By Christopher Briem, on April 9th, 2012
Mark my words, the energy story of 2012 will be the 2nd order effects of a natural gas glut that will peak as they run out of storage to even keep the natgas being produced. What then? Good for some manufacturers for sure, but not for others.
Take for example the opening paragraph in this story today from Calgary: Gas supply glut curbs pipeline spending
The dampening of support for two proposed northern frontier natural gas pipelines to Alberta by their backers indicates an economic awakening that’s been at least three years in the making
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As much as I know the Keystone Pipeline, and all the investment and jobs it could potentially induce, is at the center of national politics… the investment being turned off elsewhere will be a bigger deal. The pipeline just in the news above is a $16 billion dollar project. That is a lot of pipe that is not going to be bought.
You would think low prices and potential that the nation will run out of storage capacity for natural gas prices would slow production, you would not know from looking at Ohio. There will be books written on all of this someday.
and while we are all still absorbing the news of a potential ethylene cracker going into Beaver County, just note that Shell is also making noise about an even bigger Natural Gas to Diesel project that may go to Louisiana.
The bigger Pennsylvania story is going to be the royalty payments many households have already been spending. There just have to be a lot of folks spending their initial royalty checks without much consideration of how long they will last. With natural gas prices dropping there is going to be an impact for sure and it may be bigger than some expect.. Pennsylvania court rulings have meant that state landowners only get royalties on the market price net of production costs which are reported to be just under 90 cents/mcf for Marcellus gas. So at current prices the royalty base ($2 minus 90 cents) is down conceivably 90% from mid 2008 (when prices were over ~$10/mcf). It is not inconceivable royalty payments will virtually disappear if gas prices continue to drop. I have seen no stories on this across Pennsylvania which makes me wonder what the delay is between production and royalty payment calculation. If that delay is long, it means most just have not seen the bulk of the impact yet in their checks. Since I hear stories of people paying cash for a lot of the noveau riche mega purchases… maybe the consequences won’t be so dire, but hopefully there are not credit purchases that will come back to bite folks.
Finally if you are all doom and gloom on the price of oil and gasoline, some useful perspective in USNews: Be Wary of the Gloom and Doom Predicted by Energy ‘Models’.
By The Energy Report, on April 4th, 2012
 Examining the macro-economic environment is how Jim Letourneau, publisher of the Big Picture Speculator, likes to begin his stock-picking process. However, his understanding goes beyond headline news to reveal surprising investment themes with profit potential. In this exclusive interview with The Energy Report, Letourneau talks about the hype and commodity investment cycles and where to dig for blue-sky stocks.
The Energy Report: You publish the Big Picture Speculator. What does that title imply?
Jim Letourneau: I believe the macro context is often more important than the details about an individual company. I read a broad range of material every day that helps me form my views, and one of my best skills is putting together the big picture and connecting the dots for audiences. A recent example of my method is my coverage of the natural gas sector, which focused on how the abundant supply of natural gas has led to a complete shift in the types of companies that people should be following. Rather than natural gas producers, investors should find companies that are consuming natural gas, like Methanex Corp. (MEOH:NASDAQ; MX:TSX; METHANEX:SSE), Westport Innovations Inc. (WPT:TSX) or Energy Fuels Inc. (EFR:TSX). These companies are in great shape because their costs are significantly lower. That’s a huge big-picture shift, but people get bogged down in all of the debates about fracking and other controversies.
The bottom line is the U.S. now has the cheapest natural gas in the world, and that’s not a horrible problem to have. When I talk to technical people, we just look at each other and think this is a miracle. No one saw this coming.
TER: As a geologist, how does your technical knowledge shape your investment decisions? What do you look for in potential investment opportunities?
JL: Technical knowledge includes pluses and minuses. In general, the types of companies I look for are usually going to have a market cap of under $100 million (M) and for me to get excited about them, they have to have the potential to surmount that $1 billion (B) market cap. So there’s a potential tenbagger upside in them, if everything pans out. That potential could be in the form of a new technology backed by a critical management team or a higher-quality mineral property. Either way, management teams are critical for these types of things to play out.
TER: How far down in market cap do you go when considering investments?
JL: Sometimes I go down too far, but I think $50M is better than $5M. While you can argue that it’s easier for a $5M market-cap company to go to $50M, your odds start to dwindle. It’s a matter of finding that balance point. Obviously, it’s nicer to buy a company cheap and have it grow into something bigger, but the company is usually cheap for a reason. I don’t want to have to write about 50 companies a year that didn’t quite make it. I’d rather go up the food chain a little bit and follow ones that are going to survive, and whose progress we can track year by year.
TER: You spoke at the Cambridge House Energy and Resource Investment Conference in Calgary on March 30 and 31. What subjects did you cover?
JL: My keynote talk was called “Making Money Using Commodity and Hype Cycles.” I overlayed two kinds of cycles: The commodity cycle is a longer cycle that we’ve been in for over 10 years now. Hype cycles refer to heightened public awareness of a new technology or a particular element on the periodic table that hasn’t been speculated on yet. A recent example would be graphite. Uranium is another really good example of a hype cycle; there was a huge amount of interest about eight years ago and hundreds of companies were formed. Investors were making lots of money with uranium stocks. Then it all withered away. There is still opportunity because some of those companies are still around and advancing their businesses.
I also did a workshop called “How to Find Billion-Dollar Companies,” where I mentioned some of the companies I like that have market caps near $100M with the blue-sky potential to get up to the $1B level.
TER: What do you think the potential is on a percentage-wise basis of finding billion-dollar companies?
JL: The odds are challenging. This is more speculative and it’s much higher risk than a nice dividend-paying stock with cash flow. These companies have lower market caps for a reason; there is either skepticism about the technology or a lot of competition. We don’t need 100 new rare earth mines, but maybe we have 100 rare earth companies. So which companies are going to win that race? It’s a bit like horse racing; you pick your favorites. The odds are you’re not going to win on every one of them.
TER: For a company to get to a $1B market cap these days is probably going to involve some acquisitions and consolidations, unless it really has some amazing property or technology.
JL: That’s very true. Sometimes companies just lay it out and if you can see that it can get the sales and the trajectory, it is certainly possible, and it does happen. It’s a challenge, and that’s what we’re looking for.
The other important part of the stock-picking process is the timeframe. The commodity cycle has a long-term timeframe, whereas the hype cycles can be pretty brief. Eventually, the market turns and the interest goes away. The challenge for these companies, if they have something real, is to keep moving the project forward until the next hype cycle comes around, when people get really interested again. If you’re investing in equities related to commodities, you’re speculating both in the market and on commodities. Sometimes you can have the right commodity, but the company you pick doesn’t follow that commodity’s price performance very well.
TER: Can you point to any companies you’ve seen in the last few years that have turned out that way?
JL: There are a few. To be honest, the other part of this strategy is that for every company that I talk about and like, there are probably 100 that I don’t. There’s a lot of screening and filtering to get rid of the ones that don’t have the potential. One company that I like right now is a biotech that I think we’re at a triple on right now called biOasis Technologies Inc. (BTI:TSX.V). It has a protein that can cross the blood-brain barrier. Therapeutic molecules can be conjugated to this protein, allowing it to cross the blood-brain barrier. This can dramatically increase an existing drug’s effectiveness. That’s one. We found it under $0.50, and now it’s in the $1.40–1.50 range.
