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Introduction

The recent controversy in Washington, DC over the use of small quantities of expensive algal-based biofuels to power the "Green Navy" has left many investors wondering what these "next-gen" fuels are and how they differ from the existing slate of biofuels that is currently available at gas stations. Meanwhile, in a closely related but underreported event, the same pathway responsible for algal-based biofuels has become the first advanced biofuels pathway to achieve commercial-scale production, both in the U.S. and globally. Indeed, Louisiana - a state better known for its offshore production of fossil fuels than its onshore production of biofuels - is currently expected to be home to a greater volume of advanced biofuels production than the rest of the states combined through at least 2013.

The purpose of this article is to provide investors with a primer on this pathway, which produces renewable diesel and jet fuels via lipids hydroprocessing. It examines the differences between the lipids hydroprocessing and lipids transesterification (biodiesel) pathways, while also covering the different feedstocks available for use and discussing how a pathway that has proven competitive with petroleum-based diesel at $4-6/gal is currently costing the U.S. Navy $15/gal.

Transesterification versus hydroprocessing

Most people are familiar with the lipids transesterification pathway, which yields an output popularly known as biodiesel. The pathway has achieved widespread production globally over the last decade and currently yields nearly 1 billion gallons of transportation fuel per year in the U.S. alone:

(click to enlarge)US Biodiesel Production Chart

US Biodiesel Production data by YCharts

Biodiesel is produced from lipids, which can take the form of either fats (generally animal-based) or oils (generally plant-based). Lipids transesterification consists of reacting the lipid triglycerides with methanol to yield fatty acid methyl esters [FAME] and glycerol (ethanol can also be used to yield fatty acid ethyl esters [FAEE], although methanol is generally a cheaper input). When used as a transportation fuel, these esters have similar combustion properties as petroleum-based diesel, thus the name "biodiesel."

(click to enlarge)

Lipids transesterification to FAME and glycerol (Credit: Wikipedia)

Biodiesel is not chemically identical to diesel despite the similarity in combustion properties, however, and has a few important operational differences as a result. The most important of these are low temperature clouding and water contamination; the former can limit its utility in colder climes while the latter can reduce its energy efficiency. Finally, biodiesel is not suitable for use in jet engines (although I was surprised to hear a senior U.S. cabinet official say differently at a speech on our campus earlier this year, which I used as an ironic teaching tool for my students on the perils of receiving science lessons from lawyers). This greatly limits its aviation and military applications - in addition to the obvious aviation uses, many of the military's heavier land vehicles, such as the M1 Abrams Main Battle Tank, run on turbine engines. The U.S. military has been at the forefront of efforts to develop alternative diesel and jet fuels as a result.

One alternative fuel pathway that has only recently gained traction in the U.S. is the reaction of lipids with hydrogen instead of alcohol. This "hydroprocessing" has two important effects: the hydrogen reacts with the oxygen in triglycerides to produce water while also cleaving their propane backbone, thereby yielding long chains consisting entirely of hydrogen and carbon - i.e., hydrocarbon chains. Depending on the feedstock used, these hydrocarbon chains will have a carbon number of between 8 and 22 [1]. Jet fuel has a carbon number of between 7 and 17 while diesel fuel has one between 9 and 23 [2], so the hydrocarbon chains produced via lipids hydroprocessing can be readily blended with petroleum-based versions for vehicular use (although, like biodiesel, these straight-chain hydrocarbons suffer from low-temperature clouding). Alternatively, the straight-chain hydrocarbons can be further reacted with hydrogen via hydroisomerization to yield branch-chain hydrocarbons that have virtually identical properties to the petroleum-based versions, allowing them to be used in very high blends with petroleum-based fuels or, theoretically, as a sole fuel source. Most importantly for U.S. consumption, this process yields both renewable diesel and jet fuels, giving producers employing the pathway a much larger market than biodiesel producers have access to. That said, hydrogen is more expensive than methanol so the lipids hydroprocessing pathway's operating costs are higher than those of lipids transesterification, although the recent fall in natural gas (UNG) prices has narrowed this difference somewhat.

