You’ve heard about the crack spread, and the crush spread — as means to value oil refining and crop refining.
Let’s think about biomass densification and compression, and in that context, a little about KiOR.
You might have heard a little or a lot about KiOR — which is
currently commissioning its first commercial-scale (11 million gallon)
biofuels plant in Columbus, Mississippi.
Now, the oil industry might, via the American Petroleum Institute, be
currently talking down the validity of the Renewable Fuel Standard —
but it is not entirely clear that KIOR would have found the financing
that it did without the EISA Act galvanizing investors into action.
KiOR’s secret sauce
Now, it is getting more clear — among all the glittering pieces of
technology that the biofuels industry has developed — that the oil
refining and marketing sector would really, really like to have invented
KiOR’s BFCC unit — KiOR’s secret sauce.
What is a BFCC? It is a fluidized-bed catalytic cracker that works
with biomass (in KiOR’s case, they are working now with southern yellow
pine they expect to obtain at $72 per bone-dry ton).
Why is it coveted? It takes biomass, which has low
density, and liquifies it into an intermediate with very high energy
density — and does so at a transformatively low cost. That intermediate
can be hydrotreated into an in-spec drop-in fuel — either in the
gasoline range, or diesel, or even jet.
Why is that important? Because it is expected to be
available at a lower cost than the marginal cost of oil production —
when taken to an appropriate scale.
Equally importantly — because it is produced from renewable biomass —
it can help de-carbonize an atmosphere that is producing increasingly
wacky weather.
The marginal cost of producing oil
In a world where oil prices are highly volatile, one statistic for
price prediction has held true for a long time — and that it is averaged
cost of marginal production of oil for the world’s 50 largest public
oil companies.
What exactly does ” the marginal cost of production” mean? It is the
cost of exploring and capturing the last barrel of oil needed to meet
overall global demand.
Bernstein Research circulated a note last year estimating that the
marginal cost of production (for the top 50 public companies — note that
some national oilcos have very different cost structures) increased by
229 percent between 2001 and 2010. Meanwhile, oil prices increased by
228%. Eureka — a driver of long-term oil prices.
It stands to reason. If the oil price falls below the marginal cost
of production – production stalls until the price rises. That’s simple
economics.
All that lovely Bakken crude
Further, it is not as easy as many suppose to disrupt that price
with, for example, an explosion of oil production in the Bakken
oilfields of North Dakota or the tar sands of western Canada. Bakken
crude sells at a very deep discount, already, to Brent Crude — the
spread has exceeded $30 per barrel at times.
That’s because of the lack of pipeline and railcar capacity to move it to international markets.
Which brings us back to KiOR — and the possibility that, long-term,
the future of the company may focus less on building complete
field–to-wheels fuel capacity via hydrotreating intermediates onsite, at
its own facilities.
It has a future — perhaps a very big one— not so much as a supplier
of finished fuels to its own customer base of fuel buyers, but as a
supplier of crude-equivalent feedstocks to existing refinery
infrastructure.
That’s where that $92 a barrel becomes important — not the $100-$115
retail value of the barrel, but the production cost of that barrel.
Recovering prehistoric algae as an energy business
You see, at the end of the day what you get from punching holes in
the ground (i.e. oil exploration) is a well tapping into some
prehistoric algae which — over 60 million years or so — has been
transformed by Nature into crude petroleum and natural gas.
Nature made the biomass for free — via its own cocktails of carbon
dioxide, water, and trace nutrients. Then, Nature conveniently densified
the biomass for free, too. What we pay for is the harvest — it’s the
energy equivalent of hunter-gatherer.
With a barrel of oil, you get around 5.8 million BTUs. That’s around
$15.86 per million BTUs for the marginal cost of production.
In the case of KiOR, you have to pay for the biomass — the
aforementioned $72 for each bone-dry ton. In that ton, you start with
14-20 million BTUs. So, you are paying $3.60-$5.14 per million BTUs for
the wood.
The problem is, you can’t burn wood in a car engine — and even if you
could, you think range anxiety for battery-electric vehicles is bad.
Sheesh!
So, here’s the challenge, and here’s the prize, and a caveat.
Challenge? Densify the wood biomass into a
crude-equivalent refinery feedstock for less than $12.72 per ton of
biomass, including your operating and capital costs and your cost of
capital.
Prize? Well, the International Energy Agency expects
that energy demand will rise some 50 percent over the next 25 years —
rising demand that you can serve.
Caveat? Lowest-cost producer wins. No one is likely to buy your $92 per barrel intermediate if there’s a $90 barrel available.
Catalytic fast pyrolysis
Where does this all lead us? In the case of making crude-equivalent
intermediates — catalytic fast pyrolysis has emerged, of late, as the
lowest-cost path towards answering that challenge. It is not entirely
clear this class of technologies will actually reach scale — and reach
the targeted costs — and find boatloads of affordable capital any time
soon. But the signs are quite encouraging.
Catalytic fast pyrolysis — that’s what KiOR does. That’s why so many
people watch their development with such attention. Why there is such an
intense interest in their progress that media have been snooping around
the plants, trying to get information on production prior to the
company’s quarterly earnings call (earnings are expected to be reported
March 25,
according to NASDAQ).
Other paths to biofuels heaven
Nor is it entirely certain that crude-equivalent intermediates are
the only viable path to market. For instance — there is the entire class
of alcohol fuels, which are controversial in the US and the EU because
of infrastructure issues, but are well-established in Brazil.
Crude-equivalent intermediates certainly are attractive — if one of
your goals is to avoid finding out how much the oil & gas industry
is willing to spend to send you to the devil, if you come up with a
technological path to affordable meeting transportation fuel demand that
doesn’t pass through oil refineries.
The oil industry’s anguish over alcohols is as profound as the Prohibition Party’s anguish used to be.
Back to KiOR
So — that brings us back to KiOR, and its prospects. We’ll know quite
a lot more on the next earnings call. For now, they are in the business
of making finished fuels and earning revenues from RINs and fuel sales.
For sure, right now they are proving the validity of their process to
investors. One might speculate that they are also surrounding their IP —
their secret sauce — with a complete path to market so that never
become the captive of a refiner & marketer who can form a barrier to
entry between their crude and the downstream gas station. With ethanol
producers we have seen, ahem, where that can lead.
Long-term — we don’t see a process that can turn that much southern
yellow pine (and other biomass, down the line) into sub-$92
crude-equivalent intermediates having a market cap of $584 million, as
KiOR has today. If the technology does not work out — well, it’s not
very valuable, is it? But if it does work out – as sports broadcaster
Keith Jackson used to say “Whoa, Nelly!”.
Why? Looked at it as a technology that converts resources into proved
reserves (valued at, say, $20 per barrel, or the spread between Brent
crude and the marginal cost of production) – KiOR is valued at around 29
million barrels of oil. That’s the volume of oil you get from
converting 400,000 tons of wood into oil refining intermediates.
But there’s a lot more wood out there.
The above-ground oil field a/k/a the US wood basket
The US Department of Energy, in their Billion Ton update study in
2011, estimated that there would be 120 million tons of wood biomass
available, per year, at $80 per ton, that could be sustainably used for
bioenergy. The figure declines to around 85 million tons at $40 per ton.
That’s a big spread.
So — in all things biofuel – keep that cost of densification very much in your mind.
The Compression Spread
In traditional oil and agricultural economics, we think about the the
cost of liberating a known molecule. In the new bioenergy — getting
biomass sufficiently densified, via technology instead of Nature — may
open the door to ultra low-cost feedstocks and some amazing upside value
for the liberators and their inventions.
That’s the compression spread.