DNI Metals Inc. (DNI:TSX.V; DG7:FSE) has also performed really well. While it’s down now, it had gone from around $0.20 to more than $0.60. I like it because it’s pushing the frontiers a little bit. It has a very large, black shale metal deposit in northeastern Alberta, a bit north of the oil sands. Historically, very few geologists studied shales, but they’ve become more popular now because of shale oil and gas. The Alberta Geological Survey has done numerous studies going back to the early 1990s that mention an anomalous metal content in the Second White Speckled Shale. The grades are really low, but the deposits are very extensive. There are huge resources in place containing a whole cocktail of meterials, including rare earths, nickel, iron, vanadium, uranium, zinc, copper, cobalt and molybdenum. It’s almost a conceptual play in some ways. Although the grades are not stellar, they are a little bit higher than we’d expect anywhere else.
So it’s a resource-in-place story, but it’s also a technology story because we’ve seen other industries dealing with a low-grade resource that suddenly become economic plays because of technological breakthroughs. The best example of that is probably shale gas, where people knew for a long time that there was gas in these shales, but nobody was really making any money from them. New technology comes along, and suddenly these shale deposits are worth a lot of money.
For DNI Metals, the challenge is how to get the metals out and make money doing it. The best method to extract these metals is pointing to a technology called bioleaching, which is being used by a company called Talvivaara Mining Co. Plc. (TALV:LSE) in Finland. That’s the exciting part that’s pushing the frontiers.
TER: Are these metals pretty much disseminated throughout this whole deposit, or are certain metals concentrated in certain areas?
JL: The metals are widely disseminated within a fairly uniform and consistent material. That makes it similar to coal or potash mining, where the ore bodies are tabular in shape. They may not be exciting, but at least you know what to expect and you can plan very large operations around that.
TER: With bioleaching, is in situ recovery (ISR) an option?
JL: There may be some way to use ISR, but the bioleaching at Talvivaara involves actually digging it up, piling it onto pads and leaching it by letting the bugs do their work and make acid. But there may be a way to apply in-situ technology in the upper zone. Bioleaching in heaps seems to be the approach with the most potential at the moment.
The value of the minerals in this shale is probably $40 per ton (/t). Extracting the metals for less than $30/t is the challenge. No one’s done it before, so there’s a lot of skepticism. I think a really big mining company would eventually take interest in this because it’s the kind of project that, if it can get up and running, has a life-of-mine potential of over 100 years.
TER: You mentioned uranium earlier. Despite Fukushima, people are realizing that nuclear is here to stay and one of our best sources of energy generation for the foreseeable future. Is there still life after its hype cycle has ended?
JL: I think uranium’s future is very bright and it is a critical part of the world’s energy matrix. We can’t really afford to just turn it off. There actually are a lot of benefits to using it. In terms of the actual price of uranium, the market may not be as excited about it yet, but Russia said it will not renew its supply agreement with the U.S. so analysts are anticipating shortages starting in 2013, which isn’t that far away.
TER: What other companies would you like to comment on?
JL: I like the uranium companies that use ISR technology. The main plays I’ve been considering are either in Wyoming or Texas, where you don’t get the really high grades that you find in the Athabasca Basin. There were hundreds of uranium explorers in the Athabasca Basin and the only one that’s really been successful for investors was Hathor Exploration Ltd., which was recently acquired by Rio Tinto (RIO:NYSE; RIO:ASX). With an ISR uranium project, you have a degree of certainty that a company will actually be able to build the mine and get it into production.
There are three companies in that space that I like. Going from the smallest market cap to the biggest, there is Ur-Energy Inc. (URE:TSX; URG:NYSE.A), in Wyoming. It’s on track to be a producer very soon with expected permitting for its Lost Creek mine early this summer. Then it will be able to get its mine into production probably within six months.
Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.A) is a similar company in Wyoming. It has actually started its mine construction and is looking to start producing 600–800 thousand pounds (Klb) uranium/year very shortly. Both are very near-term production stories.
The last one, Uranium Energy Corp. (UEC:NYSE.A), is currently producing in Texas. It has an inventory of projects coming online and the company announced property acquisitions in Paraguay and Arizona earlier this year. These are all companies with uranium resources that, once their facilities are built, enable extremely long production runs. Typically, they’ll have a centralized uranium processing plant and all of the mines around it will be satellite projects.
The challenge for all of these companies has been permitting. The various U.S. government regulatory bodies didn’t really have anyone qualified to evaluate ISR projects because there haven’t been any new ones developed for decades. The absence of a competent regulatory structure has slowed down progress on getting these mines built. These companies have typically spent a year or two longer than they expected on the regulatory process; it’s not a reflection of any gaps in the quality of their projects.
TER: At least the regulators are willing to permit these operations, which apparently was quite a problem for a while.
JL: That’s a very good point. These are viable, useful industries with quite good safety records and low environmental impact. Again, I like to talk about the big picture.
TER: What sort of capital costs do these uranium ISR projects have?
JL: There’s a range, but the costs are usually $20–30/lb. But these companies are pretty comfortable that they can eke out a living at the current uranium price, which is not going to encourage a whole bunch of new projects to come along. They’re anticipating higher longer-term prices, which should make them quite profitable.
TER: Do you have any thoughts on the current gold market?
JL: I just tell people to look at a 12-year gold chart. Gold is probably the best-performing investment product over that timeframe. I personally don’t think gold has that critical a role in the monetary supply, but it is a place to preserve wealth and look for protection. This recent consolidation pullback is probably an opportunity, but people need to remember that bull markets don’t last forever. However, gold still has legs right now, and the trend is your friend.
TER: Looking at the “big picture,” what do you suggest people do to figure out how they should invest their money these days?
JL: Investors have to do their research and be informed. We are in dangerous times. A lot of assets are correlated so it’s hard to find safety. Sometimes maybe the best safety is not even being in the market, which I hate to say. I like finding good companies that are going to grow into viable businesses. But the markets are not kind, and we’ve seen what can happen when the flow of capital gets turned off. The valuations of publicly traded companies, big and small, in all sectors, tend to drop in unison, even precious metals prices. It’s important to be mindful of the downside. I look for upside opportunities because I’m an optimist and I assume that life will go on.
We do have some structural issues in the financial system. If that breaks down, you really don’t want to own anything that’s not tangible. That’s the strongest investment thesis for owning hard assets. That doesn’t mean owning shares in a hard asset company; that means owning the physical hard asset. If you own a car, a house or some gold, those things will still be around no matter what happens to the money supply and currency valuations. The monetary system is a wild card, and that’s the thing that keeps everybody nervous. We can make informed guesses, but nobody really knows how that’s going to play out.
TER: We appreciate your time and input today.
JL: My pleasure.
Jim Letourneau is the founder and editor of the Big Picture Speculator and is a professional registered geologist living in Calgary, Alberta. He has over 20 years of experience in the oil and gas sector.
By The Energy Report, on March 30th, 2012
 With ever-higher oil prices encouraging record investment interest, the cleantech energy sector looks poised for leaps and bounds. The most successful investors will be those who understand the challenges facing not only different industry segments, but individual companies within the same segment. In this exclusive interview with The Energy Report, Raymond James Energy Analyst Pavel Molchanov explains the four principal areas that comprise the cleantech arena—wind, solar, smart grid technology and biofuels—focusing on case-by-case investability. He also shares some names that just might be the next big winners in this rapidly developing space.
Companies Mentioned: KiOR, Inc. – Power One Inc. – Solazyme, Inc.
The Energy Report: Your research at Raymond James covers a number of alternative energy and biofuel companies. Can you give us a brief description of the various cleantech industry segments?
