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Introduction

Corn ethanol producer BioFuel Energy Corp (BIOF) investors enjoyed a rare surge in the stock price last Wednesday on news that the company has signed a collaboration agreement with isobutanol producer Gevo (GEVO) to explore large-scale production of isobutanol. BioFuel Energy's stock price is down 80% YTD in the midst of an incredibly challenging operating environment for corn ethanol producers, so it's worth examining why this news caused such a sudden shift in investor sentiment.

Background

BioFuel Energy operates two 115 million gallon per year corn ethanol facilities in Minnesota and Nebraska. It has taken investors on a wild ride since last October, as the following chart shows. What initially appeared to be a favorable spread between low corn and high petroleum prices quickly reversed as the global economy began slowing and the Midwest was hit by the worst drought in decades. Like most dedicated corn ethanol producers, BioFuel Energy can dehydrate the ethanol it produces into ethylene, providing a modicum of product diversity. Even this option is no longer available to the company, however, as increased shale gas production has yielded an abundant and inexpensive ethylene feedstock that ethanol can't economically compete with. As a result, corn ethanol plants are being shuttered in the face of operating losses exceeding $0.20/gal.

(click to enlarge)BIOF Chart

BIOF data by YCharts

Gevo takes a slightly different approach to the fermentation of corn starch. Rather than produce ethanol, it has genetically modified a yeast strain to produce isobutanol instead. Isobutanol is currently being investigated as a possible gasoline additive, similar to ethanol but with the notable advantage of an energy density that is only 10% lower than gasoline's (ethanol's is 50% lower than gasoline's). While this makes isobutanol more attractive as a gasoline additive than ethanol, it has a similar disadvantage as ethanol in that butanol-gasoline blends are currently limited to small volumes (up to 16 vol%).

Biobased isobutanol as a chemical product

Isobutanol's real value lies in its use as a building block for butylene production. Whereas natural gas is a useful feedstock for ethylene production, butylene is still largely derived from petroleum and has thus become significantly more expensive as petroleum prices have remained relatively high in recent years. This can be seen in the contract price for isobutanol, which is currently at $2400/metric ton (while historical prices are not available at that source, it was at approximately the same level when I looked back in April for a class lecture). This is more than twice as valuable as gasoline, which is worth about $1000/metric ton. This suggests that isobutanol production is a much higher-value pathway than ethanol production (which is worth about 67% of gasoline on an unsubsidized market basis, or $667/metric ton at current prices).

The agreement

Gevo takes a different approach to biofuels production than most biofuel companies. Rather than build and operate its own dedicated isobutanol production facilities, it works with existing corn ethanol companies to retrofit their facilities to yield isobutanol instead of ethanol. Gevo has already signed agreements to retrofit corn ethanol facilities in Minnesota and South Dakota; in each case the retrofitted facilities will produce 37 mgy of isobutanol in place of 50 mgy of ethanol, or a conversion efficiency of 75%. While BioFuel Energy's agreement with Gevo is only to investigate retrofits rather than actual retrofitting, any subsequent decision to retrofit one or both BioFuel Energy facilities would represent the largest biobased isobutanol conversion yet, with each facility yielding 86 mgy of isobutanol in place of 115 mgy of ethanol (based on the 75% conversion efficiency). Using isobutanol's and ethanol's current market prices of $2400/metric ton and $667/metric ton, respectively, this would represent $619 million (86 mgy = 258,000 metric tons per year) instead of $250 million (115 mgy = 345,000 metric tons per year) in annual revenue per facility. While Gevo hasn't disclosed the cost of a retrofit, it will need to be substantial to negate this increase in facility revenue.

Market limitations

While the potential of an 150% increase in facility revenue has clearly excited BioFuel Energy investors, the company will need to move quickly if it is to take advantage of isobutanol's high price. According to a SBIR report that Gevo was involved with, the current market size for isobutanol is a mere 175 mgy. In other words, retrofitting both BioFuel Energy facilities would yield almost enough isobutanol to match current market consumption. Isobutanol's current high price will undoubtedly fall substantially if even a handful of existing corn ethanol facilities switch to isobutanol production; one can only imagine how low it would go if a major ethanol producer such as Archer Daniels Midland (ADM) or Valero (VLO) made a large-scale switch. While isobutanol would be more valuable than ethanol as a gasoline additive due to its higher energy content, at current gasoline prices this would not be sufficient to offset the conversion yield loss ($232 million annually assuming an isobutanol price of $900/metric ton as a gasoline additive).

Conclusion

The recent agreement between BioFuel Energy and Gevo to explore conversion of the former's facilities to isobutanol production presents the possibility of a substantial increase to BioFuel Energy's revenues and profits. That said, investors should temper their enthusiasm some in light of the small size of the isobutanol market. While commercial-scale isobutanol production is very attractive at current prices, the conversion of only a small handful of U.S. corn ethanol facilities would be sufficient to swamp the isobutanol market and drive down profits of retrofitted facilities. While isobutanol's ability to serve as a gasoline additive represents a much larger potential market, current production yields are unlikely to be sufficient to justify the retrofitting of existing corn ethanol facilities under such a scenario.

Source: Why BioFuel Energy Corp Investors Are So Excited About Isobutanol