KiOR Inc. and Re-Crude

Barrett (2009) writes that a dramatic shift in technological innovation will serve as the key to propelling the mitigation of climate change. In the long run, undoubtedly, he is right. Technological innovation, however, is costly, high-risk, takes time and absorbs extensive amounts of financial and physical resources. At the same time, the estimated costs of climate change are high enough to warrant innovation and technological investment. But what is the real value of the new technology? How realistic are the results often promised by these entrepreneurs? The following is an exercise in determining the business and economic value of a new technology recently brought forward for IPO in April 2011. The company is KiOR Inc. and their product is a synthetic crude oil, “Re-Crude,” that is made from woodchips (though potentially expandable to other forms of cellulosic materials) and utilizes catalytic cracking to extract energy, a technology that has been used in the liquid transportation fuel industry for over 30 years and that is well understood. The final product can be refined in the current liquid-fuel infrastructure and can be refined into both gasoline and diesel fuels, much like it fossil-based counterpart.

According to the S-1 released by the company, the facts are:

• Estimated cost of $190mm for a 500 Bone Dry Ton (BDT)/day plant

• Production of 1500 BDT/day will put price of Re-Crude at $1.80/gal or $76/barrel

• 1 BDT yields 67 gal of Re-Crude

• 1 high-grade BDT costs $72.30 (Southern Yellow Pine)

• KiOR backed by $1bb long-term matching loan guarantee from DOE

• Estimated to release 80% less greenhouse gases throughout the lifecycle of the product

• Energy equivalent of crude

• Completely incorporates into current liquid fuel infrastructure

From a business perspective, the calculations suggest:

• Yearly production: 1500 BDT/day x 67gal/1 ton BDT x 1 barrel/42gal x 365 day/yr

873,400 barrels/yr

• Yearly Revenue: 873,400 barrels/yr x $76/barrel

$66.4mm

• Costs of biomass: $72.30/BDT x 1500 BDT/day x 365 day/yr

$39.6mm

• Annual Overhead costs: estimated at ~$10mm

So, from a business perspective, this is a viable business. What about from an environmental perspective?

• 1 gallon of gas releases: 20-22lbs CO2/gal

• ~$20/ton of CO2

• Re-Crude production: 873,400 barrels or 36.7mm gallons

• Re-Crude reduces emissions by: 16 lbs CO2/gal

• Re-Crude saves:

16 lbs CO2/gal x 36.7mm gal/yr

587mm lbs of CO2

587mm lbs CO2 x 1 ton/2000lbs x $20/ton

$5.9mm saved in costs incurred otherwise due to CO2

The purported savings of Re-Crude could amount to nearly $6mm in adverted externalities as well as a great business potential. Sound too good to be true? Well, it is, sort of.

Sensitivity analysis suggests that if the price of the input rises to above $121/BDT, the fuel becomes more expensive than the current (April 23^rd, 2011) price of oil ($113/barrel). Prices in the lumber market have been rising steadily in the past years due to increasing demand worldwide for construction materials (and this new technology would only exacerbate this trend). Similarly, the $1.80/gal production cost estimate is an at best figure only achieved after sufficient scaling of the (expensive) production facilities. More than likely, the price of $1.80/gal won’t be achievable in the near-term (within 2-3 years) and will most likely remain above $2-3/gal. The breakeven point with current oil prices is around $2.85/gal Re-Crude.

Similarly, this production method promises potential, yet the absolute amount of current consumption of fossil-based fuels in the US alone far surpasses the annual supply by this company. We consume over 20mm barrels of oil a day. That’s almost 7.5bb barrels a year! Re-Crude, to even make a 1% annual dent in the liquid fuel industry would have to incorporate over 400 plants (399.5 more than exist currently at a cost of ~$200mm per plant) and also would require forest resources that would deplete current stocks within 25-40 years (100 years if we stop harvesting for lumber to build anything). Similarly, current stocks of the most sought after woods are in the southeastern United States, where it may be difficult to develop 400 plants.

In short, the technology has potential, but will not serve as the change agent for the liquid fuel industry. The physical and environmental resources (currently) do not exist. On a small scale, this may provide a potential gap fuel, but will ultimately not be a long-term solution to climate change or emissions reduction. The variable costs will surely become volatile or at least higher as demand grows, and though the producers ensure that other forms of input material will soon be incorporated, it simply doesn’t stand that this particular process will make the revolutionary impact on the liquid transportation sector that Barrett suggests is needed. At the same time, the value of this production method is that it provides another option in circumventing future energy concerns. Barrett pointed out that as cliché as it is, there is simply no silver bullet to mitigate all issues associated with climate change. Ultimately, KiOR and Re-Crude will serve as one potential step in the multi-system approach necessary to challenge climate change.