Pavel Molchanov: The cleantech arena comprises four key areas in terms of what’s investable in the public equity markets today. Solar carries the biggest market caps. Solar power companies in the public market tend to mainly be in the photovoltaic (PV) hardware manufacturing arena. These include producers of wafers, cells, modules and inverters, and to a much lesser extent, companies engaging in project development and system installation.
The biofuels subspace is quite a bit smaller in market cap than the solar arena, but it’s been growing more quickly because most of the recent initial public offering (IPO) activity in cleantech has been in biofuels. Many investors associate biofuels with ethanol, and there are still a few publicly traded corn ethanol producers. But most of the recent IPO activity involves more advanced, next-generation biofuels, such as cellulosic, algae and other emerging products.
There is also the wind arena. This one is more difficult to invest in because many of the companies with exposure to the wind industry are highly diversified. Some of the largest industrial conglomerates are in the wind turbine manufacturing business. There are many overseas companies in this space, as is also true of solar. But whereas many of the international solar companies, especially from China, trade in the U.S., when it comes to wind, many of the companies trade in overseas markets, such as Spain and Germany.
Lastly, there is the smart grid subspace, which is at the crossroads of cleantech and communications. Similar to wind, many of the companies with smart-grid exposure are larger businesses, both in the information technology sector as well as the industrial sector. But there are some smart grid pure plays that are publicly traded.
TER: As far as stages of development, how evolved are the various industries?
PM: Let’s take a look at solar and wind first. The global solar market last year was approximately 27 gigawatts (GW), whereas the global wind market was about 50% larger at 41 GW. Both markets are in the tens of billions of dollars, in terms of total industry revenue, and quite large as far as cleantech goes. Still, the market share of both solar and wind in total electric generation remains very low. In the U.S., solar is well below 0.5% of total electricity sales and wind is about 2%. In some European countries like Germany, the numbers are higher, but in general they are quite low.
We have to differentiate between first-generation and second-generation biofuels. Corn ethanol already encompasses about 10% of the gasoline market in the U.S., and sugarcane ethanol is even more prevalent in Brazil. Next-generation biofuels, on the other hand, tend to be very early-stage. Generally speaking, the cellulosic and algae companies are pre-revenue, pre-production businesses. It’s going to take two to three years before the industry scales up and enters the mainstream. Certainly, it’s going to be smaller in gallon terms than the corn ethanol market well into the second half of the decade, possibly even until 2020.
Next is the smart grid industry, which encompasses a lot of different products. Smart meters are perhaps the widest known product in this subsector, and they have been unquestionably ramping up in adoption both in North America and elsewhere. As of the end of last year, approximately 27 million (M) smart meters had been installed in the U.S. There are many more in Europe, China and Brazil as well. But there are other elements of smart grid technology that are a little bit more difficult to measure because they don’t lend themselves to counting units of hardware that are installed—things like demand response.
TER: The more established companies in ethanol, wind and solar have their basic technologies already in place. Are smaller companies largely focused on the research and development (R&D) stage, and therefore not generating much cash flow?
PM: Essentially, all of the publicly traded companies in the solar and wind arenas are currently generating commercial product sales. In the smart grid arena, that is also true. The one area where there is a significant number of public companies that are still in the pre-revenue commercialization stage is advanced biofuels. Over the past two years, there have been more IPOs of biofuel companies than all other cleantech companies put together. The vast majority of those have been pre-production, early-stage businesses.
TER: Government subsidies have been instrumental in giving alternative energy and fuels a kick-start to compete with conventional oil and gas. Will these new technologies be able to compete without subsidies?
PM: Yes, and again we have to look individually at the different subsectors within cleantech. In solar, the vast majority of demand for PV right now is in Europe. Last year, it was about 70%. A few years ago, it was even higher. Just about every major country in Europe has what’s called a solar feed-in tariff, which is a guaranteed purchase price for solar electricity that is set by the government. Utilities have to purchase the solar electricity that’s produced both by individual households that have a solar panel on the roof and solar developers with their own solar farms. Because it’s government-set and government-guaranteed, the economics are extremely visible and secure.
It’s not a subsidy in the sense of a direct cash payment by the government because the utilities pay the money and ultimately pass on the costs to the rate payers, but clearly it is an incentive. In the U.S., there are a few small programs in a couple of states, but certainly nothing comparable to Europe, which is why last year Germany installed more solar in the month of December than the U.S. did in the last two years combined. Keep in mind that Germany has one-quarter of the U.S. population and a lot less sunlight. So subsidies can be very important, and solar is a good example of that.
In the renewable fuel arena, the dynamics are a little bit different. With oil prices in the triple digits, it’s quite possible for renewable fuels to be cost competitive relative to gasoline or diesel without subsidies. The fuel tax credit for corn ethanol that had been in place for decades went away Dec. 31, 2011, and the U.S. continues to blend ethanol in billions of gallons annually. Government support is, however, important for the development of the next-generation biofuel industry. The greatest help comes from Department of Energy and Department of Agriculture loan guarantees to these early-stage companies.
Many early-stage businesses, even if they have a good technology platform and a well-defined business plan, have difficulty getting financing. Clearly, the IPO option is open, and many companies have been going public. Commercial lenders are certainly reluctant to lend to pre-revenue businesses in many cases, so the federal loan guarantees have been very valuable. The Department of Defense has also been quite active in supporting advanced renewable fuel through R&D partnerships, and in many cases, purchasing fuels from these early-stage businesses helps provide these companies with cash as well as the seal of approval from the Pentagon, which is the biggest energy consumer in the U.S.
TER: When oil prices were down at $40 or $50/barrel (bl), it made it pretty tough for alternative energy companies to compete. Have higher oil prices changed the economics for cleantech companies?
PM: Absolutely. At $40-50/bbl oil, it’s very difficult for most renewable fuels to compete strictly on economics. I will note in this context that many of the renewable fuel companies have been pursuing opportunities in the chemicals arena. You might ask, why would they sell into the chemicals market? The global chemicals industry is about a $3 trillion (T) market, certainly smaller than transportation fuels, but still enormous in absolute terms, and a huge addressable market. Most importantly, pricing and margins tend to be higher for chemicals, especially specialty chemicals, than for commodity transportation fuels. So many of the companies that are developing next-generation biofuels, both public and private, have been focusing their early stages of commercialization on selling into the chemicals industry, because it’s easier for them to make money without subsidies.
TER: But the volumes are much lower, correct?
PM: Three trillion dollars is the size of the overall global chemical industry, and within that, specialty chemicals are about $200 billion. For companies that in many cases have zero production today, that is more than enough running room. The name of the game here is market penetration. The addressable market is very large indeed.
TER: What technologies hold the greatest potential for longer-term economic success at this point?
PM: One of the difficulties in investing in cleantech has been commoditization. Five years ago, solar panel manufacturing was a relatively specialized business that tended to carry pretty high margins, 25–30% or even higher. Since then, the Chinese competitors in solar have been so aggressive in grabbing market share and expanding production that pricing has cratered amid this severe industrywide glut of solar panels. Margins have dramatically compressed to barely 10% on average for just about everyone. That’s the lesson of commoditization. Therefore, I would encourage investors to focus on technologies across cleantech that do not have the same degree of commoditization.
In the long run, perhaps just about everything can be commoditized, but certainly for the foreseeable future, there are a few areas that stand out. For example, the market for solar inverters tends to be significantly less commoditized than solar cell or solar panel manufacturing. Why? For one thing, there are a lot fewer companies making inverters. It’s a more sophisticated and fairly complex piece of electrical engineering compared to a solar panel. There is also not the same element of competition from China: There are just a few significant solar inverter producers in China compared to at least 100 on the solar panel side.