Feedstock flexibility = fuel flexibility

The fatty acid composition of the lipid feedstock utilized plays an important role in determining the yields of diesel and jet fuels due to the pathway's adoption of the existing triglyceride carbon chains (as opposed to pathways such as fast pyrolysis and gasification, which depolymerize the biomass compounds before repolymerizing them as hydrocarbons in the desired fuel range). For example, soybean oil mostly yields hydrocarbon chains with a carbon number of 18 [1], which is suitable for diesel fuel but too large for jet fuel, while microalgae oil yields hydrocarbon chains in both the diesel and jet fuel ranges [3] (one of several reasons that the U.S. Navy has pursued the development of algal fuels over those from other lipid feedstocks). Furthermore, the type of fatty acid in the feedstock influences process economics, as unsaturated fatty acids require more hydrogen consumption during hydroprocessing than do saturated fatty acids.

This relative flexibility has prompted a number of lipids hydroprocessors to begin using lipid-rich waste products, including yellow grease (used cooking oil) and animal fats. These feedstocks have a number of advantages over soybean oil, which is the primary biodiesel feedstock in the U.S. First, soybean oil has low jet fuel selectivity [4], likely due to its high proportion of hydrocarbon chains with carbon numbers that are above the jet fuel range [1]. Rather than just compete directly with biodiesel producers, the utilization of these other feedstocks enables hydroprocessors to sell to the jet fuel market as well. Second, both yellow grease and waste animal fats trade at a signficiant discount to soybeans. This is something that biobased diesel producers are watching closely, as soybean prices (SOYB) have been following corn prices (CORN) higher due to the Midwestern drought. Furthermore, utilization of waste feedstocks allows lipids hydroprocessors to avoid the "fuel versus food" debate that comes with utilizing soybeans and other food crops. Finally, U.S. corn ethanol and soybean biodiesel production have been accused of destroying Amazonian rainforest [5] and, while this contention has been more or less disproved in the literature [6], the public perception of 1st-generation biofuel producers as famine-causing destroyers of the world's rainforests has remained.

The feedstock supply issue

Yellow grease and waste animal fats have a major disadvantage relative to soybeans, however: as waste products, the national supplies of both feedstocks is significantly smaller than that of soybean oil (according to even optimistic estimates). Additionally, national yellow grease output tends to be widely distributed, necessitating substantial transportation costs for a commercial-scale facility employing it as feedstock. It is no coincidence that every commercial-scale lipids hydroprocessing facility in operation or under construction within the U.S. is located in the middle of a heavy shipping corridor near multiple railheads on the lower Mississippi River.

These concerns over feedstock supply have led the world's largest producer of renewable diesel and jet fuel, Neste Oil (OTC:NTOIF), to rely on palm oil that is grown on dense palm plantations. Palm oil has also proven controversial in recent years for environmental reasons, however, so publicity-sensitive entities seeking to employ the lipids hydroprocessing pathway have focused instead on another densely-grown but eco-friendly feedstock: microalgae, more popularly known as "pond scum." Perhaps the most attractive feature of microalgae as feedstock is that an area the size of Maryland, if completely devoted to microalgae production, could supply enough feedstock to meet most U.S. transportation fuel demand. Furthermore, as a waterborne "crop", microalgae production does not require the use of cropland, thereby avoiding the controversies over "food versus fuel" and rainforest destruction.

When placed in a stressful growing environment, many algal strains begin to produce a large proportion of lipids. This so-called "lipids trigger" is relatively well known (Google News is full of press releases about this or that company "discovering" the trigger) but difficult to exploit, as microalgae also have a tendency to stop growing when the trigger event occurs, thereby reducing overall yields. Furthermore, the highest yields are only achieved under very strict growing conditions, requiring the construction of expensive facilities just for the production of microalgae feedstock, let alone its conversion to biofuel. In 2012 Syntroleum (SYNM), which operates a commercial-scale lipids hydroprocessing facility as part of a JV with Tyson Foods (TSN), reported ex-feedstock operating costs of $1.32/gal. Assuming that the Navy's purchase of algal fuel for $15/gal from Solazyme (SYZM) was at cost, this results in a microalgae feedstock cost in excess of $13/gal. While this figure is expected to fall in the future due to genetic engineering and other technological breakthroughs, it will need to fall drastically if it is to compete with other lipid feedstocks, let alone petroleum.

