The Energy Report: The biofuels sector encompasses a range of products. Can you give us an overview of this commodity space and how production processes differ?
Mark McHugh: Biofuels are derived from agricultural commodities. There are three types of "first-generation" biofuels, two liquids and one solid. Bioethanol is added to gasoline. It is produced largely from corn grown in the U.S., sugar beets grown in Europe and sugar cane grown in Brazil. Biodiesel is produced from vegetable oils and/or animal fats. The third biofuel is biomass or biomass pellets, which are used in electricity generation to replace coal. The pellets are produced from wood chips or renewable energy crops.
TER: With traditional fossil fuel prices ever steeper, is it possible that biofuels could take over a significant share of that market?
MM: Energy scenarios produced by Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) and the World Energy Council project that by the year 2050, biofuels will source 15–25% of global energy consumption. The biofuel industry will be the same size the oil industry is today. Whether you believe or disbelieve that, it's what energy analysts are projecting.
TER: Many industry players are involved in biofuel research and development. What state-of-the-art technologies are changing the landscape in this space?
MM: First-generation transportation biofuels, such as corn-based ethanol, are mature technologies. Unlike energy sources for hydrogen or electric cars, no major infrastructure investments are required to accommodate them. Corn ethanol is about 1.3 times more efficient than fossil fuel and has little or no benefit in reducing carbon emissions. Brazilian sugar cane-derived ethanol is 8–10 times more energy efficient, and it is lower in carbon than the fossil fuel equivalent.
However, corn and sugar cane are also food crops, and that presents sustainability challenges. The next generation of biofuels is not produced from food crops; it is more environmentally sustainable. While second-generation biofuel production costs are not yet competitive with first-generation costs, renewable fuel standards are friendly to non-food biofuels. In the U.S., governmental mandates require that 10 years from now, $16 billion gallons (Bgal) of second-generation lignocellulosic biofuels must be produced. The mandates allow for the production of $15 Bgal of conventional biofuels, which includes corn-based ethanol. It's going to take 10 years for the lignocellulosic biofuels' volume to equilibrate with first-generation volumes.
TER: What are lignocellulosic biofuels?
MM: Wood or cellulose is the main component of lignocellulosic materials. I am a strong believer in lignocellulosic energy crops, particularly elephant grass, switch grass, or the generic name, miscanthus. Miscanthus is among the most efficient and most sustainable of the second-generation feedstocks.
TER: Who are some of the major players developing miscanthus?
MM: It's very patchy. There are some plantations in Europe and the U.S. Developmentally, miscanthus is in the early stages. In Brazil, Embrapa, the agricultural research institute, is developing new strains of miscanthus to obtain optimum yields. New Energy Farms (private) is a key developer of miscanthus as a feedstock for second-generation biofuels in the U.S., Canada and the U.K. However, nobody is a significant player yet.
TER: What level of demand currently exists for second-generation biofuels?
MM: Supply is constrained, but there is a substantial demand. Europeans are converting existing coal-fired plants to burn biomass pellets. There just isn't enough agricultural land available in Europe to produce a sufficient quantity. Brazil is a prime candidate for growing exactly the type of energy crop to produce biomass pellets from miscanthus, but substantial investment is needed to kick this off.
Demand in Europe for biomass pellets is about 10 million tons (Mt) today, and that figure is projected to climb as high as 50 Mt within the next 10 years. But producing 5 Mt requires a plantation of 200,000 hectares, whereas the lignocellulosic plantations today are still small in Brazil, in the range of 1,000 hectares. So it's a question of scale. Some of the Brazilian timber companies are growing eucalyptus and other fast-growing wood products, and a Brazilian company called Suzano Papel e Celulose S.A. (SUZb5:BOVESPA) has the potential to produce 2 Mt biomass pellets from wood chips. But miscanthus has a key advantage in that it delivers two crops annually, whereas it takes four to five years to get maturity on timber-based products.
TER: What are the technological impediments to developing miscanthus?
MM: There are a couple of methods of converting lignocellulosic material into biofuel. One is a thermal cracking process. The other involves using enzymes to convert the cellulose into sugar and then fermenting the sugar into alcohol. Companies, including Dow Chemical Co. (DOW:NYSE), are investing in this route. Yet individual industries are all trying to develop their own proprietary methods. That's the main factor that's stalling it.
TER: Does miscanthus serve all three types of biofuel?