Within the biofuels sector, next-generation biofuels are all about intellectual property—not simply converting corn into corn ethanol at very slim margins. Each company has its own “secret sauce,” or production process and technology platform, and there is a myriad to choose from. While the different players in this arena are still in their early stages and have lots of execution risk, over time they should have the ability to generate pretty good margins because they benefit from their own internally developed intellectual property.
TER: What criteria do you use in deciding which high-potential companies to cover?
PM: My coverage encompasses 21 companies, both good and bad. So, by no means do I recommend every company that I cover. In fact, at this point, I have a fairly large number of sell-rated stocks simply because of some of the industrywide challenges I mentioned earlier, especially in solar. It’s certainly important to look at investability. Wind is a very interesting market with a large global footprint. But it’s very difficult for investors to play wind because, again, many of these companies are mega-conglomerates for whom wind is a tiny portion of their business.
Therefore, I tend to focus more on the cleantech pure plays. Within every industry, there are companies that are in a better competitive position than others. So we have to look at everything case-by-case. It’s very hard to make a universal, far-reaching call regarding whether a particular subsector is now the right or wrong place to invest. The solar industry is facing a lot of headwinds and yet there are still companies in that space that are quite profitable and successful.
TER: Can you tell us about some of these companies that you cover and why you like them?
PM: Within solar, Power One Inc. (PWER:NASDAQ) is the world’s second-largest manufacturer of solar inverters. This is a company that has been consistently profitable in recent years. Gross margins have been under some pressure, but nothing compared to the pressure that solar panel makers have faced. It has no debt on its balance sheet and about $200M in cash. It’s actually generating free cash flow just about every quarter. It has been repurchasing some stock, and I think there is lots of room for it to accelerate repurchases in 2012 and beyond.
In biofuels, I would mention two names. One is KiOR, Inc. (KIOR:NASDAQ), a true cellulosic biofuel company. It takes woodchips, uses a catalytic process very similar to a refining catalytic process and turns those woodchips into what we call biocrude, or renewable crude oil. It actually is crude oil but unlike petroleum, it is entirely renewable. That crude oil can be refined using normal refining infrastructure into just about any finished product—gasoline, diesel, jet fuel, you name it.
I would also highlight Solazyme Inc. (SZYM:NASDAQ), which is an algae-based company. Unlike KiOR, which uses a thermochemical process, Solazyme uses a fermentation or biological process utilizing its internally developed algae. It needs to use a relatively more expensive source of feedstock, sugar cane, rather than KiOR’s cellulosic biomass. The tradeoff is it can sell into very high-value markets such as cosmetics and specialty chemicals. In fuels, it would tend to focus on the most high-value products, such as jet fuel.
TER: What sort of revenues are these companies generating?
PM: KiOR is entirely pre-production. Its first plant is expected to come online late 2012. Solazyme has a bit of product revenue for the time being, but in 2013, its first large-scale fuels and chemicals plant is expected to start up in Brazil. Both companies are in their early stages of commercialization.
TER: Do you have any parting thoughts you’d like to leave with us?
PM: The key message to investors is twofold. Number one, focus on companies with a defensible technology platform and distinct intellectual property, rather than a pure commodity business. Number two, be very company-focused when looking at cleantech. Don’t make any far-reaching or sweeping conclusions about cleantech as a whole or even within individual subsectors, because there is so much differentiation from company to company. Companies that may look superficially similar can have very different fundamentals.
TER: Thanks for joining us today.
PM: Thank you for having me.
Pavel Molchanov joined Raymond James & Associates in June 2003 and has worked as part of the energy research team since that time. He initiated coverage on the alternative energy sector in fall 2006. Molchanov became an analyst in January 2006. He graduated cum laude from Duke University in 2003 with a Bachelor of Science degree in economics with high distinction.
By Simon Grey, on March 26th, 2012
Emirates, the biggest airline by international traffic, said more carriers will go bust this year as fuel costs and sluggish economies undermine profitability.
“We can reel off a whole load of airlines that are teetering on the brink or are really gone,” Tim Clark, the Dubai-based carrier’s president, said in an interview. “Roll this forward to Christmas, another eight or nine months, and we’re going to see this industry in serious trouble.”
Airline profits will plunge 62 percent in 2012 to $3 billion, equal to a 0.5 percent margin on sales, as oil prices rise, the International Air Transport Association said this week. Emirates’s fuel bill accounts for 45 percent of costs and may jump by an “incredibly challenging” $1.7 billion in the year ending March 31, according to Clark, who says he’s sticking with a no-hedging strategy rather than risking a losing bet.
There are some environmentalists who aren’t completely economically retarded, and thus have recognized that one way to reduce consumption of a good that releases CO2 into the air is to raise the price. Some have even suggested using gasoline excise taxes as a way of essentially reducing the consumption of gas. This is practically what will happen with air travel, as higher gas prices will reduce consumption and/or profit margin, leading to the bankruptcy of several airlines. (Of course, this means that there will be fewer people buying a get-out-of-unconstitutional-patdowns-free card.) I’m not entirely sure what’s all at play in rising airline fuel prices, but I’m going to assume that regulation plays a huge role. It’s omnipresent throughout the entire process of turning crude oil into jet fuel, including drilling regulations, transport regulations, refinement regulations, and so forth. I can’t imagine that US inflation helps, since it is still the world’s reserve currency, and seeing as how all the other major players are inflating their currencies, as well as some of the minor players, it doesn’t look like the nominal price of jet fuel will be coming down soon.
At any rate, it looks like the environmentalists have pretty much won this battle, with everyone being worse off as a result. Gaia demands sacrifice, after all. She’ll probably demand the sacrifice of cars next.
By Christopher Briem, on March 26th, 2012
I was a bit distracted last month, so I missed the latest inflation data for Pittsburgh covering the 2nd half of 2011. The short story is gasoline is up in itself and you see the energy transportation costs filtering through a lot of other things. Other than gasoline, electricity costs over the year are +11 percent over the year. so even though “Utility (piped) gas service” is down 5.9% (the biggest drop in any category) overall household energy costs are up 7.5%.
Other than the natural gas costs coming down, the smallest price increase was in “Alcoholic Beverages” with an increase of 0.5 percent over the year. So in real terms, big drop in alcohol prices. What is up with that? It all adds up to the cheapest thing to do is to not travel and just drink at home.
Anyway, this is the overall inflation trend for the region:
By The Energy Report, on March 9th, 2012
 For investors seeking high potential returns and the thrill of participating in market innovation, the smallcap energy space is where it’s at. Managing Director and Co-Founder Laird Cagan of merchant bank Cagan McAfee Capital Partners has built his career by backing companies that are both filling current demand and creating new markets. In this exclusive interview with The Energy Report, Cagan shares his experiences and discusses several companies at the forefront of the energy revolution.
The Energy Report: Laird, you and your partner are active investors. You are company founders, you sit on the boards and you actually run the businesses in some cases. What kind of advantage does that give you?
Laird Cagan: We are involved with fewer portfolio companies compared to a private equity or larger firm. Because we take a very active role and are starting companies at early stages, our preference is to create a new platform company and a new business opportunity. So the benefit is that we can be very close to the company and try to launch it quickly to take advantage of whatever market opportunity we see. We have a lot of skin in the game, a lot of ownership, and we try to help guide companies in the right direction. But like private equity investors, we generally have professional managers from the industry who were either co-founders or who were brought in to lead the company on a day-to-day basis. One exception is the case of my partner Eric McAfee, who has been running Aemetis Inc. (AMTX:OTCPK) since 2005, when we started that company.
