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Introduction

Many investors in advanced biofuel producers such as Amyris (NASDAQ:AMRS), Avantium, Gevo (NASDAQ:GEVO), Solazyme (NASDAQ:SZYM), and Virent have been undoubtedly surprised to learn over the last year that their biofuel investments have morphed into commodity and specialty chemicals investments. Long term trends in petroleum-based commodity markets suggest that this is an appropriate course of action for small biofuel producers as they attempt to attain commercial-scale production (or "cross the Valley of Death", as Jim Lane memorably put it earlier this year). This article examines these trends and discusses how advanced biofuel producers are using polygeneration (i.e., product diversification) to leverage them to achieve higher profit margins.

Ethanol's Impact on Petroleum Product Prices

Ethanol is an imperfect fuel source. Its high oxygen content makes it less efficient than gasoline and damaging to unmodified fuel equipment. Perhaps more harmful on a macroeconomic basis, however, is the fact that it is a gasoline substitute rather than a petroleum substitute. This is not just a matter of semantics: ethanol cannot operate in diesel and jet engines, nor can it serve as a substitute for asphalt and most petrochemicals (ethylene being one of the few economical exceptions to this rule). Approximately 43% of every barrel of petroleum is converted to gasoline, with the rest being converted to co-products such as diesel and jet fuels, petrochemicals (i.e., commodity chemicals), and asphalt.

(click to enlarge)Product output (gallons) per barrel of petroleum

Gallons of products derived from a barrel of petroleum. Source: U.S. Department of Energy.

Total U.S. gasoline consumption is declining and any increase in fuel ethanol consumption necessarily comes at the expense of gasoline consumption as a result. Gasoline is the primary refining output (the other outputs can be considered co-products) and refiners have little profit incentive to refine a barrel of petroleum if there is no demand for the resulting gasoline. In this way ethanol consumption manages to displace petroleum consumption despite not being a petroleum substitute. Economic theory suggests that the natural result of this situation is an increase in the prices of petroleum products other than gasoline.

Until the 21st century, total fuel ethanol consumption in the U.S. was low enough to make any petroleum non-fuel product price distortion marginal. This changed in 2001 and ethanol gained strong bipartisan political support as a domestic fuel source following the revelation that most of the 9/11 hijackers came from petroleum giant Saudi Arabia. A variety of legislative measures incentivizing U.S. ethanol production were quickly passed. To say that U.S. ethanol consumption boomed as a result is an understatement: it quintupled between 2003 and 2012 and ethanol now replaces nearly 10% of domestic gasoline consumption.

(click to enlarge)US Fuel Ethanol Consumption (Annual) Chart

US Fuel Ethanol Consumption (Annual) data by YCharts

Diesel fuel and, to a lesser extent, jet fuel prices have avoided price distortions resulting from this rapid increase in ethanol consumption by being the subject of separate biodiesel and, more recently, renewable diesel government incentive programs. Biomass has yet to replace petroleum as feedstock for petrochemicals and asphalt on a commercial scale, however, and petrochemical and asphalt prices have greatly increased relative to petroleum prices as a result. The price distortion caused by the increase in ethanol consumption can be seen by comparing historical petroleum and asphalt prices:

(click to enlarge)Difference between asphalt and petroleum price indices (light blue) with 12-month moving average (black) and 2nd-order polynomial trendline (red) [1, 2].

Asphalt prices have increased more than petroleum prices over the last decade, a trend that has only increased in pace in recent years. While this could be a result of falling U.S. cement consumption (cement being a competitor with asphalt), a comparison of data on cement consumption and asphalt prices [1] shows a very weak correlation. A moderate correlation exists between ethanol production and asphalt prices, on the other hand:

(click to enlarge)Correlation between U.S. ethanol production and the asphalt/petroleum price differential [1-3].

A similar result is seen when examining the relationship between the prices of gasoline and petrochemicals. In a recent paper [4] colleagues and I looked at this relationship in the context of biorenewable products by comparing the value of biobased gasoline and biobased chemicals produced via the fast pyrolysis pathway. As the following figure shows, the 12-month moving average of a price index based on the value of chemical products (BTX, butylene, ethylene, and propylene) derived from 1 metric ton of bio-oil has not fallen below the value of gasoline derived from the same since early 2004, whereas it frequently did so from 1993-2003:

(click to enlarge)Adapted from [3].

