Chadbourne hosted a discussion in New York on September 28 on the growing interest in biodiesel projects in the United States.“Biodiesel” is fuel made from plant oils, like oil from soybeans,  sunflowers or rapeseed.The following are excerpts from the discussion.The speakers are Richard  Fumoso, business manager for biodiesel at Lurgi PSI, Dave Fennema, vice president of biofuels at Marathon Capital, LLC, Gene Gebolys, president of World Energy Alternatives, LLC, Jerome Peters, managing director of Hudson United Capital, and Jonathan Phillips, a lawyer in the Chadbourne office in Houston.The moderator is Todd Alexander, who is also with Chadbourne in Houston.

MR. ALEXANDER: Richard Fumoso, what is biodiesel?

MR. FUMOSO: Biodiesel is a methyl ester, and it is produced primarily from vegetable oils. In Europe, rapeseed oil is the primary feedstock. In Malaysia, it is palm oil or palm kernel oil. In the United States, soybean oil is the predominant vegetable oil used. 

MR. ALEXANDER: How is it made? How do you convert the feedstock into motor fuel?

MR. FUMOSO: It’s a very simple, benign chemical reaction. I say “benign” because it is low-pressure and lowtemperature simple gravity separation.

MR. ALEXANDER:The technology to do this has been available for many years.There is more than one kind of technology.What are the differences?

MR. FUMOSO:There are two basic technologies — the Lurgi process and a centrifuge process.  Centrifuges are expensive mechanical equipment that Lurgi stays away from. Lurgi has been  building biodiesel plants for decades because they were part of the oleo-chemical technology sector.

Market Size

MR. ALEXANDER: Gene Gebolys, how large is the biodiesel market today?

MR. GEBOLYS:The US market for biodiesel in 2004 was just over 19 million gallons.We know that with a fairly high degree of certainty because virtually every gallon produced in the United States is subsidized.The total subsidy paid can be confirmed in the US Department of Agriculture records. The market has grown. US output was about 37 million gallons through the first three quarters of 2005. Note that this is the figure for the government’s fiscal year 2005 that started on October 1, 2004, so the figure is production through June.

MR. ALEXANDER: Just to give our audience a frame of reference, let me put these numbers into context. Biodiesel output in 2004 was almost 20 million gallons. Roughly 36 billion gallons of over-the-road diesel fuel is used each year in the United States, and 55 billion gallons of distillates are 
used each year. So biodiesel in the sub-100 million range is undetectable.What people are  interested in is the rate of growth in the market. My guess is growth will be something on the order of 100% again next year. If the market went from 19 to close to 53 million gallons this year, I would expect it to go from 53 to something to close to 100 million gallons next year. Gene Gebolys, who is buying biodiesel today?

MR. GEBOLYS: The vast majority of biodiesel use in the United States to date has been in what
is known as the EPAct fleets.These are the original 1992 Energy Policy Act regulated fleets.There are government fleets and utility company fleets that use biodiesel as a mechanism for complying with the Energy Policy Act.That is a pretty boring little market, and it is not growing very much.

All the new growth is in lower blends. EPAct fleets use a 20% blend.The fuel put into their cars is 20% biodiesel and 80% regular diesel fuel.

The real growth is in lower-blend applications — 2% to 3% blends. For example, Minnesota requires a 2% blend for all diesel fuel. Illinois encourages production of an 11% blend. At that level, biodiesel becomes less expensive than diesel fuel.Texas has an incentive to make a 20% blend, which makes biodiesel significantly cheaper than diesel fuel. At those levels you no longer need a government incentive to get consumers to buy the fuel.The market is becoming more mainstream.We are starting to sell a lot into heating oil applications in the northeast for this winter. Power generation is also a huge opportunity.The thing that makes this fuel attractive is that it is extremely versatile, and it can go into a lot of different applications pretty seamlessly. Attracting Financing

MR. ALEXANDER: Dave Fennema, on what should developers focus who want to raise private equity for their projects?

MR. FENNEMA: There are parallels between the ethanol industry and the biodiesel industry.  Everyone assumes that biodiesel is kind of the kid brother following down the same path. I think the industry will learn a lot and quickly get up to speed.That said, I don’t see the private equity or the large institutional players getting involved immediately in biodiesel with a full head of steam. If they get involved today, it will be on a one-off basis, and on more of a corporate basis for plants and groups of plants that have a creditworthy developer behind them.The overall capital costs for
biodiesel are lower than ethanol. One of the reasons that ethanol is really showing up on the radar screen for the big private equity firms and for the bankers is that the dollars are getting big enough.The dollars are not as big yet for biodiesel.