MM: That's its key advantage. I've been having discussions with large investors, still very much at the idea stage, but that's exactly the issue. If you're considering a position in the second-generation biofuels business, miscanthus is a very good starting point. If you accept the hypothesis that the biofuels or bioenergy business is going to be as large as the oil business in about 40 years, then you want to control supply. The demand is already there. It's a bit like the growth of the original oil industry in that the biofuels industry will be driven by supply considerations, certainly for the first 20–30 years.
TER: You mentioned earlier that allocating land for biofuel feedstocks presents a challenge. Where are the potential feedstock hot spots?
MM: There are suitable locations in South America, specifically in Brazil. Sub-Saharan Africa is ideally suited. Miscanthus grows best in a tropical zone within eight degrees north or south of the equator, but it doesn't mean that there aren't opportunities for North American production. Large plants in the U.S. and Canada are producing biomass pellets from wood fiber.
TER: In light of the fact that biofuels are in part encouraged by sustainability-focused government regulations, what is the carbon footprint of miscanthus?
MM: As miscanthus grows, it absorbs carbon dioxide from the atmosphere. When it's burned, it gives out the same amount of carbon dioxide, so in theory it is carbon neutral. However, it is important to factor in what we call a "land use penalty." If we convert existing land to plant corn or sugar cane for biofuels, we have to keep replanting it, thereby repeatedly creating carbon emissions. Miscanthus, on the other hand, only needs to be planted once. After it is cut, it grows again and again. And while it's not strictly carbon neutral, the land use penalty for miscanthus is among the lowest of the second-generation feedstocks.
TER: Are there any major players getting involved in Brazilian feedstocks?
MM: There are some small players in biomass pellets, but that's a side show. Brazil is the second-largest market in the world for bioethanol. The U.S. is the largest market. Brazil and the U.S. supply 75% of the world market for biofuels. In the Brazilian market, about 400 sugar mills produce ethanol. About 10 large players control 50% of the total capacity. About 150 smaller players own single mills.
TER: These are all local firms?
MM: They all started out as local firms, but multinational players are entering as Brazil's ethanol industry consolidates. The only significant vertically integrated company, Raizen S.A., is a recent joint venture between Royal Dutch Shell and Cosan S.A. (CSAN3.SA:BOVESPA). Cosan was an ethanol producer that acquired Esso's, or Exxon Mobil Corp.'s (XOM:NYSE), downstream assets in Brazil three years ago. Another big producer is ETH Bioenergia (private), which in its formation included a takeover of Brenco Holding S.A. by Odebrecht S.A., a Brazilian construction and engineering company. The larger players have multiple mills in states surrounding Sao Paolo. They typically enjoy efficient agricultural yields. Such producers build two capacities into their sugar mills that are key to its profitability: One is the ability to switch production from sugar to ethanol and vice versa, depending on market prices for sugar. The other capacity is co-generation. These plants generate electricity using biogas, or sugar cane waste, as fuel. The company sells that power to the grid in Brazil at a preferential price for renewable fuels-produced electricity.
Then there are about 150 sugar mills that are smaller in terms of size and production capacity. Traditionally, they were financed with soft loans from government banks in the early days of the Brazilian ethanol Pro-Alcohol program. They don't typically have the capacity to switch from ethanol to sugar, and they don't have co-generation. Because they're smaller, their yields are typically lower. So a number of them are struggling and bigger players are buying them up.
On the distribution side, there is one big vertically integrated player: Raizen. It manages the Shell and the Esso retail sites throughout Brazil. It is the third player in the retail fuels market behind Petrobras (PBR:NYSE; PETR3:BOVESPA), or Petróleo Brasileiro, and Empresas Petróleo Ipiranga (state-owned). But it also produces biofuels. And because it is vertically integrated, Raizen can see the whole value chain and price accordingly. That allows it to be more competitive, because the gasoline sold at the pump in Brazil contains 25% ethanol. Fossil fuels are only refined by Petrobras in Brazil. The Shell and Esso brands buy fuel from Petrobras and blend in the ethanol before they sell the grade at the pump.
TER: Is consolidation the name of the game in Brazil?
MM: There are a lot of family businesses for sale. And the industry in Brazil is not currently expanding capacity. Brazil is inwardly focused at the moment, trying to improve efficiencies with consolidation. This business is very much defined by national boundaries.
Brazil used to export 30% of its ethanol production, after accounting for domestic consumption. For years, the Brazilian biofuel industry had been hammering at tariff barriers in the U.S. to develop the biofuel export business. But when the price of sugar went up a while ago, Brazilian ethanol producers switched into sugar production. Ironically, due to a poor harvest last year, Brazil had to import corn-based ethanol from the U.S. in order to make up for its domestic shortfall in biofuel.
