Alt Fuels: Not Ready for Private Equity Primetime?

Interesting article out of U Penn's Wharton School of Business about the role of private equity and energy. The basic premise: while the energy sector is experiencing unprecedented interest from private equity investors, it's doubtful that alternative fuels will. At least at this point.

No surprise why private equity is moving into 'traditional' energy. The article lists the following data supplied by the U.S. Energy Information Administration:

• World oil prices will be 35% higher in 2025 than was projected in 2005.
• World economic growth is increasing at an average annual rate of 3.8% over the period through 2030.
• World energy consumption is expected to expand 71% by 2030. (From 421 quadrillion BTU in 2003 to 722 quadrillion BTU in 2030).

According to Jonathan Farber, cofounder of energy specializing private equity firm Lime Rock Partners energy: "In 1998, there were just five or six other private equity firms in the energy business with about $2 billion worth of capital invested. Now, there are 15 to 20 competing firms with $30 billion invested in the industry."

Makes the $32 billion spent by the consortium of private equity groups led by Kohlberg Kravis Roberts to acquire Texas based energy supplier TXU Corp seem pretty straightforward.

Alternative fuel companies shouldn't hold their breath for an onslaught of private equity $, however. Here's why, according to Bill Macaulay, chairman of First Reserve Corp., a 25-year-old private equity firm focused on energy:

"Alternative energy investments may be attractive for smaller firms or venture capitalists, but they are unlikely to attract classic buyout artists because there is often little, if any, cash flow to pay down debt. Alternative energy is [also] extremely price sensitive... you need high prices to justify almost any alternative."

Tesla: I Don't Get It

Apologies: I know I just posted on Tesla recently. But something's bugging me.

Far be it from me to denigrate the great job that Tesla has done so far with their roadster. They figured out one of the great issues related to EVs: there's no significant market for a electric far that looks goofy. Their roadster, despite a recent drop in estimated total range, is a sexy, exciting high performance car that has changed the way people look at EVs. Yeah, the phrase is tired, but it's a paradigm shift for electrics.

But I can't figure out their marketing plan to save my life. Reading the company blogs related to marketing, you learn that the company is taking the car on a road show. In addition to showcasing the vehicles to suppliers, Tesla staff are visiting car shows, Earth Day events, and all manner of grassroots car events and organizations.

On the surface, this is a HUGE waste of time and money. Taking the Tesla roadster to an Earth Day event is like trying to sell hamburgers to Hindus: wrong market. Yes, environmentally conscious audiences will lust for the car. But it's a long trip from lust to purchase.

Tesla needs to go back to what makes the roadster so compelling in the first place: it's a limited edition, high performance, attractive car that attracts attention. It's aspirational. It's expensive. It just happens to be an EV. This electric status sets it apart from competitors like Porsche, BMW, and the other high end performers that Tesla should be considering competitors.

Marketing plans should be adjusted accordingly. Opening boutique "showrooms" on the most exclusive shopping districts in the US : Rodeo Drive, Park Avenue, the Miracle Mile, etc. Marketing partnerships with other aspirational brands: Rolex, Coach, etc.

With the roadster entrenched as an object of desire, future releases planned for the rest of us will enjoy the roadster's halo effect. That's the pathway to future economic success.

Ethanol: Khosla is at it again

Khosla Ventures has staked claim to a leadership position among VCs active in the emerging fuels, particularly ethanol. (Not this is any big secret: see founder Vinod Khosla's article in Wired.)

To reinforce the point, Khosla just put $3.5 million into LanzaTech, a New Zealand-based developer of a process that uses fermenting bacteria to convert carbon monoxide into ethanol. From the press release:

"The technology could produce 50 billion gallons of ethanol from the world’s steel mills alone. The technology will also contribute to the production of biofuels from cellulosic feedstocks, as it can convert syngas—comprising hydrogen, carbon monoxide, and carbon dioxide—into ethanol."

The Khosla money will be used for several purposes, most interesting of which is production of a pilot production facility.

Frankly, it's encouraging to see funding support for ethanol production in areas other than corn, which is of questionable value (see earlier post). The LanzaTech solution has a nice closed loop feel to it, and appears to have an experienced group working on the technology (including the former senior scientist from Genentech.)

Should be an interesting one to watch.

Ethanol: What Falling Corn Sounds Like

Scratch the shiny surface of the ethanol "boom", and you get something just beneath that's far less attractive. Don't believe me? Ask Goldman Sachs analyst Arjun N. Murti: he just released a report lowering his stance on biofuels from "Neutral" to "Cautious".

(You might remember Mr. Murti's assertion in the summer of 2005 that we were headed for a "super-spike" in oil prices, potentially as high as $105. At the time oil was trading at ~$45/barrel, and would soon reach over $70 a barrel. No, it didn't reach the lofty heights he predicted, but that's a pretty significant spike nonetheless.)

Why the caution? Pretty simple: dropping ethanol prices and record prices for corn. Not exactly a recipe for success.

The impact of this new caution was pretty quick, and probably best exemplified by VeraSun Energy (VSE). The company announced it is building a sixth processing plant that will raise the company's total output capability to 670 million gallons. Their shares responded by losing 3.6% of their value.