MR. ALEXANDER: How much does a typical plant cost?

MR. FENNEMA: In the ethanol market, a fifty million gallon plant is a fairly standard plant. Hard  nd soft costs might be in the $80 to $85 million range. Biodiesel will be in the range of $10 to $40 or $50 million.

MR. ALEXANDER: How many million gallon plants are there?

MR. PHILLIPS:The average plant being proposed is 20 to 30 million gallons.

MR. ALEXANDER:What building blocks must a developer put in place to bring equity and debt into his deal?

MR. FENNEMA: An investor will want to get comfortable that there will be a market for the  ethanol. Ethanol today is becoming a fairly mature market. On the biodiesel side, every time you do a 20 or 30 million gallon plant, you are just about doubling the capacity for the entire industry. Investors must be careful.They will want to confirm that there will be a market for the output, whether it is in the United States or in an export market like Europe. I am guessing that most people in the audience are here today because they believe the US market has incredible potential. But that does not mean an investor can just assume the output from a plant built today can be sold.

MR. ALEXANDER: Gene Gebolys, what do you think as a marketer?

MR. GEBOLYS: Must an investor know exactly where the biodiesel will be sold before putting  dollars into a project? I agree completely that if you are going to build a 30 million gallon plant in an industry that produced 20 million gallons last year, you had better know where the additional output will go.

The key is to manage risk and diversify your markets.We see lots of people that come through with the great wisdom and idea of taking cheap palm oil from southeast Asia, producing biodiesel in Texas, and then exporting the biodiesel to Europe so that the same gallon gets subsidized through the US machine and then gets subsidized again through the European machine.That’s great, but you had better make an awful lot of money in a short period of time because that play is ripe for being shut down. 

MR. ALEXANDER: Because the government sees it as manipulative?

MR. GEBOLYS: No.There is a significant regulatory risk. Where World Energy sees the critical path to success is through diversifying your markets. Yes, the European play is great for now, and the Illinois play is great when it is available, and the Minnesota play is great when it is there, and the Texas play is great when it is there.The Canadians are working on incentives that will be really attractive, particularly for plants built in Ontario.Those are all excellent plays, but in any market that has been created by government, you had better diversify quickly so as to reduce your exposure to any one government decision maker.

MR. ALEXANDER: Richard Fumoso, how do Lurgi and other construction contractors minimize the construction and technology risks? Also, talk about the differences in the feedstock so that our audience understands what factors go into the decision which feedstock to use.

MR. FUMOSO: First, there is no technology risk.We have been doing this for decades, so I believe that it is a non-issue. The construction risk is handled by our company.We are a direct-hire construction company.We look at the site specifics, the labor pool, the productivity of that labor  pool, and before we put out a fixed-price bid, we fully understand how best to mitigate the risks.

MR. ALEXANDER: Does Lurgi offer a turnkey contract with a guaranteed schedule and  guaranteed performance?

MR. FUMOSO: We provide a guarantee based on our technology, a performance guarantee based on feedstock and utility costs, a date-certain completion and a parent guarantee.We are one of the few companies in the industry that has the financial ability to provide a parent guarantee.

MR. ALEXANDER: Jerry Peters, assuming the developer has raised the required equity, at what point should he or she approach you about the debt?

MR. PETERS:When a project comes to us with the equity already embedded, it may be tough to kind of stuff the debt in and make it fit with what the equity expects as a return. It is often too late. In every transaction that I have been involved in as a construction lender and term lender, we have negotiated the deal from the very beginning with the construction contractor, with the equity, the feedstock provider and the ultimate marketer so that all the pieces fit together properly at the end of the day. It takes a long time to do that. I have had several transactions that were a year to a year and a half in the gestation period. It takes a long time, but at the end of the day, you have an integrated transaction that makes sense from a lender’s standpoint.

MR. ALEXANDER: Dave Fennema, what should the equity do to leave room for debt in the deal?