TER: How do governmental policies affect the development of biofuels?
MM: The evolution of this business is being driven by regulatory incentives, such as the Blender's Tax Credit in the U.S. and public subsidies for renewable fuels. But a mature industry will not need subsidies. There needs to be healthy international trade in biofuels, just as there is in oil. And if biofuels are going to generate 15–25% of global energy consumption, the industry needs to focus on developing miscanthus and other energy crops. Sustainability is a key to this business.
TER: What companies do you recommend for investors interested in second-generation biofuels?
MM: Dow Chemical is leading the pack with work on enzyme technology. It's a good pick.
In the biodiesel business, there are some good export markets. Argentina is a key exporter of biodiesel to Europe. I've been working with a company called Incoming Inc. (ICNN:OTCBB), which is a U.S. company that is looking to build a transnational biodiesel business with a position in Brazil, exporting to the U.S. In the U.S., biodiesel has been subject to major ups and downs as government subsidies have been set and removed and then replaced. It makes sense to hedge regulatory risk by having a position in more than one export market.
The Brazilian biodiesel market is booming at the moment. That's also driven by policy mandates. The current blending target for biodiesel is 5%. There is talk of that going up to 7%. Margins are profitable for efficient local Brazilian players in that market.
TER: Thank you for speaking with us today.
MM: My pleasure.
Mark McHugh is president and CEO of CenAm Energy Partners SA, an independent professional consultancy and investment advisory partnership focused on the oil and renewable energy industry in Latin America and Africa. He is based in Brazil and has experience in the international oil industry in marketing, sales, strategy consulting and general management. He spent 26 years with Royal Dutch Shell and reached the level of vice president of regional marketing based in the U.S. He is experienced in leading new business development and M&A initiatives and managing new business start-ups.
Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
DISCLOSURE:
1) Peter Byrne of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Royal Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for services.
3) Mark McHugh: I personally and/or my family own shares of the following companies mentioned in this interview: Royal Dutch Shell Plc. I personally and/or my family am paid by the following companies mentioned in this interview: Incoming Inc. I was not paid by Streetwise Reports for participating in this story.
Mark McHugh: Biofuels are derived from agricultural commodities. There are three types of "first-generation" biofuels, two liquids and one solid. Bioethanol is added to gasoline. It is produced largely from corn grown in the U.S., sugar beets grown in Europe and sugar cane grown in Brazil. Biodiesel is produced from vegetable oils and/or animal fats. The third biofuel is biomass or biomass pellets, which are used in electricity generation to replace coal. The pellets are produced from wood chips or renewable energy crops.
TER: With traditional fossil fuel prices ever steeper, is it possible that biofuels could take over a significant share of that market?
MM: Energy scenarios produced by Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) and the World Energy Council project that by the year 2050, biofuels will source 15–25% of global energy consumption. The biofuel industry will be the same size the oil industry is today. Whether you believe or disbelieve that, it's what energy analysts are projecting.
TER: Many industry players are involved in biofuel research and development. What state-of-the-art technologies are changing the landscape in this space?
MM: First-generation transportation biofuels, such as corn-based ethanol, are mature technologies. Unlike energy sources for hydrogen or electric cars, no major infrastructure investments are required to accommodate them. Corn ethanol is about 1.3 times more efficient than fossil fuel and has little or no benefit in reducing carbon emissions. Brazilian sugar cane-derived ethanol is 8–10 times more energy efficient, and it is lower in carbon than the fossil fuel equivalent.
However, corn and sugar cane are also food crops, and that presents sustainability challenges. The next generation of biofuels is not produced from food crops; it is more environmentally sustainable. While second-generation biofuel production costs are not yet competitive with first-generation costs, renewable fuel standards are friendly to non-food biofuels. In the U.S., governmental mandates require that 10 years from now, $16 billion gallons (Bgal) of second-generation lignocellulosic biofuels must be produced. The mandates allow for the production of $15 Bgal of conventional biofuels, which includes corn-based ethanol. It's going to take 10 years for the lignocellulosic biofuels' volume to equilibrate with first-generation volumes.
TER: What are lignocellulosic biofuels?
MM: Wood or cellulose is the main component of lignocellulosic materials. I am a strong believer in lignocellulosic energy crops, particularly elephant grass, switch grass, or the generic name, miscanthus. Miscanthus is among the most efficient and most sustainable of the second-generation feedstocks.
