Notes on Sustainability

Today we are talking with Martin Kleinelanghorst who is the most knowledgeable person I know about biofuels…

S: Hi Martin, Welcome to Notes on Sustainability.

M: Hi Steve. Thanks for inviting me to this forum.

S: With crude oil and palm oil prices so low, biofuels in Asia aren’t looking too attractive. What do you think will evolve in the industry?

M:

That’s right, Steve. Crude oil and palm oil prices have gone through a very volatile phase and even for real experts who are supposed to know, it can be a frustrating experience to predict the future. I remember Lord Brown forecasting US$ 40 a barrel in the first half of 2007, just before prices steadily climbed to over $140. That made him look like a fool for a while, despite having access to perhaps the best and most reliable data in the industry. In that sense, I guess I am in good company when I share my views with you. Let me give you a brief answer first, and then I shall try to shed some light on a range of issues which I believe need to be considered before we can dare to make a more comprehensive prediction.

First, my short answer would be that biodiesel will continue to play a role as a component in the global renewable energy mix, albeit a less prominent one than generally assumed as recently as 2006. The role will shift to the regional and local level where production and consumption points move closer together and distribution costs are kept low.

This shift is clearly the result of significant changes in commodity price dynamics, new correlation effects and distribution cost developments that were previously not observed. But it is also due to recent and ongoing discussions about its impact on biodiversity and the destruction of rain forests as an important carbon sink.

Critics argue that palm oil plantations are the main culprit for the loss of biodiversity and large stretches of rain forest. However, it should be noted that there is a considerable degree of hypocrisy at work here, as none of the critics care to mention that rubber comes from the same latitudes, yet it has been used for car tyres for decades without ever being questioned or discredited as eco-unfriendly. What is also omitted is that palm oil plantations are often established on land that has already been cleared and plundered of its very valuable tropical woods by logging companies who very often engage in illegal logging on the back of permits of rather dubious origin.

There is of course another issue latent in the discussions. When, say, the UK or Norway extract their domestic resources, which happen to be oil and natural gas, and burn them to their respective nation’s benefit and produce significant amounts of CO₂ in the process, there is by and large a general level of acceptance. Yet, when Indonesia and Malaysia use their national resources, which are rain forests, and extract lumber and vegetable oil for their nation’s benefit, we hear an outcry in the international community that such behaviour must be stopped in the interest of biodiversity and to maintain our CO₂ balance. Nobody would question the sovereign rights of the UK or Norway over their oil and natural gas. Yet, implicit in the discussion over biodiversity is the notion that Indonesia’s and Malaysia’s assets are somehow a common good of humankind that must be protected and therefore should be off-limits for these two countries. An interesting conundrum of considerable ethical and legal dimensions. I am afraid I cannot offer you a solution this time round, Steve.

It is all a question of degree, I suppose. With over 6 billion inhabitants on this planet, we have passed the threshold of sustainability (some believe as early as 1980 in fact), which compels us to draw a line in the sand and say, “No further on this path. We have to alter our ways.”

I believe the prospects of biodiesel can be developed from looking at a few simple facts: Size of the industry, growth rates, and supply and demand balance. Let’s start with size.

Biodiesel is a direct substitute for petroleum based diesel. Annual petroleum diesel demand worldwide comes to well over 1 billion tonnes. If we take just the top five consumers (US, Europe, China, India, and Japan) representing some 600 million tonnes, and ask them to replace 5% of their petroleum diesel with biodiesel, this will translate to a demand of 30 million tonnes of biodiesel.

Against this, the entire vegetable oil market is only 130 million tonnes in size (leaving aside the fact that not all vegetable oil is suitable for biodiesel conversion). If all those 30 million tonnes were converted into biodiesel, it would take away 23% of the entire vegetable oil market, with significant repercussions in the market place that would dwarf the price swings we have seen since 2006. Extend this formula to all countries, and these 23% become 50%. At the same time, the impact on CO₂ reductions is limited to 5%. In view of this, it comes as no surprise that the initial euphoria surrounding biodiesel has been replaced by a more realistic assessment, namely a relaxation of the target date of a 10% bio-component in diesel in the EU from 2010 to 2020.

Ramping up vegetable oil production would partly help to address the issue, and indeed this is what we have seen with palm oil. Production has virtually exploded in a mere 10 years, from 20.5m tonnes in 1999 to almost 40m tonnes now. And mind you, this increase in supply has barely kept pace with a corresponding increase in demand, mostly from India and China, so here this rapid expansion had for most of the period very little to do with the demand for biodiesel.