MR. FENNEMA:The equity should have some flexibility, as Jerry Peters said. It is a chicken-and-egg issue.The debt and equity go together. As the debt structure alters a little, it affects the equity.The equity should make sure that it has taken care of the feedstock appropriately, it knows as much as possible about where the output will be sold, it understands the working capital requirements for that the project — in other words, the equity should have addressed as
much as it can everything that might affect revenue from the project before approaching the lenders.

MR. ALEXANDER: How much competition is there for equity? Is there a lot of equity ready to invest in biodiesel or is there a fairly small group of potential investors? 

MR. PHILLIPS:The energy bill that President Bush just signed and the booming ethanol market have certainly peaked the interest of potential equity investors, but this is still an immature market.

MR. ALEXANDER: Jerry Peters, I have heard people say that you are one of the few lenders with a keen interest in financing biodiesel plants. Is there a lot of competition to lend to these projects, and how do you see the terms for debt evolving over time as this market matures?

MR. PETERS:That is the key. There have not been many potential lenders. Biodiesel projects have a lot in common with ethanol projects.The agricultural banks understand the commodity nature of the business.They know from ethanol that this is a petroleum market price commodity, and they get comfortable with that. It should be fairly easy for them to get comfortable with biodiesel.The problem is that there are still plenty of ethanol deals to do, and why learn something new when you are already busy with ethanol? Going forward, many of the agricultural banks that have done ethanol will eventually do biodiesel, but I don’t think you will to see a CSFB doing a B loan deal on biodiesel any time soon.

MR. ALEXANDER: Gene Gebolys, you are out in the market, with plants, working with people. How deep a market is there currently for debt?

MR. GEBOLYS: It is a pretty small market. A couple of plants have had debt components in them, but not so much to fund construction as to provide working capital. In biodiesel, the working-capital-to-original-constructioncapital ratio is much higher than for ethanol.

MR. PETERS: It is one to one or better.

Commodity Risks

MR. ALEXANDER: Explain this further — how the price of feedstock is not necessarily correlated to the price of biodiesel?

MR. GEBOLYS:This gets to the heart of any financing. It is the intersection of risk. You are taking an agricultural commodity and selling it in an energy market.Those commodities don’t necessarily trade in any relationship to each other, and so managing that intersection properly is the key to success in both financing deals and maintaining commercial success in the business. Biodiesel is different from ethanol. Biodiesel can be made from an array of feedstocks, and many plants are being designed specifically with feedstock flexibility built into them. A plant can use cottonseed oil, palm oil, rapeseed oil, soybean oil, animal fat, poultry fat and other products.

MR. ALEXANDER:What is the relationship between the amount of working capital needed and the feedstocks the plant plans to use?

MR. GEBOLYS:The capital costs are relatively low to get into the biodiesel game, but the operating costs are reasonably high. Focusing on feedstock, if you take 25¢ a pound soybean oil on any given day, that translates into almost $2 a gallon. You are almost $2 a gallon into the product before you have even converted the feedstock into biodiesel. Also, the downstream subsidies don’t come back to the ultimate seller for almost 100 days after the biodiesel is sold. B99 is emerging in the marketplace. B99 has a very small blend percentage of petroleum fuel; actually it is B99.9. It has a very small amount of diesel fuel in it so that it can be sent out with a blender’s credit. It comes to the marketplace with the blender’s credit already embedded in the price.This means that you are waiting for a very good receivable from the federal government; you are waiting for it for 100 days. Make 30 million gallons on an annual basis, and you end up
having higher and higher operating costs. A lot of the deal flow you see today is very small guys who are strapped for cash.

MR. PETERS: I think the length of the supply and delivery chain is also a factor.Take a highly flexible plant that is going to source low-cost palm stearin from Malaysia.The feedstock will come on a slow boat.Then the biodiesel made has to be put back on another boat for shipment to Europe because that is where biodiesel fetches the highest price today. You may have up to a third or a quarter of your total annual production in transit at any one time.

MR. FENNEMA: Let me add to what has been said about flexibility to use different feedstocks. I think it is a misnomer to talk about flexible feedstock when the point is the plant might be using soybean oil on Monday and rapeseed oil on Tuesday and so forth. It is not a faucet. Here is what flexibility to use different feedstocks gives you. Right now, we have a glut of crushing capacity for soybean oil and an abundance of soybean oil in the market.The great thing about biodiesel is that might not always be the case. Any plant built today may use soybean oil, but at some point when the numbers change, the plant has the ability to change feedstocks. A key factor in plant economics is overall crush spread.