TER: What kinds of companies interest you most?
LC: For the last 10 years or so we’ve been focused on building companies in the microcap public space. We have found that this has given us better, faster access to capital for the right opportunities. Public investors don’t want to take the three, six, nine or 12 months that venture capitalists and private equity firms take to investigate opportunities before making an investment decision. Public investors want to see something faster and want an opportunity that they can understand. Typically, that means we stay away from pure-play technologies, but we do look for technologies that are creating new markets. For example, we founded Evolution Petroleum Corporation (EPM:NYSE) in 2002, when oil was $25 per barrel (/bbl). We created that company to do enhanced oil recovery using technologies like lateral drilling, which was not very prevalent back then. We could take mature oil and gas fields and extract additional reserves using new technologies. But we also benefited greatly from having oil prices go from $25–100/bbl. We founded Pacific Ethanol Inc. (PEIX:NAS) to replace gasoline additive MTBE (methyl tertiary butyl ether), which was outlawed in 2004 in California and many other states. Ethanol was the only known oxygenate that would burn gasoline cleanly enough to meet the clean air act. So, it was less of an alternative energy play than a replacement-commodity play with a West Coast focus. Those companies, Evolution Petroleum and Pacific Ethanol, got us into the energy space. With rising energy prices and a multitrillion-dollar marketplace, all sorts of new opportunities began to arise because of technology. Aemetis, originally called AE Biofuels, was focused on next-generation biofuel moving from corn to other feedstocks that would be more plentiful, more predictable and would not be in the food chain.
TER: Was horizontal drilling technology more capital-intensive at the time, with oil at $25/bbl?
LC: Not particularly. There were thousands and thousands of wells around the United States that had been drilled and shut-in or were at a trickle of their former production. Some were getting ready to shut down. People would practically give them away because it costs money from an environmental standpoint to close them. For us, Evolution was an opportunity to create an early-stage platform company to produce oil using enhanced oil recovery. We were fortunate that by 2006 oil prices were at $40–50/bbl.
TER: What’s the technique?
LC: The technique used is called CO2 (carbon dioxide) flooding, where you inject CO2 into the ground and it releases the trapped extra oil, which then bubbles up. The CO2 adds pressure, just as it does in a carbonated beverage. When you drill an oil well for the first time and release the virgin pressure by traditional means, you might get 40% of the oil. This means somewhere between 50% and 60% of the original oil in place is still there. With the CO2 floods, you can typically get between 15% and 20% of the original oil in place, and that’s a meaningful well.
TER: As a pioneer of this technology, where did you incur the most extensive costs?
LC: You have to have a pipeline to get your source CO2, and that’s a challenge. If you’re close to a source, the cost of injecting it can be around $10/bbl. But a project’s viability depends a lot on the fixed cost of getting the CO2 to the site. At the Delhi Field in Northern Louisiana, Evolution Petroleum formed a very effective partnership with the leading CO2 player in the industry, Denbury Resources Inc. (DNR:NYSE). Together we’ve done very well. The Delhi Field was 14,000 acres and is estimated to be capable of releasing an additional 60 million barrels (MMbbl) of oil. And with oil now over $100/bbl, that’s $6B worth of oil, and you can afford to spend a lot to go after that.
TER: Great foresight.
LC: I would say yes, it was foresight and some luck. We didn’t anticipate $100/bbl oil at the time. But, we really do focus on trying to get a play at the beginning of a growth cycle. Of course for any investor, being at the beginning of a rising tide is one of the keys to success and having superior returns.
TER: You’re not as actively involved in Camac Energy Inc. (CAK:NYSE) as you are in some of your portfolio companies, but starting the company has been an interesting saga. Can you tell us about that?
LC: In 2006, after having had some success with both Evolution Petroleum and Pacific Ethanol, I was introduced to Frank Ingriselli, the former head of Texaco International. He developed some important relationships in China and he had a lot of very high-level experience with majors in that region. After Chevron Corporation (CVX:NYSE) bought Texaco in 2001, he wanted to start a new oil and gas company and needed capital to grow, for which I was approached. We ended up funding a $21M offering and creating a new public entity, Pacific Asia Petroleum. Frank went to China to visit as a long-time contact and was granted a concession of 175,000 acres in the prime coal-bed-methane region of China. Without any upfront money, we got a hold of a major resource that launched the company. The Chinese government’s goal was to bring in people that had expertise and ability and who could bring capital for projects, because the country needs energy. Over time we ended up acquiring Camac, which owned a large property in offshore Nigeria that was just beginning production. In a sense it was a reverse merger for Camac because it became the majority shareholder and ended up taking control by its Chairman and CEO Kase Lawal. I dropped off the board around that period of time.
TER: Camac shares have been flat over the past six months, but down about 50% from a year ago. What accounts for the lag in the stock price?
LC: Its first production well started out at 20 thousand barrels per day (Mbbl/d) and it has gone down to about 4 Mbbl/d, but there’s still a huge reserve there, which is estimated to be between 600 MMbbl–2.2 billion (B) bbl of recoverable oil in the entire field. Camac is working on getting a new partner to come in and develop that. I’m bullish on the long-term. It’s going to take time, but it should be very exciting. I’m still a big shareholder and waiting, watching and hoping for the best.
TER: Were there any other companies you wanted to mention briefly?
LC: I recently became chairman of Blue Earth Inc. (BBLU:OTC), which is in the energy efficiency space. This is a very important new category, and it is frankly the lowest-hanging fruit of energy conservation by reducing energy consumption. Commercial real estate uses about 20% of our nation’s energy. Making those buildings more efficient is very important, and provides quick returns. For example, replacing old motors and with energy-efficient motors produces a one- to two-year payback. Blue Earth is geared toward doing that.
TER: Is the company actually manufacturing new technology?
LC: It’s not a technology company, but it’s using the latest improvements in energy efficiency to retrofit commercial real estate. It will also do energy audits for clients’ buildings and recommend an energy-generation project, be it solar, fuel cell, etc. that fits the client’s needs. This is called distributed generation: Instead of going into the grid and selling power back to the utility, the company sells directly to the customer. It therefore has none of the energy losses of going through the grid, nor any of the capex issues. Retrofitting to localize energy at a site is a tremendous innovation that needs to happen in order to reduce national and even global energy consumption. I’m very bullish on the energy efficiency and distributed generation space for the next 50 years. It has the power to replace and transform our energy production. We are not going to get rid of utilities because we need them, but we can chip away at our use of fossil fuels from our insatiable appetite for energy in a way that is cost effective. It also reduces carbon emissions.
TER: Is Blue Earth a consulting company?
LC: No. It’s more of a contractor, or a construction company. In other words, it does the work. In the solar world it’s called Engineering Procurement Construction or EPC. After the energy audit, the company does the engineering, including procurement of parts and construction. As we move on and migrate this business model, the company will also provide the financing and effectively become the developer. There are some good tax incentives involved in alternative energy, both in solar and fuel cells. Depreciation is also available, and that adds to the return.
TER: Solar systems would be on the roof or on land, but how far away would a generating fuel cell typically be from the building?
LC: Adjacent to the building. There’s no sound, and there are no moving parts. You need a footprint about the size of a tractor trailer. There are a few significant fuel cell manufacturers in the U.S., and they are growing nicely. Fuel cells are significantly more cost effective than solar if you can use energy 24 hours a day such as in a data center and can have net paybacks in 5–10 years at most, whereas it might take solar 10–20-years to payback.
TER: What are the fuel cell companies?
