How to Incinerate $2 Billion
The Inherent Challenge for Advanced Biofuels
In last week’s Energy Letter, I reviewed some of the technologies used to produce so-called “advanced biofuels” in Pulp Fiction: The Broken Promises of Biofuels. These biofuels tend to be expensive to produce, even though there are significant sources of waste biomass that does not compete with food crops and can be used as a feedstock.
In a nutshell, the fundamental problem is that biomass (generally plant material of some sort) has a low energy density. This factor increases the cost of transporting it, and it results in decreased yields and increased production costs relative to current fossil fuel prices. When you consider what fossil fuels represent, this becomes easy to understand. In the case of crude oil, for instance, Mother Nature grew and harvested the biomass. The earth supplied the heat and pressure to slowly convert this ancient biomass into the energy-dense form we know as crude oil.
In the case of biofuels — both advanced and conventional — human inputs are required to plant and harvest the biomass, as well as energy-intensive steps to convert the biomass into a (typically) liquid fuel. Even after initial processing these liquid fuels are generally of lower energy density than petroleum, and often more steps are required to make them more compatible with the transportation infrastructure.
These issues explain the challenges of producing biofuels economically, and they are the primary reasons for failure of many advanced biofuel companies. Some first-generation biofuels — such as ethanol produced from corn or sugarcane — have nevertheless overcome the challenges and can be competitive with petroleum (depending largely on geography). But the extra steps and lower yields inherent in most advanced biofuel schemes have meant that commercialization of these fuels remains elusive.
Advanced Biofuel Companies Go Public
Nevertheless, a number of companies are trying. In 2011 venture capitalist Vinod Khosla took three companies public with the goal of commercializing advanced biofuel production: Gevo (NASDAQ: GEVO), Amyris (NASDAQ: AMRS) and KiOR (NASDAQ: KIOR). Gevo’s route involves production of iso-butanol, a commodity chemical, and subsequent conversion of this chemical into jet fuel, chemicals, and speciality fuels. Amyris uses genetically modified microorganisms to produce fuels and chemicals, although lately the company has focused more on the speciality chemicals industry.
KiOR, on the other hand, billed itself as a pure-play advanced biofuel producer. KiOR promised to turn biomass not into ethanol (despite some early headlines touting KiOR’s “cellulosic ethanol” technology), but into an actual drop-in petroleum replacement.
There were claims made by the company and repeated (and sometimes confused) in the media such as “KiOR’s process produces a near-perfect match to crude oil in a matter of seconds”, or “They’re going to do what it takes millions of years for Mother Nature to do in a matter of seconds.” That latter quote was made by then Mississippi Governor Haley Barbour, who helped KiOR secure a $75 million loan from the state of Mississippi to entice KiOR to build a $213 million demonstration plant there. More on that below.
The Problems with KiOR
Because I am a chemical engineer working in the area of alternative fuels and providing advice to investors, KiOR’s claims piqued my interest. What it claimed, and more generally what the media reported about the company, didn’t ring true. So I investigated, became convinced that the company was overstating its case, and in a 2011 article — Why I Didn’t Short KiOR — argued that KiOR was “grossly overvalued” after fueling unrealistic expectations among investors.
On the day I wrote that, KiOR closed at $15.50 and sported a market capitalization of about $1.7 billion. Last Friday, KiOR closed at 9 cents a share. The market capitalization has dropped to $5.9 million, and is down 99.4% in not quite three years. Gevo and Amyris haven’t fared much better, with Gevo down 97.3% since its IPO and Amyris down 76.4%. (Note that these stocks are extremely volatile. Now that it’s a penny stock, a few cents’ movement in KiOR’s share price can amount to a very large percentage move, so understand that investing in KiOR at this point isn’t much different than simply gambling).
KiOR share price from IPO through Aug. 25, 2014
So what happened to this company that many investors believed had such a bright future? While KiOR hasn’t commented extensively on what went wrong, it is clear that once it started up its wood-to-fuel plant in Columbus, Mississippi, the production process proved more difficult and costly than expected.
KiOR was using a variant of the fast pyrolysis process described in last week’s Energy Letter. As explained last week, this process results not in hydrocarbons, but rather in compounds that contain oxygen such as aldehydes, carboxylic acids, ketones, alcohols, and sugars. In order to be used as transportation fuel, these compounds require further upgrading, and less than 40% of the mass of the pyrolysis oil is converted to gasoline or diesel. The low yields drive up the costs.
Investors should have recognized trouble brewing when KiOR kept failing to meet its own guidance. The company lowered production targets in August 2013 and again in November of that year, yet still ended up short of the twice reduced forecast at the end of the year. In December, KiOR said it was idling the Columbus plant to save money and to work on improvements. At that point, I figured it would be bankrupt by the end of 2014. In fact, that was one of the five predictions I made in January.
