When discussions of flopped biofuel company IPOs arise, Gevo (GEVO) inevitably leads the list of names. It's easy to see why: the company's share price has fallen 88% from its starting value, and roughly 94% from peak to trough (see figure). The most recent bout of bloodletting occurred in late September, when the company announced that its goal of achieving commercial-scale corn biobutanol production at its first large facility in Luverne, MN by the end of 2012 would be missed, with production instead occurring sometime in 2013. At the time the company said that it would produce corn ethanol at the facility until the technical difficulties with biobutanol production were worked out, allowing the company to generate revenues despite the delay. Shares are falling again following yesterday's Q3 earnings call, however, when CEO Patrick Gruber stated that the Luverne facility hasn't begun ethanol production yet, and won't unless it "makes economic sense." As I've discussed elsewhere, this standard is unlikely to be achieved in the near future. In other words, it appears that the Luverne facility will remain idle until the difficulties with biobutanol production are fixed.
That's not to say that this sort of event is out of the ordinary. Scale-up of new biorenewable pathways is notoriously difficult, particularly when independent actors in the form of microbes are involved. It is virtually unheard of for a new biochemical pathway to commercialize as smoothly as those that have been around for thousands of years have (e.g., corn and cane ethanol). These things are to be expected. Furthermore, Gevo's cash situation means that a delay of a few months won't put it in mortal peril (as opposed to a company like KiOR (KIOR), for example). In July the company issued $45 million in 10-year convertible notes, which will incur $3.4 million in annual interest payments but leave Gevo with $92 million in cash on hand. Even assuming continued quarterly losses of roughly $12 million while waiting for Luverne to come online, the company has enough cash to last at least seven quarters. While it would likely prefer to use that cash for future commercialization projects, it's in no danger of declaring bankruptcy anytime soon.
The conference call also briefly touched on advanced biobutanol production, which the analysts on the call really didn't pay much attention to. Its mention in the transcript caught my eye, however, as this has the potential to eliminate my concerns regarding the economics of corn biobutanol production in the U.S. As a reminder, Gevo's business model involves retrofitting existing corn ethanol facilities to biobutanol production. Biobutanol has several advantages over ethanol, both as a commodity chemical, where current market prices are over $2800/metric ton, and as a transportation fuel due to its higher energy content and higher blend limit. That said, the market for biobutanol as a commodity chemical is relatively small, and my concern is that only a handful of facilities can produce enough to swamp the commodity chemicals isobutanol market, at which point it will need to take advantage of the much larger transportation fuel market. The problem with the latter is that a fall in fuel yields occurs on a feedstock basis when converting from corn ethanol to corn biobutanol production, so fuel biobutanol prices must be quite high to offset this efficiency loss. While corn biobutanol meets the definition [pdf] of a renewable fuel (the largest biofuel category) under the RFS2 and therefore qualifies for RINs, the low RIN value for the category ($0.036/RIN) means that the company will only receive $0.047 per gallon of biobutanol produced, even after accounting for the fact that every gallon of biobutanol qualifies for 1.3 RINs due to its higher energy content. This is unlikely to be enough to merit biobutanol fuel production, particularly at current feedstock costs.
Advanced biobutanol is a very different story. A little background is important here: corn ethanol was the predominant biofuels pathway at the time the RFS2 was created by the Energy Security and Independence Act of 2007, and was considered to be the "gateway biofuel" to cellulosic ethanol production. Corn ethanol was also coming under significant attack at the time that the RFS2 was being designed, with a UN official calling it a "crime against humanity" and a former Environmental Defense Fund lawyer accusing it of causing widespread rainforest destruction within the span of a few months. As a result of these accusations, Congress inserted a short clause in the definition of advanced biofuels under the RFS2 (the second-largest category, which primarily covers cane ethanol) stating that ethanol from corn starch cannot qualify, regardless of how small its carbon footprint is. (Both the food versus fuel and rainforest destruction accusations have been thoroughly refuted in recent years by empirical analysis, although nobody accuses Congress of adhering too closely to scientific rigor and the legislation is unlikely to be revised as a result.) Importantly, however, the exclusion just applies to ethanol made from corn starch; no mention is made of other alcohol fuels made from corn starch (of which biobutanol is a member).
According to the Q3 earnings call, Gevo is teaming up with Midwest AgEnergy Group to explore the conversion of a planned 65 million gallon per year [MGY] corn ethanol facility in South Dakota to biobutanol production. Midwest AgEnergy Group also produces renewable electricity, and Gruber indicated in the earnings call that the carbon footprint of any corn biobutanol produced at this facility would be small enough to qualify as an advanced biofuel under the RFS2 as a result. (As a reminder, the biofuel definitions under the RFS2 primarily depend on each biofuel category's lifecycle greenhouse gas reduction threshold relative to gasoline in 2005, with advanced biofuels requiring a 50% reduction.) Having its biobutanol qualify as an advanced biofuel would bring two major benefits to Gevo. First, the RINs for that category are currently trading at $0.40/RIN, or roughly 10x the value of the renewable fuel RINs. Each gallon of advanced biobutanol would receive $0.52 in RINs if produced today, for example. Second, advanced biofuels production is falling short of its mandated volume; production is on track in 2012 to achieve 428 MGY of the mandate's 500 MGY requirement. Approximately 90% of that amount is imported (primarily in the form of Brazilian cane ethanol) and the mandated volume will double by 2014, so domestically-produced biobutanol will have a competitive advantage for the advanced biofuel RINs.
Advanced biobutanol production is still a year or more in the future. While an attractive long-term prospect for Gevo's entry into the transportation fuel market, the company will first need to demonstrate its ability to produce biobutanol on a commercial scale at its Luverne facility. While the recently announced production delay is to be expected for a commercial-scale facility employing a new pathway, the company's prospects look best if it begins production soon. While Gevo has enough cash to last it several quarters at current spending rates, management (and shareholders) would undoubtedly rather see this used to bring additional capacity online, especially advanced biobutanol capacity. Gevo investors have had a particularly rough ride since the company's IPO and its recent production delay is an unfortunate reality of the "Valley of Death" conditions endured during initial commercialization. That said, its entry into the isobutanol and advanced biobutanol markets will result in some attractive returns, provided it can get the Luverne facility up and running.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GEVO over the next 72 hours.