MR.VICTOR: My name is Adam Victor from Trans Gas Energy. I have two questions directed  mainly to Richard Fumoso. I have no interest in subsidies. I want to know what the real cost is per million Btus for biodiesel assuming today the soybean price is about $450 a metric ton. I assume that feedstock is about 80% of the cost, and I assume that the capital cost is about $1 per gallon per year. Based on that, what do you believe is the real all-in cost assuming you can lock in the soybean oil for 10 years, what would the cost be for Btus for soybeans and for canola oil? And second, how much of that cost is offset by pharmaceutical glycerine that you can produce from the biodiesel plant? You said that it is 100% efficiency in the sense of one gallon in and one gallon
out, but I know that there is some glycerine produced. How much subsidy does that glycerine give you for your Btu cost?

MR. FUMOSO: Our responsibility is to establish a capital cost of a facility.We provide you with the energy inputs required. Your cost structure for that energy is going to determine your cost of producing the profit. It is specific to each site. I can’t answer your questions in the abstract.

Glycerine

MR.VICTOR:The question is, you mentioned that you have 100% efficiency. Actually, some glycerine comes out of your plant.What do you find — if you’re just doing an average in the United States — what are you seeing at today’s prices? What does it cost a million Btus for biodiesel? Forget the subsidy. And how much of that can be subsidized by glycerine? The next question I was going to ask somebody is whether you can get a blender’s credit if you are using the biodiesel for power generation so that you are not putting it into the automotive market but you are consuming it yourself? Will the federal government give you an incentive for consuming this in a  power plant?

MR. GEBOLYS: I can answer the easy one. Yes, you can go into off-road, and you can go into  lower generation. It doesn’t affect the blender’s credit.

MR. PHILLIPS: Gene is correct.The credit is not use specific. 

MR. ALEXANDER:Why are we even talking about glycerine?

MR. PHILLIPS: Glycerine is a byproduct of production. In other words, if you produce biodiesel, you get a natural byproduct, which is crude grade glycerine unless you have the ability to refine the glycerine further.There is a big question as to what you do with the crude grade glycerine. My experience is that projects try to market it on a longterm basis. I believe it may be 5% or less of  the revenues of the project on a long-term basis.

MR. GEBOLYS:That’s about right.

MR. ALEXANDER: Jerry Peters, what do you do with the glycerine, and what happens if we have  a 300 million gallon biodiesel market?

MR. PETERS: Crude glycerine is like crude oil. You really can’t use it; you can’t put it in your car. So you have to do something with it; you have to refine it; you have to put it into other products.There is a finite market for crude glycerin. It has to be refined for the downstream markets.

MR. ALEXANDER:What are people using it for? 

MR. PETERS: Soaps, surfactants.

MR. GEBOLYS: Lipstick, cough syrup, you name it.

MR. PETERS: It makes things thicker. And think if you have a large amount coming into the market, as we had with DGS in the ethanol market, you should expect the price to fall. Now, there is something that is a mitigant to that, and that is that glycerine can be used in a lot of other things for which it is not used currently because it’s too high priced. As the price falls because of the additional supply, we anticipate that the market will find other uses for glycerine.That said, if, as a lender, you don’t forecast in your model a falling price based upon the current market, then I think you will be in trouble.

MR. ALEXANDER: Gene Gebolys, do you agree?

MR. GEBOLYS:Yes. Directionally, that’s absolutely right, but I think the key thing isn’t to pick a point in time and conclude that 12% of total revenue will come from glycerine, or 15% or 8%, because these are just wild guesses and they will inevitably look wrong at some point in the future.The challenge is to come up with durable strategies to deal with the day when it is 8% and  deal with the day when it is 15%. Going back to what this means for plant design, obviously if you have a glycerine refinery, you have two products that will be a source of revenue for the plant. You will have both a refined product and a crude product. If the refining spread takes a beating, then you can put out crude if you feel it is a better alternative. A lot of people have opted against putting in the refining capability for fear that there will be an oversupply of glycerine.That philosophy leads to one revenue stream when the plant could have two.

Core Competencies

MR. ALEXANDER: Do you need to hire a third-party operator, or can you find a project manager with the experience?

Since this is an infant industry, I assume there are not many experienced operators.