But there is a natural limit to how much vegetable oil can be produced every year on the land available. Barring some spectacular invention that could increase yields by a factor of ten or more, vegetable oil supply is too small by a factor of 20 to meet worldwide diesel consumption. Sumatra Bioscience has announced the filing of a patent in Sept 2008 that promises a tripling of yields with their F1 hybrid seeds. They expect commercialization of this hybrid by 2018, so it won’t have any impact for at least another 10 years. Algae have also enormous potential in theory, as some species under lab conditions have produced yields that were five, sometimes ten times as high as those of the oil palm. While technically feasible, we have not seen any significant technological breakthrough that would make algae as a source of vegetable oil commercially viable on a large scale, and in my view they are unlikely to be viable for perhaps another 10 years.

I remain skeptical until I have seen further evidence. Furthermore, the general release of Genetically Modified (GM) seeds into the biosphere is an irreversible step the medium to long term consequences of which are largely unknown. I can only hope that the people in charge act responsibly.

What matters greatly in this context is the utilization of land. The oil palm easily produces 4000 kg of oil per hectare, compared to a mere 400 kg in the case of the soybean plant. Hence we should be far more worried about soybean plantations in Brazil than about oil palms in Indonesia.

Predicting future demand, we also ought to look at the cost of production. Although government intervention tends to distort the market fundamentals in all sorts of ways (import taxes, export taxes, domestic subsidies) at the end of the day a product will be subject to the law of supply and demand.

Fundamentally, production costs of both crude oil and palm oil are of the same order of magnitude. At a heat value of biodiesel of 37.5 MJ/kg, and a palm oil yield of 4400 kg/ha.yr, plus production costs (including conversion into biodiesel) of US$ 300/to, we get US$ 28.80/MWh energy cost. For petroleum diesel the heat value is 43 MJ/kg. If we assume extraction plus conversion costs of US$ 0.75/gallon, we get US$ 20.91/MWh energy cost, which is lower, but a similar figure. For comparison: the corresponding figure for PV solar energy would be US$ 1000/MWh or higher. In other words: barring extraordinary political tensions that could impact supplies, the market will be driven by demand for both commodities. However, significant increases of production costs are far more likely to occur for crude oil than for palm oil. In that sense, on the cost side palm oil has the edge. In Europe on the other hand, with rapeseed oil as feedstock being more expensive to produce, crude oil has currently the edge.

Furthermore, although 85% the supply of palm oil is coming from just two countries and the liquidity of palm oil is a minute fraction of that of crude oil, there are short term direct substitutes for palm oil, such as sunflower, or soybean oil, which can be grown from one year to the next. Crude oil has enormous liquidity, but crude oil based products do not have such substitutes as palm oil based products as long as biotechnological innovation and the build-up of biochemical plant capacities have gained greater traction.

Back in the here and now, however, other mundane, yet crucial factors remain: consumption patterns of Indian and Chinese housewives would be one of them, representing still the largest single consumer category of all.

Perhaps the most important point at last: the two dominant palm oil producers Malaysia and Indonesia are facing dwindling oil reserves, while experiencing population growth, continued industrialization, motorization (with families and small enterprises switching from scooters to cars), urbanization (with commuter distances increasing between sprawling suburbs and inner cities), and a rise of the middle class. All these factors will cause fuel consumption to grow in these countries at 4% or above. With fuel subsidies already crippling their national budgets today, the prospects for both countries will only worsen, if no remedy is found and implemented. We will therefore see an increase of domestic consumption of biodiesel in these countries at the expense of exports to Europe, the US, or the rest of Asia. The case can also be made for other populous ASEAN countries such as the Philippines, Thailand, and Vietnam who will face similar transportation fuel supply challenges, but do not have significant domestic crude oil reserves.

In summary, the biodiesel industry in Asia is here to stay, but it is undergoing a change of direction to shift its focus towards the domestic and intra-Asian markets away from its export orientation it started out on around four years ago.

S: The argument against using food crops for fuels has been widely accepted in the EU.  Do you think it will be sustainable for EU governments to push for the use of biofuels in the long term and if so, where from?

M:

The trouble with the EU is that there is not one single policy reflecting the shared view of all member states. We are dealing with four large countries (Ger, Fra, Ita, UK) each with their own agenda how to address their national energy challenges. Then there are a number of medium sized countries (Spa, Pol) with a few ideas of their own. The remaining countries — and there are 21 of them! — are left to choose which agenda they consider most favourable to their own interests.

Just take for instance the sharp contrast between the UK which has enjoyed energy autarky for the best part of the last 30 years, but is now running low on North Sea Brent, France which is relying heavily on nuclear energy, and Germany which has made arrangements with Russia over the supply of natural gas for the medium term, with some not insignificant political implications that follow from such a deal. Viewed from this angle, it is difficult to conceive of the notion of one single EU wide biofuels policy other than on paper.

