Home / Chapter 7 - Commercial Contracts for Algae Biofuels Projects / New Model for Historically Commodity - Driven Business

New Model for Historically Commodity - Driven Business

Typically the term “feedstock” means the predominant raw material used in biofuels production, e.g., corn in ethanol and soy oil in biodiesel.  The term “raw materials” means other necessary inputs to the process, including methanol and catalysts such as sodium hydroxide in biodiesel production.  In the case of algae biodiesel, the feedstock is the algae oil and the raw materials are the nutrients and components required to grow the algae and extract the oil, and the inputs for the conversion of the algae oil to biodiesel.  Unlike the traditional feedstock model, an algae biofuels facility that produces its own algae oil largely independent of the traditional commodities feedstock market.  A producer of algae biofuels will have a good idea of the cost to produce algae oil.  Generally these costs will be fixed, subject to variables in raw materials costs.

The Fuels Industry:  Biofuels vs Petroleum Based Pricing

The biofuels industry has rapidly evolved in structure and scale over the last twenty years and particularly over the last five years the evolution of “Big Oil” that defines the current transportation fuel market.  Since its development in the early 1900s, oil has powered the tremendous expansion in human capabilities, but consumption has begun to overtake availability.  The world’s dependence on oil is due to the fuel’s abundance, vast distribution network, and diverse uses.  In energy-hungry countries like the United States, citizens have access to a ready supply of high-quality oil-based products, and this convenience conceals the processes of extraction, refinement, and delivery that have to comply with stringent quality, safety, and environmental specifications.

Biofuels enter the petroleum distribution river at several insertion points.  Bulk ethanol, with its larger volume scale, properties as an oxygenate, and specialized handling requirements, is typically blended at the terminal level, whereas biodiesel, that meets ASTM standards, is usually introduced at the bulk plant level.  Terminals are large volume wholesale distribution facilities and can be co-located with refineries where crude oil is processed and piped to storage tanks.  Other terminals receive deliveries of only finished products.

Biodiesel, which currently enjoys approximately 10 percent of ethanol’s market penetration, has reached terminal scale (or been mandated) in only a few states.  Biodiesel’s relative ease of handling, its varying blend levels, and the potential margin opportunities for petroleum distributors have supported its introduction at bulk plant facilities.  These bulk plants are typically controlled by independent petroleum distributors that store modest quantities of diesel, fuel, lube oils, and specialty products to distribute to their customers.

The wholesale market in refined petroleum products is characterized by diversity in market participants, pricing transparency, and market-based pricing.  Vertically integrated major petroleum companies maintain separate earnings and profits, refinery, wholesale, and retail departments with complex internal pricing structures.  Independent petroleum distributors typically “buy off the rack,” where pricing fluctuates at least daily if not hourly.  Though there are grumbles when pricing moves up, typically the entire rack complex in a market follows suit and petroleum distributors are no worse off than their competitorsunless they filled their bulk plant at the wrong time or bought substantial quantities forward.  Because of the high risk in forward speculation, bulk contracts to encourage rack loyalty are based on “discounts to rack” or a certain price reduction from the posted market price.  Thus, when independent petroleum distributors buy biodiesel, they want to see this same pricing structure.

In the case of biofuels, market-based pricing poses several challenges.  The primary one is that the independent petroleum marketers are not looking for biofuels market-based pricing; they want petroleum fuel-based pricing.  This presents a fundamental inconsistency because the cost of biofuels is not determined by petroleum costs.  Even if buyers will consider biofuels market-based pricing, the biofuels market is typically unsatisfactory from their perspective due to its relative immaturity, limited number of suppliers, and lower quantities of product.  Biofuels sellers typically lack the ease of delivery, volume, pricing transparency, and fungibility present in petroleum markets.

In mandated markets, the integration of biofuels has become a cost of doing business.  In economic markets, biofuels provide profit opportunities for the market participants most able and willing to make money from them.  Depending on their motivation, petroleum market participants will buy biodiesel at a fixed price, on a petroleum index, on a cost plus basis, or on a biodiesel index.  They will buy spot or fixed, short  or long-term.  However they buy the fuel, they likely will demand that it be delivered on schedule at the agreed on pricing and quality level.

The Bank’s Perspective 

The final factor that comes into play in the algae biofuels market is the impact of financing.  Projects that are self-financed can make unilateral decisions about pricing structures and business opportunities; determine their appetite for risk; and act accordingly.  Companies that rely on loans and equity investors cannot be so flexible.  The project lenders or investors require oversight of the project and risk mitigation. 

Integrated algae biofuels facilities do not have the same issues as traditional biofuels plants that must acquire agricultural feedstocks.  The cost of the algae oil is not directly tied to the commodities market.  The predictability of the cost to produce algae oil can be a great advantage for an algae biofuels plant if the algae oil production cost is competitive.  Currently, algae companies have claimed they can or will in the near future produce algae oil biodiesel for approximately $3 to $6 per gallon, although a June 2009 study by Algae 2020 indicated the cost ranged between $9 to $40 per gallon, depending on the technology used.  New technologies hopefully will help to drive down the costs to commercially competitive prices.

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