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Coskata announced last week that it has shelved plans for a $100 million initial public offering just a week after announcing that its first commercial-scale facilities will produce natural gas-derived ethanol rather than cellulosic ethanol. Neither of these moves is necessarily surprising given recent developments in the biofuel markets, although they do represent an important shift in the biomass gasification industry.

First, a recent crop of IPOs by advanced biofuel companies such as Amyris (AMRS), Gevo (GEVO), KiOR (KIOR), and Solazyme (SZYM) have left early investors with significant losses. Those companies yet to complete their IPOs face the prospect of raising far less capital than needed in a public offering due to investor jitteriness.

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Second, the unprecedented (at least since 1985) divergence between U.S. natural gas and petroleum prices since 2009 has presented gasification companies with a unique opportunity:

(click to enlarge)US Natural Gas Wellhead Price Chart

US Natural Gas Wellhead Price data by YCharts

Gasification companies (such as Coskata) convert blends of hydrogen, carbon monoxide, and carbon dioxide (commonly called syngas) into transportation fuels, either hydrocarbon-based fuels such as gasoline or gasoline substitutes such as ethanol. Unlike most biofuel companies, however, they are not restricted to gasified biomass as a source of syngas. Steam reforming of natural gas, for example, yields the same blends of hydrogen and carbon oxides. The drastic fall in natural gas prices since 2008 has made the commodity a very cheap source of syngas. Petroleum prices have remained high over the same period, however, providing a substantial profit margin for transportation fuels derived from natural gas (so-called synthetic fuels, or synfuels).

Unlike biofuels, synfuels do not qualify under the RFS2 mandate and therefore cannot receive RINs, which can be very valuable in biofuel sectors for which there is a binding mandate. Uncertainty as to if and when the mandate will become binding for cellulosic biofuels is high. However, I was recently told by a researcher at a major U.S. refiner that they aren't even accounting for cellulosic biofuel RINs in their baseline analyses due to this uncertainty. In all likelihood, Coskata determined that the reduced operating costs resulting from a switch to natural gas as feedstock more than offset any additional revenue that can be derived as a cellulosic biofuel producer under the RFS2 in the near future.

It's worth mentioning that most of the equipment for producing synfuels can also be used to produce biofuels (the latter require a gasifier and more rigorous syngas cleaning techniques), so this feedstock shift does not preclude Coskata from switching back to biomass or a blend of biomass and natural gas at some point in the future. For the time being, however, Coskata will be a privately-held synfuels company rather than a publicly-held biofuels company.

Of the publicly-traded advanced biofuels companies, Rentech (RTK) is in the best position to take advantage of an industry shift to natural gas feedstock. The company produces hydrocarbon-based transportation fuels via Fischer-Tropsch synthesis of syngas and is capable of utilizing both biomass and fossil fuels as syngas feedstock. While the company recently shelved plans to build a commercial-scale coal-to-liquids facility in Mississippi, it operates a demonstration-scale integrated natural gas- and biomass-to-liquids facility in Colorado.

Rentech investors should pay particular attention to Congressional efforts to expand the RFS2 to include transportation fuels derived from fossil fuels other than petroleum. The inclusion of synfuels within the RFS2 would quickly serve to make Rentech one of the better-positioned and more profitable alternative fuel producers in the U.S. on a per unit basis. In addition to the reduced costs associated with utilizing cheap natural gas instead of expensive biomass as feedstock, the company would also be able to generate additional income in the form of RINs by doing so. As it is, coal-to-liquid synfuels are estimated to be competitive with $100/bbl petroleum [1] and gas-to-liquid synfuels are even less expensive to produce [2]. Both are established pathways (commercial-scale Fischer-Tropsch synthesis of fossil fuel-based syngas dates to the 1940s) and there is more certainty with regard to their production costs than with many advanced biofuel pathways. While the inclusion of fossil fuel feedstocks within the RFS2 could clash with the mandate's environmental goals, it would support the mandate's economic, energy, and national security goals and is therefore not completely improbable (although at present the House and Senate only appear capable of passing a bill if they know it will fail in the other body).

Rentech has vastly outperformed its advanced biofuel peers in the last year. A broad switch to natural gas feedstock within the gasification industry will only serve to improve the company's prospects by reducing pathway production costs in a manner that will not benefit all advanced biofuel companies equally.

References

[1] Mantripragada HC, Rubin ES. Techno-economic evaluation of coal-to-liquids plants with carbon capture and sequestration. Energy Policy 39:2808-16.

[2] Adams TA, Barton PI. Combining coal gasification and natural gas reforming for efficient polygeneration. Fuel Processing Technology 92:639-55.

Disclosure: I am long KIOR.

Source: Coskata Leaves Biofuels For Synfuels - Rentech Investors Should Take Note