TEN COMPANIES currently control more than 80% of U.S. refinery capacity. Of those 10, most have entered into the biofuels business through outright acquisition or research investments. What could this mean to the U.S. ethanol and biodiesel industries and the growers who produce the feedstocks for them? Can oil and ag mix?

The two industries are already mixed today. The major oil companies have become players because they have been required by law (through the Renewable Fuel Standard, RFS) to blend ethanol into their gasoline pool or pay significant fines.

“The future role of the oil industry in biofuels depends in part on the types of feedstocks that will be used,” says Todd Alexander, partner at the law firm of Chadbourne & Parke, New York. “If the feedstocks are energy crops, then there is a greater likelihood that the oil industry will play a more significant role than today. In the past, we have seen a reluctance by the oil industry to dive into the biofuels market for a variety of reasons, including fear of being caught up in the food versus fuel debate and because the ag business was viewed as something out of its core competency.” Once those issues become less of a concern, the oil companies should become more involved in biofuels production.

Of all the oil company investments in the biofuels industry to date, the most significant has been Valero Energy Corporation's purchase of seven of VeraSun Energy Corporation's ethanol production plants. (The U.S. Bankruptcy Court approved the sale of VeraSun assets in March.)

“In one swoop, a major oil company became a player in ethanol production, representing about 6.5% of the industry's operating capacity,” says Robert Starkey, vice president, fuels, Jim Jordan & Associates (JJ&A), Houston, TX, a market analysis provider to the transportation fuels, ethanol and methanol industries. Valero is a major buyer and importer of ethanol and blends millions of gallons a year in its own operations, he adds.

Valero got into the business because ethanol is part of the fuel mix, says Bill Day, Valero's executive director of media. “Valero is the largest blender of ethanol in the U.S. Therefore, it made sense to be an ethanol producer.”

Just as important was the price at which the company was able to buy the VeraSun plants. Low margins in the ethanol business enabled it to pay only 30% of the replacement cost for the plants. These seven plants are currently producing positive cash flow for Valero, Day says.

He points out that Valero acquired just seven of VeraSun's 16 ethanol plants, based on the facilities' modernity, size, location (proximity to feedstocks and transportation), and ability to produce dried distillers grains for area feedlots. These plants also were selected based on their ability to integrate new cellulosic ethanol production technologies once they become available.

Valero has no other acquisitions pending in the ethanol production industry right now, Day says. But it does have research investments in alternative fuels.

Another significant investment in the ethanol business was Sunoco's acquisition of Northeast Biofuels, which also had gone bankrupt. “As the largest ethanol-manufacturing facility in the northeastern United States, where much of Sunoco's retail gasoline network is located, the facility is well situated to serve our ethanol requirements,” says Thomas Golembeski, manager, media and public relations, Sunoco. When running at full capacity, the Volney, NY, facility is expected to supply approximately 25% of Sunoco's ethanol-blending needs.

“Sunoco views this purchase as a first step into alternative fuels,” Golembeski says. “We also are currently evaluating investment opportunities in the development of cellulosic ethanol.”

Oil industry researches biofuel

Outright ownership is significant, but oil company investment in biofuels research is also important. It will take a variety of business models, investors and technologies for the biofuels industry to achieve its full potential, says Bob Dinneen, president and CEO, Renewable Fuels Association (RFA).

The investment in biofuels research is significant. BP, for example, is investing $500 million in The Energy Biosciences Institute that includes the University of California-Berkeley, Lawrence Berkeley National Laboratory and the University of Illinois.

Last summer, ExxonMobil announced it would invest $300 million into in-house algae research and another $300 million in Synthetic Genomics, a genetics firm that has developed techniques for harvesting algal oils and increasing lipid content of algal strains.

In the biodiesel business, Chevron has been the most visible with its efforts, including a biodiesel feedstock development and testing agreement with Solazyme, a synthetic biology company based in South San Francisco, CA.

“Refiners have not been very involved with biodiesel until now,” says Joe Jobe, CEO, National Biodiesel Board (NBB). “Things have changed because refiners are the obligated parties for fulfilling the requirements of the new Renewable Fuels Standard [RFS-2].” In 2010, 650 million gallons of biodiesel must be used.