LC: One of the companies to look at is Bloom Energy (private). It has the larger units, and Google Inc. (GOOG:NASDAQ) put Bloom units into its building in Silicon Valley with a lot of publicity a year or so ago. Bloom is different from the other three manufacturers, as there is no waste heat, which is interesting. So, if you have large, consistent needs, Bloom is good. The data centers that Google runs are 24-hour operations. So, it would not be quite as suitable for a company that shuts down at night because you can’t amortize 24 hours, and perhaps solar would be better for a company that needs mostly peak daytime energy. That’s why an energy audit is so important, so clients can understand what’s most appropriate for their business.
Other companies include FuelCell Energy Inc. (FCEL:NASDAQ) and ClearEdge Power (private), the latter of which makes a variety of units, including small residential-size fuel cells. ClearEdge is blitzing homes. It’s the SolarCity (private) equivalent. SolarCity is trying to put solar on your roof, and ClearEdge is trying to put a fuel cell next to your house, and it makes systems all the way down to 5 kilowatts, which is appropriate for a midsize house.
TER: It has been a pleasure meeting you, Laird.
LC: Thank you.
Laird Cagan is managing director and co-founder of Cagan McAfee Capital Partners LLC, a merchant bank in Cupertino, CA. Cagan McAfee has founded, funded and taken public 10 companies in a variety of industries including energy, computing, healthcare and environmental. The company has helped raise over $500M for these companies, which achieved a combined market capitalization of over $2B. Mr. Cagan was the founder/chairman of Evolution Petroleum Corporation (AMEX: EPM), a company established to develop mature oil and gas fields with advanced technologies, and he is a former director of American Ethanol (AEB) and Pacific Asia Petroleum (PFAP).
By Christopher Briem, on March 7th, 2012
So last week I tweeted that I have yet to see a natural gas vehicle being fueled at the new station which opened up in the Strip District last year to a certain fanfare.
So I was about to compose a post aimed at ferreting out whether there are any owners of non-fleet natural gas vehicles in the city at all. I remember one in Friendship about 15 years ago.
Then coincidentially Brian O. looked at the state of natural gas vehicles in his Sunday column. His article starts out with a local owner of a Honda natural gas vehicle. However I think it is fair to say she was a ringer since Brian identifies her as a People’s Gas executive. It wasn’t even her car if you read the article further, it implies the vehicle was loaned to her. Shouldn’t all local gas executives have their own natgas vehicles?? Voting with your feet and all.
So.. if we exclude employees of natural gas companies or fleet vehicles. I still want to ask the question. Is there a single owner of a natural gas vehicle residing in the city? I mean someone who purchased a natural gas vehicle themselves as an alternative to your run of the mill gasoline powered vehicle. I don’t know the answer to that, but I suspect if someone was out there Brian would have found them for that column.
It just got me wondering more since he quotes this: “Mr. Price said talks with private investors have him expecting 15 to 20 public natural gas stations to emerge in the next year to 18 months. “. Since there are plenty of natural gas stations elsewhere in the nation, I presume that sentence was referencing the Pittsburgh region. I just wonder how so many stations can start up before there is any demand?
So yes, I get it. Therer are no cars because there are no dealers selling natgas vehicles locally. So who are all these new stations for? The fleets one would suppose, though the fleets running natgas now likely have their own pumps. and why did Giant Eagle put natgas into its Fairywood station of all places? Fairywood?? Must be a reason. Questions I would ask is all.
I have no data on this.. am not sure anyone does. It just seems to me that no matter all the talk, the number of private natural gas vehicles in Pittsburgh is still lower than it was 15 or more years ago. Back when I think there were public natgas stations around.
Not really related, but this all sparked a neuron. There has not been a news story recently on the veggie-fuel folks in Braddock? They were on a PR tear for a while. I see they actually have a spinoff slated to go in around the corner from me. Shows what I know.
By The Energy Report, on March 2nd, 2012
 New oil harvesting technologies first perfected in the Bakken are opening up production around the world. Stephen Taylor, portfolio manager of The Taylor Fund and founder of Taylor Asset Management, is excited about the prospects for several New Zealand-based efforts. He’s also optimistic about the dawning of a new age for natural gas as the chemical sector steps in to prop up slumping prices in this exclusive interview with The Energy Report.
The Energy Report: There’s some escalating tension in the Gulf of Hormuz between Iran, the U.S. and Israel. Do you think that this will be a catalyst for oil prices in 2012?
Stephen Taylor: It may well be. It underscores the need for and the value of assets in politically stable areas. It also bodes well for energy assets in North America and places like Australia and New Zealand. The Middle East has always been a volatile place, but this issue certainly focuses investor attention on the risk in that area.
TER: What themes in energy are you positioning for?
ST: We like smaller emerging companies that are heavily focused on oil, as well as companies that are benefiting from the application of new technologies. Technologies that were pioneered in the Bakken in North Dakota have spread to similar geologic formations around the world, and there are going to be tremendous opportunities arising.
One of our largest positions, New Zealand Energy Corp. (NZ:TSX.V; NZERF:OTCQX), is applying some of those same technologies in New Zealand and is announcing terrific results. In fact, just recently the company announced terrific results from its Moki-2 well at 1,000 (K) barrels a day (bbl/d) of production. We think the company has tremendous potential ahead of it.
TER: New Zealand Energy seems to be one of the darling plays right now. Beyond its results, why do you think that is?
ST: New Zealand Energy and Tag Oil Ltd. (TAO:TSX.V) are really the only pure plays onshore in New Zealand. Of the two, New Zealand Energy is more focused on oil versus gas production. It’s a country that requires 150K bbl/d in oil yet produces only 55K bbl/d. The domestic demand is there.
The company also has tremendous land positions that potentially could mean billions of barrels of oil. It’s a question of what sort of recovery rate applies. The increasing level of exploration and drilling technology may just push that number higher in the years ahead.
We have found the company’s management team to be very solid and straightforward. We were early investors in New Zealand Energy and participated in the first private round last year. It’s a company that seems to under-promise and over-deliver, which we like.
TER: You said you prefer oil-focused plays, but you have a position in domestic oil and gas company Saratoga Resources Inc. (SARA:NYSE.A), which is a little heavier on gas. Are you concerned about Saratoga’s oil:gas ratio?
ST: Saratoga was recently listed on the NYSE Amex stock exchange. It was a great day for the company and we were there with management for the bell ringing ceremony. Tom Cooke and his team have done a terrific job turning that company around. It was in Chapter 11 in 2010. He and his team brought the company through bankruptcy without any shareholder dilution, which is quite an accomplishment.
Saratoga’s properties are focused on the offshore Louisiana Gulf Coast area. Importantly, they are all within state as opposed to federal waters, which means they are within three miles of the transitional coastline. Its leases are in shallow water, typically less than 20 feet deep. This affords significant cost savings when drilling wells. A company can get away with leasing cheaper, less sophisticated equipment than that required for drilling in deeper depths. Being able to drill cheaper wells is always a good thing.
Recent exploration activity is focusing investors’ attention on the potential for ultra-deep gas in that area. The Davey Jones well, drilled by McMoRan Exploration Co. (MMR:NYSE) is in the process of bringing a flow-testing unit online over the next few weeks. It’s becoming increasingly obvious that the deep gas may now be accessible from shallow water. A company could drill into the same formations, but only be drilling in 20 feet or less of water as opposed to 200 or more feet.
On that point, Saratoga is in discussions with McMoRan about forming a joint venture on one of its key leases. That process is continuing. We’ll see what happens, but I would expect some news over the next several weeks. Saratoga has a very valuable collection of assets and we think the stock is a good buy.