If there is one common interest shared among EU governments in their drive for more biofuels then it is the objective to bridge transportation fuel shortages, cushion the impact of price hikes, and reduce dependencies on foreign sources by establishing or expanding domestic fuel resources, until such time when other energy sources can take over, namely: wind, solar, and perhaps geothermal.

Germany, Spain, and Denmark are pioneering the use of wind and solar energy for electricity generation and for the next generation of cars that will no longer be driven by combustion engines. But this transition will take time, so combustion engines will be around for at least another 15 years in the EU, and the EU will tolerate domestic biodiesel and environmentally acceptable bioethanol imports from abroad, be it from Brazil or Asia.

Fuel cell and hydrogen technology are technically mature enough to be implemented, yet they are still far too expensive to be produced on a large scale, not least because the infrastructure that would be required for these technologies must be financed, and it is yet unclear who would pay for these new facilities.

To go further into detail, let’s distinguish between biodiesel and ethanol, because their business cases differ greatly.

Historically, the biodiesel market in the EU was the first and, perhaps apart from China, still is, the largest of its kind in terms of demand. However, while supply was produced almost entirely domestically, the expansion of palm oil production in Malaysia and Indonesia since 2000, and from 2005 onwards the explosion of the crude oil price and the price advantage of palm oil over rapeseed oil threatened to change the established status quo. The inclusion of new Eastern European EU member states vying for EU subsidies also changed the dynamics. This caused various national governments in the EU to reassess their long term strategy with respect to biodiesel. Recent policy changes have made clear to me that the preference is for domestically produced diesel over imports, although the official line might suggest otherwise.

As for the general public in the EU, they are concerned about the impact certain biofuels might have had on the availability and prices of food crops – if the biofuels were produced abroad. Yet there are companies in Germany producing biogas from grain, because EU subsidies make it worthwhile. For my father, who personally experienced hunger in the aftermath of world war 2, this is sacrilege and beyond comprehension. And many younger people who do not share his personal experience also object to it on purely ethical grounds. So the dividing lines don’t follow national borders, but divide families as well as local communities.

A cynic may summarize it this way: On a government and company level, biodiesel was “good for the environment” as long as the beneficiaries were domestic EU farmers. Biodiesel became “bad for the environment” when the beneficiaries threatened to be Malaysian and Indonesian plantation owners. Now the EU policy shift in focus towards wind and solar energy development have in my view made clear where the EU sees its long term priorities. So, I don’t see the EU mounting a fervent defense to the rescue of biodiesel or trying to get it out of the doldrums. We should not expect additional demand for non-European biodiesel coming from Europe.

In view of the EU’s decision for a 10% biodiesel component by 2020 instead of 2010, this relaxation is tantamount to putting it off indefinitely. The new catch word is 20-20-20, referring to 20% reduction of primary energy use, 20% renewables in the mix, and 20% reduction of GHG emissions, all by 2020. Given the fact that the EU is modifying its policy every year, investors have a hard time if they want to use the EU framework as a guide for making investment decisions.

Chemical plants are highly capital intensive and require at least 10 years for depreciation and amortization. Just take Germany’s decision to introduce taxation for biodiesel producers in 2007 after promising tax exemption until at least the end of 2010. This about turn has already driven a large number of local producers into insolvency, when the new tax coincided with price hikes in the vegetable oil market. I don’t think that is a coincidence. It ties in with Germany’s new focus on wind and solar.

Having said all this, my criticism may be a bit harsh. After all, Europe is the true driving force behind the global renewable energy initiative and the most advanced in terms of implementing measures to get results. We can do research in laboratories all day long, but if the results don’t get implemented we might as well leave them undiscovered and save the money for other, more useful applications. This is exactly what happened during the 1990s when oil became cheap for a while and the innovation process was stalled.

What I also like about the European policy is that it is robust. It is multi-faceted which takes advantage of trying several approaches at the same time, then comparing outcomes. This allows for adjustments and optimization in a dynamic sort of way. It’s called evolution. It may not be such a bad thing after all that within a given framework different EU countries follow different agendas. By contrast, in the US we see practically a one-track renewable energy policy: corn based ethanol.

As for ethanol, here the US and Brazil are by far the largest markets, both in terms of supply and demand, representing well over 80% in both cases. Since the bioethanol industry in the EU is insignificant in size by comparison, the EU has a less biased view on the matter. As a result, Brazil receives benign treatment and import duties of cane based ethanol are considerably lower than those for corn based ethanol from the US, and in my view rightly so, for environmental reasons.

Corn based ethanol in the US is folly, in my view. The overall energy balance is barely positive, some argue it is even negative. Cane based ethanol on the other hand makes sense. Hence I see the EU fostering relations with Brazil while driving a hard bargain with the US. Other players who can come up with an attractive proposition would be welcome in Brussels.

