Since President Bush is in Brazil this week to talk about ethanol, I though it would be appropriate to present portions of a paper by Vinod Khosla, a venture capitalist who was a internet pioneer and a founder of Sun Microsytems (NASDAQ:SUNW). You can view a bio of him here. Kholsa is himself investing millions of his own dollars building ethanol plants. The paper here, is very long and detailed. I am going to present the most topically relevant items based on what the media usually presents.
Much has been said about the energy balance of ethanol.
Energy balance is not even the right question to answer. It is not the energy balance of ethanol that matters but the energy balance of ethanol relative to the energy balance of gasoline. Dr. Wang at Argonne National Labs has built one of the most rigorous and transparent public models for energy balance calculations. His results indicate that corn ethanol has almost twice the energy balance compared to gasoline, yet this crucial fact is seldom mentioned in the press. According to the majority of studies, corn ethanol has an energy balance between 1.3-1.8 while gasoline is substantially worse, at about 0.8 (since it takes energy to extract, transport, refine and handle gasoline). Electricity has an energy balance four times worse than corn ethanol. Do we stop using electricity? No, because as Dr. Wang concludes, this is not even the right question. Dr. Wang goes on to say that energy balance is “not a meaningful number for any fuel in evaluating its benefits."
Why then does the press continue mentioning it? Why do they fail to mention that electricity has a substantially worse energy balance than ethanol? Do they recommend we stop using electricity? What is often inferred by the press is that it takes more petroleum to make ethanol than is displaced. This is emphatically NOT true, even in the most vintage of plants. Ethanol causes a very significant (more than 90%) reduction in petroleum use. The debate in scientific circles is about whether producing ethanol uses more fossil energy (not petroleum) than it creates. That is an entirely different question because if the objectives are lower cost gasoline replacement fuel, energy security and less reliance on imported oil, then in fact converting non-petroleum forms of fossil energy (mostly natural gas in the case of corn ethanol plants) into ethanol would be a perfectly acceptable strategy, especially since the production costs of a gallon of ethanol are lower today than the cost of gasoline produced from oil. Only when the climate change questions are addressed is energy balance even a relevant question (though carbon emissions per mile driven is a much more appropriate question). In fact if we have to pick an alternative to gasoline, then ethanol is the best choice today.
More importantly, it is a choice that starts a progression to increasingly “better” technologies and has far more room to improve technologically on feedstocks, development process, and ethanol and ethanol like fuels (biohols) that are more compatible with the existing infrastructure than alternative technologies. Equally important, ethanol is compatible and complementary to other petroleum reduction technologies like hybrids and plug-in electric hybrid cars. Even more critically, the key question is not energy balance but rather the greenhouse gas emissions. Certain energy sources like natural gas (the principal fossil fuel in the majority of ethanol plants) are much cleaner and greener than others, like coal. It is not the energy input but rather the total greenhouse gas emissions, from source feedstock, production and consumption of the fuel (per mile driven) that is most important according to the NRDC. Energy balance is the wrong question. Greenhouse gas emissions per mile driven is the right question.
Increasing Production Yields:
Not your father’s ethanol anymore: The energy required to produce corn ethanol is declining every year. Corn yields are increasing and fertilizer intensity is decreasing, further improving its energy balance. In five or so years we should start to see corn crops with a nitrogen fixation gene, materially reducing the fertilizer requirements and the energy consumption it entails. Even the crops used to produce ethanol will diversify. Sweet sorghum, for example, uses a lot less water and fertilizer, can be harvested twice a year, and makes for a cost effective and environmentally better feedstock that can be grown on marginal lands, lands that ordinarily cannot be effectively used for feedstock. It is the major source of feedstock for ethanol being investigated in India. But such “optimizing” options will not be seriously pursued till after the market for corn ethanol is established. Once ethanol becomes a substantial market, all parts of the production process, crops and feedstocks, manufacturing, chemistries, transportation, and more will be the subject of intensive attention and innovation. The world does not stay still when large scale economics are involved.
As to the production process, again the Wall Street Journal reports that the Broin Cos., based in Sioux Falls, S.D., has pioneered a method to convert corn to ethanol at 90 degrees, rather than the previous 230 to 250 degrees, improving energy efficiency by 10% to 12%, according to co-founder and Chief Executive Jeff Broin. And E3 Biofuels LLC is finding ways to get more out of all parts of the corn, by building plants near dairy farms and feeding cows the byproducts of ethanol processing, then using energy from the animal waste to help power the plants. "Wastes are converted to valuable products, such as biogas and biofertilizers, which replace fossil fuels and their derivatives," according to David Hallberg, co-founder of Omaha-based E3. E3 Biofuels achieves an energy balance for corn ethanol of approximately five, using the Argonne National Labs GREET model – a number higher than what many cite for cellulosic ethanol! We have seen plants at every point in the continuum form old energy inefficient plants to highly optimized plants.
Myth: Not Enough Cropland
The next question we see a lot of fear, uncertainty and doubt about is the question of land and the related issue of food. Is there enough land to meet our energy needs? Beyond the traditional critique of ‘energy balance’ mentioned above, the question of land use is often cited by critics. If all the ethanol were produced using the ‘corn-to-ethanol’ process, we would simply not have enough land. Quite true, but equally obvious is the fact that relatively predictable pathways exist to cellulosic ethanol. Using switchgrass as an energy crop, the NRDC estimates we would need about 114 million acres of land. We need to look at this another way - 73 million acres of soybeans have been planted. Why can’t we do the same with energy crops? Instead of exporting soybeans we could be reducing oil imports. In addition we have 40 million acres of CRP lands. What if we used them for energy production by growing natural prairie crops like switchgrass (more likely grass “cocktails”) on them? Between export crops and CRP lands we have more than 120 million acres in this country. We believe that a fraction of our export crop lands could more than replace all our oil imports while improving our trade balance, increasing farm incomes, improving biodiversity in the fields, and making our fuel cheaper.
