Biofuels offer a growing alternative

Biofuels offer growing alternative

With the New Year comes a new Congress and the promise of change - but some things remain the same. While the moratorium on drilling in the Gulf of Mexico has been lifted, people remain worried about oil exploration in environmentally sensitive areas. The U.S. is back to debating the issue of reducing dependence on oil, especially from distant and volatile areas. Notwithstanding recent stop-gap legislation - such as the one-year extension of biofuels subsidies as part of extending the Bush-era tax cuts - our energy future still begs the question: Is it finally time to take a close look at biofuels as a viable alternative for America's transportation energy needs?

Compared with other clean technologies, people have a love-hate relationship with biofuels. The carbon footprint of first-generation biofuels often ends up neutral or only slightly positive. They consume increasingly scarce water resources. And they compete with food markets for corn feedstock. Moreover, the U.S. biofuels industry lacks scale and is vulnerable to volatility in supply and demand. For example, the EPA recently approved an increase in ethanol blend levels from 10 to 15 percent. Yet automakers protested the effects on older vehicle engines. And biofuels still require subsidies to ensure adequate production. The temporary lapse of bio-diesel subsidies in the first three months of 2009 caused nearly a 50 percent drop in the production of biodiesel.

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Given the uncertainties, why would the U.S. even bother to make biofuels a part of its transportation energy future? We have only to look south for the answer: Brazil found a way to make ethanol a viable fuel for vehicles. On the supply side, Brazil produces sugarcane-based ethanol at a price that attracts consumers when oil prices go above $70 to 80 a barrel. Bain & Company analysis suggests that through technological advances and increased scale in production, sugarcane-based ethanol prices will fall to a level where they can compete well at the pump, even if oil prices drop to $60 per barrel. On the demand side, flex-fuel vehicles account for 95 percent of all new light-vehicle sales in Brazil. Motorists can refuel with any blend of ethanol or gasoline depending on the prices advertised at the pump.

At first glance, this may seem difficult to replicate in the U.S. In reality, it might be simpler than expected. The auto industry claims it is set to boost the demand for ethanol. General Motors Co., Ford Motor Co. and Chrysler Group LLC say they expect to meet a 2006 pledge to double their production of flex-fuel vehicles by the end of 2010 to more than 1.4 million, increasing their flex-fuel vehicle output from 30 to 50 percent of total vehicle production by 2012.

The real constraint emerges on the supply side. By current estimates, ethanol production in the U.S. will take five to 10 years to reach commercial viability. Second-generation (lignocellulosic biomass as feedstock) and third-generation (biofuel from algae) technologies have shown biofuels can be cost-competitive, but need time for commercialization.

But even here, forces of change are gathering to address the supply issue. Most major oil companies have invested hundreds of millions of dollars in developing next-generation biofuels from various sources: ExxonMobil (algae), ConocoPhillips (vegetable oil and animal fat), Chevron (cellulosic biomass), BP (cellulosic ethanol and biobutanol) and Shell (Brazilian sugarcane ethanol). Biofuels make greater use of their current liquid fuels distribution infrastructure and therefore, are closer to their core business than disruptive technologies such as electric vehicles or natural gas-fueled vehicles.

Big Oil investments alone could provide the momentum to take next-generation biofuels to commercial scale. Additional impetus comes from the conventional oil market. With oil prices projected to remain fairly high in the foreseeable future, the next generation of biofuels will find it easier to be cost competitive, perhaps even without a carbon tax or regulatory help. Given time and patience with R&D, therefore, there is no reason to believe America cannot replicate Brazil's biofuel success in developing alternative transportation energy sources.
 
Steinhubl is a partner in Bain's Houston office and co-leads the North American oil and gas practice. De Sá, a Bain & Company partner based in São Paulo, leads the firm's South America and West Africa oil and gas practice.