Pipeline companies, midstream partners and terminal companies have made the most significant investments in biodiesel, Jobe says. “As the RFS-2 begins to kick in, having biodiesel blends on the pipeline will become important to improving the economics of distribution,” he explains.

Volume matters

Valero's move in the ethanol industry might have the most significant impact on the biodiesel industry as well, says Jeff Stroburg, chairman and CEO of Renewable Energy Group, one of the country's largest biodiesel producers and marketers. This is because Valero has shown that volume matters.

“Valero entered the ethanol space when it could buy enough volume to make it significant for them,” Stroburg says, adding that consolidation in the biodiesel industry will likely continue. “I don't know what the magic size will be, but the five-million-gallon-or-smaller plants probably won't be able to sustain themselves. Market saturation will determine the optimal size.”

This does not necessarily mean that oil companies are going to take over the biodiesel business, Stroburg says. “Look at other facets of the energy business,” he states. “Oil producers don't own all the pipelines or retail stores, for example.” While some companies will be fully integrated, others will be satisfied with letting the biodiesel plants produce the fuel because they are more efficient at it.

“We'll see a variety of ways that oil will work with ag,” Stroburg says. What business models will develop is anyone's guess, but oil companies will want assured volumes with assured quality.

Oil companies are customers

“It is critical to understand that, if biodiesel is to be successful, it is only to the extent that oil and ag do mix,” says NBB's Jobe. “We have about 2.5 billion gallons of plant capacity, mostly owned by farmer co-ops, individual investors and small companies. Many are in rural areas near feedstock sources. We're not seeing a trend of oil companies trying to buy biodiesel plants. We're working to foster stronger relationships with the oil industry because they are becoming biodiesel's biggest customer, especially as RFS-2 gets implemented.”

“Ultimately, oil and ag will find a balance that allows both interests to succeed,” says RFA's Dinneen. “We will see a variety of business models, including the co-op model that has helped build the industry we see today. Changes in technology and the natural evolution of the industry will render the version we know today unrecognizable five years from now.”

Growers benefit

Rick Tolman, CEO, National Corn Growers Association (NCGA), notes that the association has a good working relationship with the American Petroleum Institute and points out that 7% of the fuel business is accounted for by agriculture, through its use of fuel, crop protection products and so on.

Tolman does not think that the oil industry will buy out the ethanol business but adds that NCGA is looking for ways to get producers more of an equity share of the ethanol business rather than being suppliers alone.

What crop producers can do to benefit from the biofuels market is to get closer to the end markets or consumers of their product, JJ&A's Starkey says. “In the case of ethanol, they need to know the value of their product to the refiner. We call this the blend value. JJ&A calculates this value along with other gasoline components every week in its Fuels & Blendstock report.”

“Growers should look at every opportunity. If that means growing another crop, they should be open-minded and ready to do it,” Tolman says. One of the first opportunities would be to sell residues from corn to ethanol plants buying corncobs and stover feedstocks. Tolman is surprised that there has not been more contracting in the ethanol business. With the continued development of traits, such as high-amylase corn, there could be more contracting.

Wallace Tyner, professor of agricultural economics, Purdue University, suggests that growers interested in the biofuels market develop a diversification strategy. This could include putting a portion of their acreage into an energy crop. Corn stover could be a real revenue enhancer, he says.

Crop producers must also bear in mind that the corn-based ethanol industry is very close to producing the 12.95 billion gallons specified in the RFS for 2010. When that “blend wall” is hit, the EPA cannot require gas companies to blend more ethanol than they are legally permitted to blend. As long as there is a blend wall, there will be “no room at the inn” for cellulosic ethanol because corn will satisfy the required level, Tyner says.

Butanol

At the same time, development continues on next-generation fuels, which can be made from corn starch or sugar beets, for example. Butanol has benefits over ethanol in that it can be blended in higher concentrations without engine modifications and does not separate out in water.

Tyner points out that butanol has a higher energy content than ethanol, which would improve miles per gallon.

Butanol is classified as an advanced biofuel in the RFS-2, and it receives a tax credit from the IRS, just like ethanol, says JJ&A's Starkey. “The reason that butanol is not used more today is that it is very expensive, and no one has developed a technology yet that can make it competitive with ethanol on a large commercial scale,” he says.