The Hype Machine
Also in January I appeared on 60 Minutes in a segment called The Cleantech Crash, in which Vinod Khosla and Lesley Stahl had the following exchange about KiOR:
Vinod Khosla: Nature takes a million years to produce our crude oil. KiOR can produce it in seconds. And we take that, add this magic catalyst-
Lesley Stahl: This is the secret sauce?
Vinod Khosla: Yeah.
Lesley Stahl: You throw that on top of the chips?
Vinod Khosla: And then, out comes something that looks that looks just like crude oil. It smells like crude, it works like crude except it’s 100 percent renewable. Then it’s distilled onsite into…
Lesley Stahl: Clean gasoline?
Vinod Khosla: Clean green gasoline.
Lesley Stahl: This goes right into the tank, right? You don’t have to build a new infrastructure?
Vinod Khosla: Absolutely.
Lesley Stahl: You make it sound almost – sorry – too good to be true. There must be a downside.
Vinod Khosla: There is no downside.
Although this segment aired in January, it was recorded in the fourth quarter of 2013. Around this time Vinod Khosla convinced Bill Gates to invest a few million dollars in the company and, as shown by the exchange above, was still hyping and overstating KiOR’s technology despite problems that were well-known at that time.
This is why investors need good, objective advice from people who understand the technology. As I explained to Lesley Stahl, while I strongly support the development of advanced biofuels, Vinod Khosla has done a lot of harm to the sector by overpromising on various technologies and then failing to deliver. This leads to public perception that advanced biofuels are a boondoggle. This becomes particularly problematic when tax dollars were secured by promising more than a technology can deliver, as it makes it more difficult for more promising technologies to secure funding.
This isn’t the first time that Khosla has been involved in an advanced biofuel company that overpromised, took public funding, and then went out of business. This also happened with Range Fuels, which squandered public funding while “inventing” technology that had in fact been practiced for decades.
In the case of KiOR, in June of this year the company was unable to make a loan payment on the remaining $69.4 million it still owes to the state of Mississippi. The state is unlikely to see those funds paid back, but it could have been much worse. In 2011 (pre-IPO) KiOR announced that it had received a term sheet for a loan guarantee supporting over $1 billion of capital spending from the US Department of Energy’s Loan Guarantee Program. This funding ultimately fell through, so the biggest losers in the KiOR failure are shareholders, the taxpayers of Mississippi, and Khosla himself.
As I noted when predicting KiOR’s bankruptcy, Khosla can continue to throw good money after bad to keep the doors open. He has in fact done just that. In March KiOR announced that it was out of money and unlikely to receive further investments from Bill Gates. Khosla stepped forward with a $25 million loan — payable at $5 million a month and subject to certain milestones being met. This loan has prevented a formal bankruptcy filing, but isn’t enough money to restart the plant.
KiOR has almost certainly by now used up that $25 million, and I don’t believe Khosla is likely to keep lending. On the other hand, he is probably desperately seeking to avoid a formal bankruptcy filing as it would be his second high-profile failure in the advanced biofuels space. He may instead seek a deal for KiOR to be taken private or to be absorbed by another company in order to avoid a formal declaration of bankruptcy.
On the Nature of Failure
This article isn’t a criticism of failure. Failure in business is to be expected, and we certainly need visionaries who push the boundaries of new technology. Failure can occur for a number of reasons, including many that are entirely understandable. However, if failure takes place because unrealistic claims were made and unrealistic expectations set, those who lost money in the failed venture may take a harsher view. They may even file class action lawsuits against those who misrepresented a company’s outlook. But in reality, outside of outright fraud, the investor can only blame himself for failing to do the appropriate due diligence.
In any case, when failures occur, we should take the opportunity to learn from them. There is much to be learned from KiOR’s journey from hot biofuel IPO in 2011 to penny stock. The odds of this technology soon being resurrected from the ashes are slim. But there are technology lessons learned that can be applied as future companies attempt this pathway.
There are several lessons for investors here. The first is that the advanced biofuel space is very challenging. It is capital intensive and can take many years to produce returns. This is not the sort of model that has been successful in the past for venture capitalists.
The second is that investors need to be careful whom they listen to. A number of analysts gave strong recommendations on KiOR, and many reiterated those recommendations all the way down. These recommendations were based on the company’s own guidance, but other statements KiOR made about its technology should have raised questions about management’s credibility for any expert.
Finally, just because some is an expert in one field does not make them an expert in another. Vinod Khosla made his fortune in Silicon Valley. Bill Gates made his fortune in software. Neither of them have any demonstrated expertise in the energy sector, nor more specifically in advanced biofuels. Therefore, an investment by either of them in a sector outside their expertise shouldn’t be viewed by investors as a particularly positive signal. Indeed, if you had invested in KiOR on the day that Bill Gates’ investment was announced and held through today, you would be down 96.5%.