TER: Who are some of the major players developing miscanthus?
MM: It's very patchy. There are some plantations in Europe and the U.S. Developmentally, miscanthus is in the early stages. In Brazil, Embrapa, the agricultural research institute, is developing new strains of miscanthus to obtain optimum yields. New Energy Farms (private) is a key developer of miscanthus as a feedstock for second-generation biofuels in the U.S., Canada and the U.K. However, nobody is a significant player yet.
TER: What level of demand currently exists for second-generation biofuels?
MM: Supply is constrained, but there is a substantial demand. Europeans are converting existing coal-fired plants to burn biomass pellets. There just isn't enough agricultural land available in Europe to produce a sufficient quantity. Brazil is a prime candidate for growing exactly the type of energy crop to produce biomass pellets from miscanthus, but substantial investment is needed to kick this off.
Demand in Europe for biomass pellets is about 10 million tons (Mt) today, and that figure is projected to climb as high as 50 Mt within the next 10 years. But producing 5 Mt requires a plantation of 200,000 hectares, whereas the lignocellulosic plantations today are still small in Brazil, in the range of 1,000 hectares. So it's a question of scale. Some of the Brazilian timber companies are growing eucalyptus and other fast-growing wood products, and a Brazilian company called Suzano Papel e Celulose S.A. (SUZb5:BOVESPA) has the potential to produce 2 Mt biomass pellets from wood chips. But miscanthus has a key advantage in that it delivers two crops annually, whereas it takes four to five years to get maturity on timber-based products.
TER: What are the technological impediments to developing miscanthus?
MM: There are a couple of methods of converting lignocellulosic material into biofuel. One is a thermal cracking process. The other involves using enzymes to convert the cellulose into sugar and then fermenting the sugar into alcohol. Companies, including Dow Chemical Co. (DOW:NYSE), are investing in this route. Yet individual industries are all trying to develop their own proprietary methods. That's the main factor that's stalling it.
TER: Does miscanthus serve all three types of biofuel?
MM: That's its key advantage. I've been having discussions with large investors, still very much at the idea stage, but that's exactly the issue. If you're considering a position in the second-generation biofuels business, miscanthus is a very good starting point. If you accept the hypothesis that the biofuels or bioenergy business is going to be as large as the oil business in about 40 years, then you want to control supply. The demand is already there. It's a bit like the growth of the original oil industry in that the biofuels industry will be driven by supply considerations, certainly for the first 20–30 years.
TER: You mentioned earlier that allocating land for biofuel feedstocks presents a challenge. Where are the potential feedstock hot spots?
MM: There are suitable locations in South America, specifically in Brazil. Sub-Saharan Africa is ideally suited. Miscanthus grows best in a tropical zone within eight degrees north or south of the equator, but it doesn't mean that there aren't opportunities for North American production. Large plants in the U.S. and Canada are producing biomass pellets from wood fiber.
TER: In light of the fact that biofuels are in part encouraged by sustainability-focused government regulations, what is the carbon footprint of miscanthus?
MM: As miscanthus grows, it absorbs carbon dioxide from the atmosphere. When it's burned, it gives out the same amount of carbon dioxide, so in theory it is carbon neutral. However, it is important to factor in what we call a "land use penalty." If we convert existing land to plant corn or sugar cane for biofuels, we have to keep replanting it, thereby repeatedly creating carbon emissions. Miscanthus, on the other hand, only needs to be planted once. After it is cut, it grows again and again. And while it's not strictly carbon neutral, the land use penalty for miscanthus is among the lowest of the second-generation feedstocks.
TER: Are there any major players getting involved in Brazilian feedstocks?
MM: There are some small players in biomass pellets, but that's a side show. Brazil is the second-largest market in the world for bioethanol. The U.S. is the largest market. Brazil and the U.S. supply 75% of the world market for biofuels. In the Brazilian market, about 400 sugar mills produce ethanol. About 10 large players control 50% of the total capacity. About 150 smaller players own single mills.
TER: These are all local firms?
