifications. Second, KiOR's use of non-food biomass as feedstock allows it to sidestep the environmental issues that the majority of ethanol producers have encountered, such as food versus fuel and indirect land-use change.
Of course, these advantages mean little if KiOR is unable to produce biobased gasoline and diesel for less than its petroleum-based counterparts, which brings us back to the National Academy report. The S-1 that KiOR filed during its IPO last summer states that it can produce biobased hydrocarbons for $1.80/gallon, although very few details are provided as to how this number was calculated. The National Academy report's figure of $3.24/gallon was based in part on rigorous analysis but also on some incorrect assumptions. First, the report assumes an annual cost of capital of 12-14%. KiOR has acquired a $75 million interest-free loan from the Mississippi Development Authority for the construction of a commercial-scale CFP facility. It has also received a term sheet for a $1 billion loan guarantee from the Department of Energy under a program that charges an interest rate of 37.5 basis points over the applicable Constat Maturity Treasury curve - or roughly 1.8% for a 7-year loan at current rates - although it recently decided not to accept the DOE guarantee this year due to its belief that it can acquire funds at an even lower rate. Even accounting for administrative costs related to these loans, the assumption of a 12% cost of capital is far too high in KiOR's case. The report's second error is in assuming a feedstock cost of $89/dry ton, as opposed to KiOR's assumption of $72/dry ton. In reality the cost most likely lies somewhere in between these two figures. The report acknowledges that its feedstock cost calculations are based on a new economic model and higher than the results of numerous field studies. Inaccurate feedstock costs can greatly skew the MSP results, as other studies have reported an extreme sensitivity of thermochemical pathways' economic feasibility to feedstock cost [3,4].
This isn't to say that KiOR's numbers should be taken at face value. Studies from the national labs on a similar thermochemical pathway (fast pyrolysis) estimate the MSP of fuel production for a fast pyrolysis facility to be $2.04-$2.11/gallon despite assuming higher process yields, lower feedstock costs and much lower capital costs ($200-$300 million versus $463 million). The actual MSP for KiOR's fuels therefore is likely higher than $1.80/gallon but lower than $3.24/gallon. Existing biobased fuel programs such as the Renewable Fuel Standard can be expected to further reduce the MSP by $0.26/gallon . Not enough to make KiOR wildly profitable, perhaps, but certainly better than the National Academy's doomsday scenario.
 Committee on Economic and Environmental Impacts of Increasing Biofuels Production (2011) Renewable Fuel Standard: Potential Economic and Environmental Effects of U.S. Biofuel Policy. Washington DC: The National Academies Press.
 Energy Information Agency (2011) Annual Energy Outlook 2011. Washington DC: EIA, April.
 Jones SB et al. (2009) Production of Gasoline and Diesel from Biomass via Fast Pyrolysis, Hydrotreating, and Hydrocracking: A Design Case. Richland: Pacific Northwest National Laboratory, February.
 Wright MM et al. (2010) Techno-economic analysis of biomass fast pyrolysis to transportation fuels. Golden: National Renewable Energy Laboratory, November.
 Maio R et al. (2010) Investment in Cellulosic Biofuel Refineries: Do Renewable Identification Numbers Matter? Ames: Center for Agricultural and Rural Development.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.