Plunging Oil Prices Require Alternative Fuel Startups to Take a Long View

11/26/08Follow @bvbigelow

Historic high prices for petroleum over the past decade have stoked a surge of interest in alternative fuels and renewable energy, and dozens of startups have been formed to develop new technologies in the field.Now this year’s extraordinary spike in crude oil prices is being matched by an equally spectacular swoon. Crude oil prices fell to $50.77 a barrel on the New York Mercantile Exchange yesterday, and GasBuddy.com shows the average price for a gallon of regular gasoline is $1.87 nationwide.

So what do plunging fuel prices mean for biofuel startups?

I raised the question in an e-mail to Jason Pyle, founding CEO of San Diego’s Sapphire Energy, which has been at the center of intense interest since the startup announced a breakthrough in using algae to make “green crude” identical to crude oil. Sapphire also has the sort of pedigree that turns heads. Sapphire announced in September it has raised more than $100 million from Bill Gates’ venture fund, Cascade Investment, as well as Seattle-based Arch Venture Partners, Venrock and Wellcome Trust.

The critical thing to keep in mind, Pyle says, is that it’s imperative for the United States to develop new sources of energy—and that process will take years, even decades.

“The price of oil does impact immediate thinking about where some investors will put their money,” Pyle wrote. “Investing in the right kinds of emerging energy products is a highly leveraged bet on the long-term growth of the world-wide economy.”

Of course, investments in biofuels companies developing ethanol fuels produced from corn and other food crops appear now to be the wrong kind of bet. VeraSun, one of the nation’s largest ethanol producers, filed for bankruptcy protection last month after betting the wrong way on corn prices. We reported that Seattle’s Imperium Renewables had to raise additional capital last month following some business reversals. It is the largest biofuel plant in the U.S. and uses either soy or canola as its base stock for making biodiesel fuel.

Congressional subsidies that favor some alternative fuels are a sore point for Pyle, who told me earlier this month it’s also imperative for policy-makers to “level the playing field” to ensure that the best alternative energy technologies prevail.

Sapphire became an overnight leader in biofuels development in May when it came out of stealth mode to say it had proven the feasibility of using algae to make “green crude” that can serve as an identical substitute for crude oil.

I took Pyle’s answer to mean that the success of Sapphire’s “renewable gasoline” depends on longer-term trends—such as declining global crude production and a push for cleaner-burning fuels—and not on transitory swings in volatile commodities markets.

I sought a second opinion from Bilal Zuberi, who specializes in cleantech investments at Cambridge, MA-based venture firm General Catalyst Partners. “We’re not at all unhappy” about plunging oil prices, Zuberi told me. “The hotness of the market will go away, so we’ll start to see more realistic valuations.”

Zuberi adds, though, that startups developing alternative fuels technologies will have to show they can be financially viable even if crude oil prices slip as low as $40 a barrel.

Pyle’s point, of course, is that even if crude prices fall more in the short term, they will only rise over time. “After we recover from the current financial debacle, expanding economies will outpace available energy supplies again,” Sapphire’s Pyle says. “The tight margin between production and demand will cause another price run up. Nations who plan for the long term are doubling their efforts to secure energy sources during these times, not pulling back.”

As an aside, Pyle says, “This is another example of a real problem with our current domestic thinking. We as Americans need to become far less focused on instantaneous cost and instantaneous profits. We need to think about how our debt is fueling a frightening foreign trade gap that is leading this nation into long-term decline. The people who built this great country used to value their decisions by the impact it would have on their children; now we have business leaders and policy makers that have a hard time thinking beyond the next quarter, next day or next 15 minutes. It’s how we ended up with the worst financial blunder in the nation’s history.”