Improved efficiency in ethanol production and use of waste biomass like corn stover, rice husks, and sugarcane baggasse, leads to a smaller land area requirement. Former Secretary of State George Schultz and former CIA Director Jim Woolsey have estimated that, with some efficiency improvements, we will need only thirty million acres of soil bank lands to meet half our gasoline needs by 2025, in total, a small fraction of the land mass devoted to the soy crop. The Department of Energy estimates in an April 2005 report that 1.3 billion tons of biomass could be made available relatively easily from existing cropland, resulting in over a hundred billion gallons of cellulosic ethanol without changing agricultural practices materially.
Myth: Food Prices Will Go Up
To allay another common misconception, it is extremely unlikely that ethanol will be competing materially with food. The current process takes the starch from corn to make ethanol and leaves the protein and fiber for livestock feed. A current rule of thumb is that one lb. of dried distillers grains [DDGs], the corn ethanol byproduct, replaces a ½ lb of corn and a ½ lb of soybean meal in a cattle feed ration. By the time we get to needing sufficient quantities of ethanol, we will be producing most of it from cellulosic feedstocks. This is why the land use arguments are incorrect. In fact many energy crops like switchgrass and miscanthus perhaps could make for excellent crop rotation plants with traditional row crop agriculture. The idea is to develop mixed grass “cocktails” that will serve as crop rotation crops for today’s row crops , increasing bio-diversity , while producing feedstock for liquid fuels. This mix will enhance the soil, keeping farmland more productive and biodiverse, according to the NRDC study “Growing Energy.”
Some impact on food prices is possible, even likely over the short term, but we suspect total household costs for food and transportation fuels will go down. It is worth noting that for the U.S. as a whole we are most likely to do crop rotation of energy crops with traditional row crops like corn and replace export crops (like soybean) with energy crops. Export crops will be replaced by reduced imports with higher value to farmers and a better balance of payments for our economy. Since a majority of our agricultural land is used to produce animal feed proteins, the NDRC believes in the potential of producing cellulose for ethanol and feed protein simultaneously. The land use argument and the related food price argument really disappear in that case.
At the international level, why have the developing countries been fighting so hard to eliminate the food subsidies? The press likes to conjure up images of food supply shortages, when the reality is that we have had burdensome surplus crops in the last few years, large enough that the western world has to support its farmers with subsidies. There is no scarcity of food, but rather a scarcity of income to buy it for the poorest of the poor. The current Doha round of talks on international trade broke down mostly over this issue.
Myth: Ethanol Is More expensive
Production costs and market prices are different things. Today, prices may be high caused by the rapid demand spike we have seen as oil companies have rapidly switched away from MTBE to avoid the legal liability they are incurring today, and to avoid the potential of additional liability they will surely incur from volatile organics, especially benzene, that are material components of today’s gasoline and are known carcinogens. The Foundation for Consumer & Taxpayer Rights released a new study of rising gasoline prices in California that found corporate markups and profiteering are responsible for spring price spikes, not rising crude costs or the switchover to higher-cost ethanol, as the oil industry claims.
But just as surely as profits are high and margins exorbitant for ethanol producers today, additional capacity, maybe even excess capacity is coming on line rapidly. There is more capacity under construction and under planning today (planned to be operational by 2008) than we have built in the last twenty years in this country. Payback periods for new plants are six months instead of the seven years investors would normally expect! Ethanol production costs in the U.S. today are about $1.00 per gallon before any subsidies or taxes.
Myth: Ethanol Cannot Use Existing Infrastructure
Not really true. Brazilian experts laugh at these misleading assertions. Brazil has thousands of gas stations using the same tanks, pumps, tankers for transportation, some with minor modifications and Brazil is building new pipelines to transport ethanol. For sure not every tank or tanker can be used as is, and we have environmental regulations more stringent than Brazil that will require us to have new nozzles for our gas pumps, but the dollars required to achieve this are immaterial compared to the size of the market. For a multi-hundred billion dollar market, I estimate that to convert 10% of the stations to offer at least one E85 pump will take no more than a few hundred million dollars over about five years, or less than 0.1% of revenue annually. Many (but not all – and we only need 10% in my estimation to kick start the market) of the same pumps in the ground can be cleaned and adopted.
Ethanol can be piped in pipelines, contrary to popular belief, but not if the ethanol is going to be used as an additive to gasoline. Piping E85 or E100 ethanol is no problem since the small amounts of water it may pickup in the pipeline is only problematic when added to gasoline in low blends like E6 or E10 (6% and 10% ethanol respectively). But the opponents like to spread these myths as general roadblocks when it is only an issue for the narrow use of ethanol as a blend stock. There are thousands of leaking underground tanks at our gas stations and we have an existing multi-billion dollar fund for replacing leaking underground storage tanks (LUST Funds). When this “fix “ is done, we can use tanks that will accommodate both ethanol and gasoline. Maybe E85 is the reason to expedite the replacement of these leaking tanks?
I believe ethanol is the answer to our oil dependence. I said it in a previous post ValuePlays Portfolio member Archer Daniels Midland ticker ADM (NYSE:ADM) is the best way to go if you want to invest in it.