The high cost of microalgae feedstock has caused algal fuels to be a relatively small player in the advanced biofuels industry; Solazyme is the only microalgae oil producer listed in the Biofuels Digest Advanced Biofuels and Biobased Materials Database, and even then its commercial-scale production will be devoted to the high-value nutraceuticals and food markets rather than the relatively low-value biofuels market. This is not necessarily a disadvantage for the company, as few other biofuel producers can compete in those same markets, although it doesn't bode well for the short-term prospects of microalgae as biofuel feedstock.

Investing in the pathway

Investors wishing to gain exposure to the lipids hydroprocessing pathway have a limited number of investment options due to the pathway's small size relative to first gen pathways such as corn and cane ethanol. That said, low RIN values have created some attractive values within dedicated lipid hydroprocessing companies. Syntroleum's share price has fallen by 35% since September 2011, during which time biomass-based diesel RIN values have also fallen from $1.99 to $0.97. The drought could cause RIN values to increase, in which case Syntroleum is positioned to directly benefit. Neste Oil could also benefit for the same reason, although its earnings are less sensitive to RIN values because of its diversified product line. The 137 MGY Diamond Green Diesel project, a JV between Valero Energy (VLO) and Darling International (DAR), is expected to begin operations in 2013. As with Neste Oil, however, both Valero and Darling have diversified product portfolios and their earnings are less sensitive to biomass-based diesel RIN values.

Indirect exposure to the pathway can be obtained via companies that license hydroprocessing technology to other projects. The most prominent example is Honeywell (HON) subsidiary UOP, which has licensed its Ecofining process to both Emerald Biofuels, which is building an 85 MGY lipids hydroprocessing facility in Louisiana, and the Diamond Green Diesel project [pdf].

Conclusion

The lipids hydroprocessing pathway has achieved a major milestone as the first advanced biofuels pathway to reach commercial-scale production. Other than those described in this article, however, no additional publicly-traded companies are planning lipids hydroprocessing projects at this time in the U.S., despite the pathway's success. This is primarily due to a relatively limited supply of inexpensive lipid feedstock, which will likely prove to be the biggest constraint on pathway growth in the near future. Microalgae are under serious investigation by both public and private entities as a possible source of lipids in the future, although very high production costs are preventing the commercialization of algal fuels at present and turning the feedstock into a political football, eliminating one of its big advantages relative to other lipids feedstocks.

References

[1] Huber GW, Iborra S, & Corma A (2006) Synthesis of Transportation Fuels from Biomass: Chemistry, Catalysts, and Engineering. Chemical Reviews 106:4044-4098.

[2] Hileman JI, et al. (2009) Near-term feasibility of alternative jet fuels. (RAND Corporation, Santa Monica).

[3] Patil V, Källqvist T, Olsen E, Vogt G, & Gislerød H (2007) Fatty acid composition of 12 microalgae for possible use in aquaculture feed. Aquaculture International 15:1-9.

[4] Veriansyah B, et al. (2012) Production of renewable diesel by hydroprocessing of soybean oil: Effect of catalysts. Fuel 94:578-585.

[5] Searchinger T, et al. (2008) Use of U.S. Croplands for Biofuels Increases Greenhouse Gases through Emissions from Land-Use Change. Science 319:1238-1240.

[6] Dumortier J, et al. (2011) Sensitivity of Carbon Emission Estimates from Indirect Land-Use Change. Applied Economic Perspectives and Policy 33:428-448.

Source: Renewable Diesel And Jet Fuels From Lipids: An Investor's Primer