Bruce V. Bigelow is the editor of Xconomy San Diego. You can e-mail him at bbigelow@xconomy.com or call (619) 669-8788 Follow @bvbigelow

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  • http://www.icis.com/blogs/biofuels Biofuelsimon

    I guess that more realistic valuations of biofuel companies and a shake out of some of the more highly leveraged and more recent entrants into the market will help the long-term viability of the industry. I’d also be interested to see any moves to integrate along the chain from source to fuel. Two things the oil business do well, but the biofuels business doesn’t. Give value to shareholders irrespective of where the profit is between the ground and the wheels of the vehicle. 2 Distribute fuel efficiently over great distances. New technology is a great story but unless it is used by firms that can do these things, it won’t make a meaningful contribution to gasoline replacement.

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  • http://tridemoil@aol.com Bob van der Valk

    The new administration will be very supportive of the Biofuels industry especially if they are environmentally friendly such as green algae process. Crude oil prices will hit bottom in the next few weeks and I have written the following article entitled: Crude Awakening with the reasons for my opinion:

    U.S. refiners would seem to want to store barrels of crude oil and finished products for future use especially with the current price of crude oil at its lowest ebb in thee years. However, banks have been very restrictive on credit lending for speculative purposes and the cost of borrowing to do so has risen.
    Crude will be a very tough call after first of the year as so much will depend on the economy. If that gets much worse crude could fall to 40 bucks per barrel (there are 42 gallons in a barrel of crude oil) before the end of this year. No one will be flying, fuel demand will keep dropping and the big consumers of energy like China and India will be cutting back their demand even further. In any case we are setting ourselves up for a spike in crude oil sometime in the near future as many crude oil production projects are now being cut back or canceled.
    There will be a big demand for Very Large Crude Carriers for use as floating storage at the end of this year because of LIFO (Last In, First Out) issues and refining utilization rate cuts. With the LIFO method of accounting, refiners watch their year-end inventories very carefully. It all depends on how each refiner started the year since end of year inventory levels will be determining either big profits or big losses for the year. The crude price contango, which happens when the futures price is above the spot price, helps to make up for the storage costs. That difference is about 75 cents per barrel for December 2008 to January 2009 trading. Instead of dumping crude oil, they could then hold on the barrels but only if they have the capital to invest in floating storage for up to two million barrels per VLCC. If a player holds crude oil off shore, there are no ad valorem taxes applied as they would be for on shore inventory.
    On top of that The EIA now estimates OPEC’s surplus production capacity could rise from about 1.8 million barrels per day to 4 million barrels per day by the end of the next year. The ten-year average is 2.9 million barrels per day. OPEC spare capacity will reach at least 3 million barrels a day, which would provide Saudi Arabia with a cushion large enough to provide a capability to dampen the impact of future disruptions or geopolitical uncertainties on crude oil prices.
    This presents the possibility for “the perfect storm” in the crude oil market along with overall fuel demand being down in the U.S. After the first of the year all of the refiners with empty tanks and enough capital will be scurrying to get them filled up in anticipation of switching their production to summer gasoline. The price of crude will be driven by market conditions instead of the other way around. Crude oil prices will initially go back up and settle in the 60’s before taking another big hike in time for the start of the summer driving season.
    Either way there will be a rude awakening for gasoline consumers on January 1, 2009.

    Bob van der Valk is a petroleum industry and fuel-pricing analyst residing in Issaquah, Washington.

    My viewpoints about the petroleum industry can be found at website address: http://www.4vqp.com/ourconsultants/thegasguy.html

  • Bill

    I really like Pyle’s last comments. “We need to think about how our debt is fueling a frightening foreign trade gap that is leading this nation into long-term decline.” That is absolutely correct, and a point I make in comments over and over again. The hold up is that bringing down the debt creates recessions with about a two year lag. And recessions are political poison.

    I read an article today in the Wall Street Journal that also cautions that there will be “declining global crude production”, as Bigelow puts it. It mentions a boomerang effect that may send oil and gas prices soaring. Bill Gates’ investment may pay off yet.

  • Bill

    I read an article today in the Wall Street Journal that also cautions that there will be “declining global crude production”, as Bigelow puts it. It mentions a boomerang effect that may send oil and gas prices soaring. Bill Gates’ investment may pay off yet.