It's pretty apparent , at least to those outside the Midwest, that the future of ethanol does not lie with corn but instead with other, non-feedstock sources. Hopefully the rush by those seeking to curry political favor from the Farm Belt will not trample innovation in developing ethanol from other, technically superior sources.

Autos: Tesla Range In Doubt

File this under "too-good-to-be-true"?

Much has been written about Tesla Motors, the electric car start up that has become synonymous with the recent innovation explosion in alterntive fuels and efficiecy technology. VCs (VantagePoint, Draper Fisher Jurvetson, JP Morgan Bay Area Equity, etc.) and private investors (notably Google co-founders Larry Page and Sergey Brin) have provided the company has been funded to the tune of over $65 million.

Initial range estimates for the company's first roadster model (the Dark Star, pictured here) indicated 250 miles before a required recharge. Following EPA compliance testing, however, that estimate has now dropped to 200 miles. The company attributes this to required added weight for the final production version of the car.

Let's hope that this number doesn't change further. 200 miles of range may still be acceptable to their market. Should it drop below, however, perceptions about the car may begin to shift, impacting the ability to move vehicles after early adopters are sated.

Biodiesel: ConocoPhillips and Tyson

Energy giant ConocoPhillips (COP) and food producer Tyson (TSN) are cooperating on a biodiesel manufacturing process that converts animal fats into fuel. A fact sheet (replete with pretty pictures) produced by the companies can be found here.

Partnerships of this type that produce closed loop manufacturing and distribution systems will undoubtedly be on the rise in the coming years. McDonald's (yes, that McDonald's) has supplied used fryer oil to a pilot biodiesel conversion program in Brazil since 2004. No word on potential US applications at this point, but consider the following: there are about 12,000 McD franchises in the US, producing an average of about 2,500 gallons of waste fry grease annually. That's 30 million gallons of potential fuel. Ergo, I'm assuming a partnership similar to CP-Tyson is inevitable.

One option may be to consider companies with stagnant market share in existing categories or looking to develop new revenue streams with long term potential to placate shareholders...

Biodiesel: Cummins

Engine maker Cummins recently announced it will approve the use of B20 biodiesel in its engines. Previously, the company had limited use to B5. However, Cummins made the move following the results of recent ATSM testing and growing confidence in the quality and stability of B20 supplies.

The important point here isn't that this is going to result in a significant short term impact to Cummins market share. Rather, it's a potential huge shot in the arm to biodiesel suppliers because a major hurdle to B20 adoption by fleet managers (the major user of diesel equipped vehicles) has been removed.

By authorizing the use of B20, Cummins will now offer comprehensive warranty support to engines using the fuel. Without this support, fleet managers charged with protecting their vehicle assets won't seriously consider biodiesel use.

As other manufacturers adopt Cummins' stance on B20, more fleets will adopt biodiesel, making suppliers a more attractive investment opportunity.

Rant: Carrots & Sticks

Two items from Monday Apr 2, one a carrot, one a stick:

1. Stick: In Massachusetts v. the Environmental Protection Agency, the Supreme Court decided that the EPA not only has the authority to regulate greenhouse gases, but has the obligation to do so. No shirking of responsibilities just because you feel like it. The 5-4 decision (is there any other kind these days...?) provides legal support for state laws mandating the development of cleaner cars.

2. Carrot: The Automotive X Prize said they are ready for the public to comment on the proposed guidelines for their clean car competition. You know the X Prize Foundation from the $10 million prize they awarded to the first private group to successfully launch a space vehicle into orbit twice in two weeks. They are doing the same thing for cars: the private group that can build a production ready car capable of 100 mpg wins a to be determined cash prize (probably in $10 million neighborhood.)

Nice symmetry to these both being announced the same day. Let's hope they spur some innovation.

Fuel Cells: Lilliputiuan Systems

Fuel cells on a chip? Sounds like snack food for computers. In truth, however, it may be a breakthrough in fuel cell based power systems.

Lilliputian Systems is yet another MIT sprung startup that has developed technology that, well, puts a fuel cell on a chip. Their focus has been on providing power for portable electronics, which gives you a sense of the size of the systems we're talking about. They are apparently concentrating on butane (prevalent and stable, though still a fossil fuel) as the fuel source.

They are backed to the tune of $40 million by some of the brand names of the VC community: Atlas Venture of Waltham, Mass., Kleiner Perkins Caufield & Byers of Menlo Park, Calif., and Boston's Rockport Capital Partners.

Unfortunately, this apparent promise isn't headed into the auto world. I asked CEO Ken Lazarus if there is any intent to push into the transportation market segment. His response is pretty black and white:

"I don't know much about the economic or other requirement for automotive fuel cells, so unfortunately I can't really comment on this. I believe there are companies looking at using SOFCs [solid oxide fuel cells] for automotive applications."

No question there's an investment opportunity given the explosion in portable electronics. And frankly, practicable applications for fuel cell technologies, particularly those using hydrogen as a fuel source are a minimum of 30 years off.