Saratoga may be about 50% to 60% in gas versus oil, but it has a number of oil-rich targets that it could drill as well. The production profile for that area is very long lived and many of its wells have been in production for 40-plus years.
I also believe that further downside to gas prices could be limited. There could be a return and rebirth of the U.S. chemicals industry over the next several years based largely on cheap and reliable supplies of natural gas in the U.S. Huntsman Corp. (HUN:NYSE) recently said it plans to expand and enlarge its U.S. capacity.
There is reemerging demand for natural gas that many investors may be underestimating. That demand will come from traditional users, like the chemical industries, but also increasingly from transportation uses, too. Energy policies like the Pickens Plan, and similar offshoots that push U.S energy independence, will target commercial vehicles and transportation fleets. That’s going to begin to use more natural gas more quickly than a lot of people are currently thinking. That’s good for the country and good for natural gas producers.
So, the long-term outlook in this case may not take quite as long as some people think.
TER: What’s your biggest regret so far in managing the fund?
ST: I’m not one to dwell on regrets. When I was on the Chicago Board of Options Exchange (CBOE) trading floor, we had an expression: “Next trade.” If you made a bad trade, you had to forget about it, get back to business and move on to the next trade without consuming yourself with regrets.
TER: What advice would you give to retail investors looking to gain further exposure to energy?
ST: Look for quality management teams. Find teams that have a track record of generating shareholder value and taking care of their shareholders. That is the most important quality—before a project or anything like that. The wrong person in charge of a good asset will not get good results. Look for teams that have skin in the game. Tom Cooke at Saratoga owns 20-30% of the company. That’s a substantial portion of his net worth tied up in the same investment as the regular shareholders.
TER: Thanks, Steve.
Steve Taylor is chairman and CEO of Taylor Asset Management, a Chicago-based investment management firm focusing on small-cap domestic equities and emerging markets. He also serves as a portfolio manager for the Taylor International Fund Ltd., a small-cap equity fund. In addition to emerging markets, Taylor’s area of expertise includes private equity, restructuring and turnaround situations and both small- and mid-cap companies. He has considerable experience in the natural resources and finance industries in Canada and China.
By Christopher Briem, on February 28th, 2012
Sometimes it is worth looking back at old posts. Actually a reader reminded me recently that there still are ‘deals’ being shopped to consumers for locking in long term natural gas prices. Reminds me that a year and a half ago I posted this letter I received myself.
Was it a good deal? Even then Elwin pointed out the problems with interpretng the offer. It seems the offer was just for the commodity price of the gas, not the total price consumers pay. If someone had taken this deal, they clearly would have lost out vs. the option of not taking it. But what about going forward? There are current version of these deals being offered are you can check out the current version of the natural gas shopping guide put out by the state. It seems to still be the case that for all the vaunted deregulation of natural gas supplies in Pennsylvania, some of us only have one alternative offer and even that comes at a price that is above prices we get by default these days. That and I am pretty sure the current natgas price has not yet fully adjusted for the recent drops in natural gas prices. The bottom line is that the only ‘offer’ I have is to pay a higher price than what I currently get with the added benefit that the higher price will be ’locked in’ for a year. You would think with all this gas literally erupting all around us there might be a few more suppliers willing to offer gas to consumers at more competitive rates? A curious system of ‘competition’ all around.
And on that state shopping guide page.. it seems that none of the archive links seem to be working??
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By The Energy Report, on February 28th, 2012
 The biofuel sector, already an $80 billion a year industry, is still in its infancy. In this exclusive interview with The Energy Report, Biofuels Digest Publisher Jim Lane discusses the exponential growth slated for this once-obscure energy source, and how its market resembles the traditional oil and gas industry in many ways. While biofuels are not for the faint of heart, as Lane cautions, investors who do their homework can get in early on companies that offer incredible upside potential.
The Energy Report: Many investors have some level of familiarity with biofuels, but don’t have the depth of understanding required to enter that market with confidence. As the publisher of Biofuels Digest, which focuses exclusively on this sector, what do you think is the best way for investors to dip their toes into these equities?
Jim Lane: The biofuels sector has grown into an $80 billion (B) industry today, even though it’s only in its infancy. Why be interested in the sector? Because it’s big and it’s going to get bigger. There’s lots of money to be made and lots of good to be done.
TER: What exactly is a biofuel?
JL: Biofuels include any fuel molecule produced from a plant source using tools and microorganisms from synthetic biology. It could be a residue from agricultural waste, forest waste, municipal solid waste, animal waste, or something made using a biological process. There are about 100 different plants that can be used to produce biofuels, and many can be grown in areas that won’t support traditional food agriculture. The main plant sources are still corn, sugar cane and soy beans, but biofuels can also be made synthetically from carbon dioxide and water, or carbon monoxide and water. Biofuel processes can turn pollutant waste streams with little or negative value into value streams sometimes worth thousands of dollars per ton.
The main basis to date has been using traditional processes, such as yeast fermentation, to produce an alcohol fuel known as ethanol. We also have a process that takes plant or waste oils and turns that into what’s called biodiesel. Those are pretty built-out industries in many ways. They’ll grow, but they won’t grow quite as much in the future as what we call advanced biofuels, which use exotic processing techniques to extract value from unusual feed stocks.
TER: Are investors making money in this space at this time? What segments are doing best at this point and why would that be?
JL: Yes, investors can make money in this market. It depends on the stage of the company. It generally takes about 10 years to go from the original lab or research work to producing on a commercial or industrial scale. Depending on a company’s stage of development, investors may see early-stage cash burn, the beginnings of commercialization, or substantial profitability. The companies that are further along on their path are very profitable. For example, Valero Energy Corp. (VLO:NYSE) is a major U.S. oil refiner, and last quarter its most profitable division was ethanol production, based on about 1,100 million gallons in capacity. But the bigger opportunities for investors are in selectively picking the winners of tomorrow, because those will offer more upside.
TER: Is there a lot of research going on in different areas that aren’t anywhere close to commercialization at this point, or has commercial production been largely standardized?
JL: While there are well over 200 companies currently developing projects around the world using advanced biofuel techniques at various stages of development, there are three basic areas for investors to consider, much like the oil and gas market. We designate these areas as upstream, midstream and downstream.
The upstream segment includes companies that are developing advanced feed stocks with higher yields that grow under more exotic conditions. They’re working on genetics and seed development.
Midstream companies utilize processing technologies that extract fuel from plants or waste material, similar to an oil refinery, whereas upstream is comparative to traditional oil and gas exploration. Consider the feed stocks an above-ground oil fuel, if you will.
Downstream companies are the ones that get the fuel to market, such as the pipelines or the gas stations that are delivering those fuels to consumers.
TER: What would you say to those critics who suggest that biofuels are just another passing fad? What are the growth prospects for this industry?
JL: Any business that’s gotten to $80B in sales is real, and in the United States and Brazil it’s now an unsubsidized business. Ethanol, in Brazil, is unsubsidized and actually outsells gasoline. The International Energy Agency projects that 30% of all transportation fuels could be biofuels by 2050. We use 1.2 trillion gallons of traditional fossil fuels worldwide, so the demand potential is in the hundreds of billions of gallons and the sales will be in the trillions of dollars. It’s definitely not a passing fad; the potential is just being unlocked now.
TER: What are the job creation possibilities in this industry?