This suggests that the production of commodity chemicals has become substantially and consistently more valuable over the last decade relative to gasoline production, even when controlling for the sustained high petroleum prices that have characterized the last several years.

Implications for advanced biofuel producers

Many advanced biofuel producers such as Amyris, KiOR (NASDAQ:KIOR) Honeywell (NYSE:HON) subsidiary UOP, and Solazyme have focused on the development of hydrocarbon products such as biobased gasoline and diesel. Both gasoline and commodity chemicals are hydrocarbon products and it is relatively easy to switch production between different hydrocarbon groups. Take the pyrolytic pathway, for example: reacting bio-oil produced via the pathway with hydrogen in the presence of a metal catalyst (hydroprocessing) produces alkanes that can be blended into gasoline and diesel fuel [5]. Alternatively, a fluid catalytic cracking step can be performed after hydroprocessing to produce a mix of commodity chemicals such as aromatics and alkenes [6]. Finally, these upgrading steps can be avoided altogether by introducing a specialized catalyst into the pyrolysis reactor to produce aromatics [7]. The same hydrocarbon groups can be produced from sugars via similar processes [8], a strategy that is being employed by companies including Amyris, Solazyme, and Virent.

In the continued absence of a RIN price incentivizing cellulosic biofuel production, many advanced biofuel producers will see greater profit margins associated with commodity chemicals production than gasoline production. Given the relative ease with which producers can switch between commodity chemical and advanced biofuel production, developing the capacity to employ both production pathways will enable these producers to maximize their profitability in the short-term while protecting themselves against risk via diversification if and when the cellulosic biofuel mandate becomes binding. It's worth noting that recent years have even witnessed the formation of biobased asphalt companies (such as Avello) to take advantage of the petroleum product price distortions caused by widespread ethanol consumption.

Conclusion

The replacement of a large volume of U.S. gasoline consumption with fuel ethanol has disincentivized petroleum refining and caused non-fuel petroleum product prices to increase substantially relative to the prices of petroleum and gasoline. Given the ease with which biobased hydrocarbon producers can switch between production of advanced biofuels and commodity chemicals, several companies have switched their focus from the former to the latter. These companies can expect to enjoy higher profit margins with commodity chemical production than with advanced biofuel production so long as the RFS2 cellulosic biofuel mandate remains unbinding. Commodity chemicals will likely remain an important part of advanced biofuel producers' product portfolios even if the mandate becomes binding, as their inclusion will allow producers to more closely replicate the business model of petroleum refiners and reduce risk via product diversification.

References

[1] Chau, Q. 2012. California Paving Asphalt Price Index, California Department of Transportation.

[2] Anon. 2011. Crude oil (petroleum) price, Index Mundi.

[3] Anon. 2011. Monthly U.S. oxygenate plant production of fuel ethanol, Energy Information Administration.

[4] Brown, T., Zhang, Y., Hu, G., and Brown, R. 2012. Techno-economic analysis of biobased chemicals production via integrated catalytic processing. Biofuels, Bioproducts and Biorefineries 6: 73-87.

[5] Elliott, D., Hart, T., Neuenschwander, G., Rotness, L., et al. 2009. Catalytic hydroprocessing of biomass fast pyrolysis bio-oil to produce hydrocarbon products, Environmental Progress & Sustainable Energy 28: 441-449.

[6] Vispute, T., Zhang, H., Sanna, A., Xiao, R., et al. 2010. Renewable chemical commodity feedstocks from integrated catalytic processing of pyrolysis oils, Science 330: 1222-1227.

[7] Cheng, Y., Jae, J., Shi, J., Fan, W. et al. 2011. Production of renewable aromatic compounds by catalytic fast pyrolysis of lignocellulosic biomass with bifunctional Ga/ZSM-5 catalysts, Angewandte Chemie.

[8] Huber, G., Iborra, S., and Corma, A. 2006. Synthesis of transportation fuels from biomass: Chemistry, catalysts, and engineering, Chemical Reviews 106: 4044-4098.

Source: Why Advanced Biofuel Producers Are Becoming Commodity Chemical Producers