Overcoming alternative-fuel slips

By Michael Butler and Randy Shefman,

Saturday, November 24, 2007

The dawn of the New Energy Economy was accompanied by a host of sunny assumptions three years ago. One of the most promising premises was that a substantial portion of the petroleum we use would eventually be replaced by ethanol and biofuels. That hypothesis might prove partially true someday. But with oil surging to nearly $100 a barrel, soybeans selling at $9 a bushel, and corn rising to just under $4 a bushel, the financial projections of 2005 have failed to materialize and the highly touted post-petroleum era remains on hold - at least for now.

Indeed, the very high returns on ethanol that investors generated when oil was $60 a barrel are no longer available - even though oil prices have nearly doubled. Why? Because the debt and equity markets believe that ethanol demand right now is weaker than originally forecast.

Despite the miscalculations, we remain confident that America can work its way out of this new energy trap. Our optimism is based on a steady stream of world-class R&D and innovation that's focused on renewable energy; and our hope is predicated on the ability of flexible executives and entrepreneurs to restructure existing business models that clearly won't work in today's unexpected new energy environment.

Looking back, we can now point to three false assumptions that have temporarily boxed us in and led us off the path to energy self-sufficiency.

First, we failed to understand the economic impact that alternative energy production would have on traditional commodity pricing. Feed stocks like corn, which help make ethanol, have multiple outputs and are, therefore, in demand and price sensitive. Recent price run-ups in corn, spurred by alternative energy development, have resulted in backlash from food and feed lobbyists. In order to succeed in alternative energy, investors must gain reasonable access to supply and lock in prices with long-term contracts that run anywhere from five years to the life of a loan.

The good news is that more and more farm acreage is being devoted to alternative energy production; and, over time, rational market forces should help bring down commodity prices.

Second, we neglected to factor in the increased cost of transporting raw materials to make alternative fuels. Train trips from cornfields to biofuel plants near refining capacity are expensive, for example, and have a significant affect on the bottom line.

Third, as mentioned above, we overestimated current consumer demand for ethanol as well as our ability to construct chains of ethanol fuel stations along our highways.

There is a bright spot here, however. Ethanol capacity on line over the next few months is expected to meet or exceed replacement volumes. If this turn of events is met with enhanced infrastructure for E85 - an alcohol fuel mixture that typically contains a mixture of up to 85 percent denatured fuel ethanol and gasoline or other hydrocarbons by volume - then consumer demand will become a market driver.

In one sense, however, the absence of a robust E85 infrastructure has been a blessing in disguise. We're still learning about how global markets impact alternative fuels, and it's conceivable that offshore agricultural powerhouses could someday control biofuel inputs after U.S. financiers pour capital into domestic infrastructure. Instead of being beholden to OPEC, we'd then be held hostage by countries that grew massive amounts of corn or soybeans.

One of the reasons we're sanguine about the future of alternative energy is that the ethanol experience has already begun to broaden our thinking when it comes to alternative energy inputs. Garbage or sewage, for example, are plentiful, must be disposed of, and have limited economic outputs. So, in the end, they may prove to be less risky investments than corn-based ethanol. And algae, which can be grown quickly and more cost-effectively than corn, might also offer less risk.

As we reconsider our early stumbles in alternative energy, it's clear this market will be guided by regulation and public policy, and sustainable technology investors and government officials need to form public-private partnerships. These hybrid alliances will allow the private sector to get ahead of the curve in the post-petroleum era - with as little risk as possible.

And once this happens, we'll be able to escape our current energy trap, head toward meaningful energy self-sufficiency, and enhance our country's national, financial and environmental security in the 21st century.