MM: They all started out as local firms, but multinational players are entering as Brazil's ethanol industry consolidates. The only significant vertically integrated company, Raizen S.A., is a recent joint venture between Royal Dutch Shell and Cosan S.A. (CSAN3.SA:BOVESPA). Cosan was an ethanol producer that acquired Esso's, or Exxon Mobil Corp.'s (XOM:NYSE), downstream assets in Brazil three years ago. Another big producer is ETH Bioenergia (private), which in its formation included a takeover of Brenco Holding S.A. by Odebrecht S.A., a Brazilian construction and engineering company. The larger players have multiple mills in states surrounding Sao Paolo. They typically enjoy efficient agricultural yields. Such producers build two capacities into their sugar mills that are key to its profitability: One is the ability to switch production from sugar to ethanol and vice versa, depending on market prices for sugar. The other capacity is co-generation. These plants generate electricity using biogas, or sugar cane waste, as fuel. The company sells that power to the grid in Brazil at a preferential price for renewable fuels-produced electricity.
Then there are about 150 sugar mills that are smaller in terms of size and production capacity. Traditionally, they were financed with soft loans from government banks in the early days of the Brazilian ethanol Pro-Alcohol program. They don't typically have the capacity to switch from ethanol to sugar, and they don't have co-generation. Because they're smaller, their yields are typically lower. So a number of them are struggling and bigger players are buying them up.
On the distribution side, there is one big vertically integrated player: Raizen. It manages the Shell and the Esso retail sites throughout Brazil. It is the third player in the retail fuels market behind Petrobras (PBR:NYSE; PETR3:BOVESPA), or Petróleo Brasileiro, and Empresas Petróleo Ipiranga (state-owned). But it also produces biofuels. And because it is vertically integrated, Raizen can see the whole value chain and price accordingly. That allows it to be more competitive, because the gasoline sold at the pump in Brazil contains 25% ethanol. Fossil fuels are only refined by Petrobras in Brazil. The Shell and Esso brands buy fuel from Petrobras and blend in the ethanol before they sell the grade at the pump.
TER: Is consolidation the name of the game in Brazil?
MM: There are a lot of family businesses for sale. And the industry in Brazil is not currently expanding capacity. Brazil is inwardly focused at the moment, trying to improve efficiencies with consolidation. This business is very much defined by national boundaries.
Brazil used to export 30% of its ethanol production, after accounting for domestic consumption. For years, the Brazilian biofuel industry had been hammering at tariff barriers in the U.S. to develop the biofuel export business. But when the price of sugar went up a while ago, Brazilian ethanol producers switched into sugar production. Ironically, due to a poor harvest last year, Brazil had to import corn-based ethanol from the U.S. in order to make up for its domestic shortfall in biofuel.
TER: How do governmental policies affect the development of biofuels?
MM: The evolution of this business is being driven by regulatory incentives, such as the Blender's Tax Credit in the U.S. and public subsidies for renewable fuels. But a mature industry will not need subsidies. There needs to be healthy international trade in biofuels, just as there is in oil. And if biofuels are going to generate 15–25% of global energy consumption, the industry needs to focus on developing miscanthus and other energy crops. Sustainability is a key to this business.
TER: What companies do you recommend for investors interested in second-generation biofuels?
MM: Dow Chemical is leading the pack with work on enzyme technology. It's a good pick.
In the biodiesel business, there are some good export markets. Argentina is a key exporter of biodiesel to Europe. I've been working with a company called Incoming Inc. (ICNN:OTCBB), which is a U.S. company that is looking to build a transnational biodiesel business with a position in Brazil, exporting to the U.S. In the U.S., biodiesel has been subject to major ups and downs as government subsidies have been set and removed and then replaced. It makes sense to hedge regulatory risk by having a position in more than one export market.
The Brazilian biodiesel market is booming at the moment. That's also driven by policy mandates. The current blending target for biodiesel is 5%. There is talk of that going up to 7%. Margins are profitable for efficient local Brazilian players in that market.
TER: Thank you for speaking with us today.
MM: My pleasure.
Mark McHugh is president and CEO of CenAm Energy Partners SA, an independent professional consultancy and investment advisory partnership focused on the oil and renewable energy industry in Latin America and Africa. He is based in Brazil and has experience in the international oil industry in marketing, sales, strategy consulting and general management. He spent 26 years with Royal Dutch Shell and reached the level of vice president of regional marketing based in the U.S. He is experienced in leading new business development and M&A initiatives and managing new business start-ups.
Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
DISCLOSURE:
1) Peter Byrne of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Royal Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for services.
3) Mark McHugh: I personally and/or my family own shares of the following companies mentioned in this interview: Royal Dutch Shell Plc. I personally and/or my family am paid by the following companies mentioned in this interview: Incoming Inc. I was not paid by Streetwise Reports for participating in this story.