JL: It’s a very robust job outlook, according to a recent report by Bloomberg called Moving Towards the Next-Generation Ethanol Economy. Looking just at U.S. ethanol, which is a small piece of the pie, they expect that by 2030, 2.4 million man years of employment would be created. A lot of that is in construction—680-odd thousand man years between now and 2030. This includes engineering talent, operators, laborers, people who collect and transport the biomass and the fuel and also the administration and management. These are very similar to jobs in traditional oil and gas facilities, with a few more biologists.
TER: What factors and investment criteria should investors consider if they want to get involved in this industry space?
JL: Investors should look at three main factors. First is the extent to which the processing technology is proven or demonstrated at scale. Has it been done at pilot? The earlier you take that on, the more risk you have that the technology may fail along the line. A later-stage technology gives you more confidence. But, the returns are going to be commensurately smaller. So, the more research you do on the processing technologies, the earlier you can invest with confidence; which should give you a bigger return. I think that goes for every kind of high technology.
Next is feedstock. To what extent does the processing technology have a guaranteed price at which that feedstock can be acquired? A company that has a 20-year contract for municipal solid waste at a fixed price is on solid ground. If it is buying a commodity crop with fluctuating prices, investors need to understand how the company has hedged that, because you don’t want to be buying $8 feedstock to make $3 fuel.
On the downstream, you want to make sure there is an offtake contract with a credit-worthy buyer. You certainly don’t want to have a long-term contract with a company that may go bankrupt. Investors should look for companies that have done a really good job of locking in feedstock costs as well as a reliable offtake contract.
The more certainty investors have on those three fronts, the less risk they will shoulder. On the other hand, less risk usually means less potential reward.
TER: What are some of the leading companies in the industry at this point, and what are they up to?
JL: We’ve had seven companies with successful IPOs in the last 18 months, with 10 in the IPO queue right now. Of the entire cleantech sector, 75% of the companies in the IPO queue are biofuel companies. That tells you a little bit about where Wall Street is putting its emphasis and which of these sectors is going to succeed in the short term. The biggest success stories include companies like KiOR, Inc. (KIOR:NASDAQ), which went public last year. It’s a company that uses a technique called Biomass Fluid Catalytic Cracking. KiOR creates diesel, jet fuel and gasoline from wood chips very cost effectively. The company already has over $1B valuation. It’s now building its first commercial facility in Mississippi with very strong support from former Governor Haley Barbour to build a total of six plants in the area.
Renewable Energy Group Inc. (REGI:NASDAQ) is another company that just did its IPO. That company is the number-one biodiesel producer in the United States, at about 300 million gallons a year, and had strong revenue growth last year.
TER: What other companies look interesting?
JL: Solazyme, Inc. (SZYM:NAS) is a company that makes renewable oils from algae using advanced synthetic fermentation. It also makes skin creams, which are selling on the Home Shopping Channel very successfully. Solazyme is making fuel and also has a joint venture with Roquette Group. It is also making algae cookies and has all kinds of products it can make from renewable oils. We expect them to be very successful not only in food and skin care but also in making jet fuel for the Navy and in all kinds of applications across the spectrum.
Gevo Inc. (GEVO:NASDAQ), went public last year and makes isobutanol, which is an alcohol-based fuel. Isobutanol also a very important component in the chemical industry. Gevo is just building its first commercial facility, which will be open in the first half of this year. That’s a very exciting company to watch.
Amyris, Inc. (AMRS:NASDAQ) is based out of Silicon Valley. Its technology uses sugar cane syrup and is being commercialized now in Brazil. Amyris makes an exotic collection of fuels and chemicals and lubricants and all kinds of great products from sugar cane, as well as a renewable jet fuel and diesel being commercializing in Brazil.
Another Silicon Valley company, Codexis Inc. (CDXS:NASDAQ), is an enzyme, fuels and chemicals developer. Its major investor is Shell, and it is producing enzymes and other components of fuel creation in its work. The company recently bought its chemical rights back from its original parent, Maxygen, Inc.(MAXY:NASDAQ). Codexis is now deploying a wide variety of solutions to make low-cost sugars for the chemical industry. That’s important because you need sugar in order to turn something into a chemical. This company is going to be the “Intel-inside” of the industry.
Then there’s Rentech, Inc. (RTK:NYSE.A), which has a very advanced process making diesel and jet fuel through what’s called gasification. It’s based in Los Angeles and commercializing its technology in Ontario, Mississippi and Colorado. These companies are examples that are at, or are going to commercial scale right now, in which investors can take a position today.
TER: Are these companies making money, breaking even, or are they still in the “trying to get there” stage?
JL: Most of them came out quite early. Biotech stocks often come out either pre-revenue or early stage. Renewable Energy Group came out a little bit later in its evolution. The other ones are still in the cash-burn phase. I think Amyris is deploying its second commercial plant and the others are in the process of building their first commercial facility. Amyris will need to get three or four up to be solidly profitable and cover the overall administration and R&D costs. You would expect to see most of those in the black around 2014 or early 2015. The most important thing for an investor is not current profitability, but where they are on their path to profitability. Waiting until they are totally in the black and everything is already established is less risky, but you’re going to be sacrificing some of the upside.
TER: What sort of capital costs are involved in putting a commercial plant into production?
JL: The first commercial plant is usually the most expensive due to the R&D involved, and can cost anywhere from $250-400M. Larger projects can be up to a billion dollars apiece. As the industry develops standard designs, costs could drop to somewhere in the range of about $200-300M per project. So this is not for the faint of heart. Certainly these companies will be accessing project financing for the debt component. This is a very capital-intensive industry similar to the traditional oil and gas industry.
TER: You also publish the Biofuels Digest Index composed of 30 component stocks that seem to cover a pretty broad range of companies. How do you determine who you cover?
JL: We look at the 30 companies that have the largest capacity and also include some pure plays. So, we have companies like BP Plc. (BP:NYSE; BP:LSE) and Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE). BP’s biofuels unit alone has 4,000 employees. It’s a very heavy investor in biofuels. Shell also just did an $8B acquisition or joint venture and merger last year. We also have Archer Daniels Midland Co. (ADM:NYSE). From large-caps we go down to some of the smaller ones I’ve mentioned like Solazyme, KiOR, Gevo, Amyris, Rentech, Codexis and Renewable Energy Group. The key there is that all of them are fully focused on biofuels and chemicals, or it’s a significant part of their operations and profit flow. We change them around a little bit, of course, as we’ve had a lot of recent IPO activity. It has been a pretty good sector to invest in over the last 18-24 months.
TER: Do you have any other points you’d like to discuss and closing thoughts you’d like to leave with our readers?
JL: Investors usually ask me what the best way is to pick winners and avoid losers. The answer to that is to read a lot and study up on the technology. Never buy anything that you’re not sure of, or you don’t know. These are exotic technologies. A lot of them are early stage. It’s very important for investors in early-stage, high-technology companies to be fluent in understanding a company’s upstream feedstock strategy, if its processing technology is proven, and who’s the offtaker. And is that represented in hope or is that represented in hard contracts and real dollars? If you’ve done your homework, you can find a lot of value, which plenty of investors have. It’s all based on being a knowledge worker before you are an investor.
TER: We greatly appreciate your time and input today on a sector that certainly provides another growth area for investors to consider. We’ll look forward to talking with you again to see how these companies progress.
JL: Much appreciated.
Jim Lane is the editor and publisher of Biofuels Digest, the most widely read biofuels daily newsletter. The Digest covers producer news, research, policy, policymakers, conferences, fleets and financial news. It is home to the Biofuels Digest Index™, The 30 Most Transformative Technologies, and the “50 Hottest Companies in Bioenergy” annual rankings.
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