S:  Cellulosic Ethanol (CE) has been a big topic recently.  Some false starts for projects promising conversion of biomass to ethanol have occurred regionally.  What is your view of the time frame for this technology being successfully implemented? The US, EU and Malaysia have made encouraging starts but do you think it will fly in the near term?

M:

Yes, some people have jumped the gun and promised more than they could deliver. That is not surprising, given the promise CE holds for the future of biofuels. Here is a fuel technology that can use almost anything made of organic material and turn it into a liquid fuel. If it gets produced on a large scale it will have a material impact on crude oil consumption for fuel.

Going by the announcements made by the technology leaders in Europe and the US, CE has still some way to go before it is commercially viable though. My estimate is that we won’t see a fully-fledged CE plant before 2012 that produces bioethanol both (1) at commercially competitive prices and (2) on a meaningful scale. Laboratories can produce bioethanol at a rate of 1 tonnes per hour. What we need to see is at least 10 tonnes per hour.

There are plenty of announcements by US based companies who claim to be able to produce “commercially viable” 2^nd generation ethanol. Yet, none of them show a fully costed price of ethanol that properly includes construction and depreciation of the plant. Until this is done, statements such as “US$ 2/gallon conversion costs” are something of a charade.

The new US president Obama and his administration may shake things up, though, but we don’t know yet. Low crude oil prices may tempt people in key positions to let up and cause the innovation process to slow down. This would obviously be the worst that can happen to the renewable energy movement.

However, with Steve Chu and John Holdren appointed to key positions in the US administration, both scientists with a track record of sound research of the highest calibre, there are good reasons to believe that the best possible policy benefiting the environment will be identified and implemented. For once, this sounds too good to be true.

Under Obama, we should expect an accelerated allocation of funds and resources towards US energy independence. CE has the benefit of combining substantially higher efficiency in producing fuel while using existing combustion technology and fuel storage and distribution infrastructure. Wind, solar, fuel cell, or hydrogen fuels require very high investments in infrastructure before their full benefits can be harvested. It gives CE an edge in the short to medium term.

S:  Despite the difficulties, CE still has immense commercial capacity. Some countries like Cambodia and Laos could achieve significant levels of energy independence.  Do you think the technology will have wide applications or only for large scale plants?

M:

It is true that small bioethanol plants have suffered from high construction costs in the past. A critical benchmark seems to be the 50 million tonnes (approx. 16.7 million gallons) output threshold. Most investors have striven to build plants of this size and tried to avoid building smaller plants. Increased energy efficiency, cost savings of construction material, and a favourable variable to fixed cost ratio strongly suggest this course of action.

Now, these insights have held for proven technology such as 1^st generation ethanol. 2^nd generation ethanol is still in its infancy and we can expect a healthy dose of teething problems in the up-scaling process. In my conversations with R&D people I repeatedly hear the mantra that up-scaling in biotechnological processes is notoriously difficult and anybody trying to take a shortcut will get punished.

It is therefore not such a bad idea to start with a 1^st generation plant, and bolt on 2^nd generation technology as and when it becomes available. The cost outlay for 2^nd generation technology will most likely be not so much for mechanical equipment, but for intellectual property rights and the purchase of enzymes. In addition, it may not be wise to commit large funds in a one-off investment into technology that two years later may have already become obsolete due to advances in the field. A phased approach is therefore highly recommended.

S:  Are there any other developments in biofuels which could make them more attractive?  For instance Indonesia has moved quickly into Jatropha biofuels but this has yet to produce results.  Do you think there is a role for government guided industry development?

M:

I am skeptical about Jatropha in Indonesia on a large scale because it represents a deviation from the optimal utilization of land. On arid land it does have an edge over the oil palm, but how much arid land is there in Indonesia? And on the arid land that does exist Jatropha competes with edible crops just as much as the oil palm does on wet land. Jatropha yields are only a quarter of what palm oil yields are.

Indonesia is very fortunate in the sense that it combines volcanic soil with being located at latitudes that allow the optimal growth of the oil palm. Few other places offer this perfect combination, not even Brazil with its abundance of land in the tropical belt. Why would anybody volunteer to squander their resources by planting suboptimal crops? Let those countries that are less blessed grow Jatropha. Burma, Cambodia, Vietnam, India, Madagascar, they all qualify in this respect.

Government guided industry development is certainly a path I can see as being beneficial and potentially very rewarding. Many countries have successfully pursued such policies, Japan, Korea, Singapore, and more recently China have used this tool to their advantage. By creating incentives to entrepreneurs and by protecting fledgling industry clusters through attractive credit terms or favourable tax regimes, various industries in these countries attained critical mass: ship building, precision engineering, electronics, automotive, biotechnology are just a few examples. A biofuels industry can become the nucleus for further development into chemical, pharmaceutical or biotechnological clusters.

S:  Thanks for your time and insight Martin.