MR. GEBOLYS:There are a lot of capable people in the oleo-chemical world that have  transferable talent. It is not necessary that the person have experience in the biodiesel world.

MR. FUMOSO: I can help him with that.These plants are very simple to operate.They involve a gravity reaction.The main thing you need is pump maintenance and instrumentation. If you have those two skill sets, you can operate a plant.

MR. ALEXANDER: Gene Gebolys, if you have a 20 or 30 million gallon plant, which is a fairly sizable plant in today’s market, do you need to hire a marketer?

MR. GEBOLYS:That is a good question.The market for biodiesel is very, very small.World Energy has sold one out of every two units of biodiesel since 1998.We pulled from nine plants over that time period and made both short-term and long-term sales.We believe strongly that somebody that is in the business of moving product through the distribution supply chain downstream adds significant value to a project. Others have basically taken the view that if they build a plant,  consumers will come.Time will tell.We can get some insight based on what is happening today with ethanol where more and more gallons are going through fewer and fewer outlets.

MR. ALEXANDER: Let me ask Jerry Peters as a more objective observer. Someone comes to  you seeking financing with a business plan that suggests the developer plans to market the output himself.Would you make a loan? 

MR. PETERS: I would have to know a lot about the marketing plan. Look at the ethanol industry and how ethanol is marketed.There are so many more users of ethanol — the market is well established — but you need infrastructure to deliver product. You need railcars; you need contacts. If you don’t have those and you expect to reach the widest market to get the highest price, then I think you need a marketing group with access, ability, transportation assets 
and storage assets to get the job done.

MR. PHILLIPS: Gene Gebolys, you are marketing biodiesel for third parties. Are you insuring the biodiesel for risk of loss?

MR. GEBOLYS: The way that World Energy does it is different than what is commonly done in the ethanol industry where somebody represents someone else’s materials. We just do a longterm type of pay agreement. Generally, those are indexed to feedstock. We focus on what the plant can control, which is the cost of manufacturing, and the more efficient the plant operates, the more profitable it is. Our cost is set at the beginning of the contract.

MR. ALEXANDER: Jerry Peters, to follow up on the last question, are you seeing the biodiesel  industry move toward long-term fixed-price contracts?

MR. PETERS: I wish, but not really.The industry is still in its infancy.The only thing that I see is, in some cases, the same entity that provides the feedstock also markets the end product, but in  most cases, there is no linkage whatsoever. In most deals, you have the full commodity risk on the supply side as well as the sale side. From my standpoint, the only way you can protect yourself in such circumstances is a thing called equity — a lot of it.

MR. ALEXANDER: How much leverage can developers expect to achieve in a project?

MR. PETERS: It depends on what kind of plant. A developer should not expect much more than  50% leverage. I have to tell you, I know of several deals with 100% equity.

MR. ALEXANDER: Is the working capital line included in those percentages?

MR. PETERS: Quite honestly right now, I would prefer to put working capital into a biodiesel plant than a lot of debt. 

Investment Returns

MR. DEVINENI: Prasad Devineni from Green Catalysts. I have two questions for the panel. One is about blending. What other states are expected to adopt incentives for blending biodiesel? The second question is, what returns should one expect on a biodiesel investment?

MR. FENNEMA: There is a great deal of variability in returns.We are in a world today when the crush spread is pretty attractive and the returns look great. But it takes time to construct the plant and then to start benefiting from that crush, and nobody knows where it is headed.Without  fixed margin contracts, which do not exist on a long-term basis today, you can reach a return of 30%, but just keep in mind the return will be highly variable.

MR. PHILLIPS: Let me tackle the other part of the question. One thing on which we have not touched today is mandated low sulfur diesel.The law requires fuel suppliers to reduce the sulfur content in diesel fuel from 500 parts per million to 15 parts per million by mid 2006. One way to
reduce the sulfur content is to add hydrogen, which is a much more cost-intensive process than blending in biodiesel. So there is a ready-made market in some sense across the United States for blending. It is hard to say what other states might enact incentives for blending. Some states will no doubt move to mandatory blending. Some may adopt incentives that may or may not be funded or appropriated. I have not seen a list of states.

MR. GEBOLYS: I’m the regulatory director for the National Biodiesel Board.We are not actively pushing states to follow the Minnesota lead.The sleeping giant is the fact that the renewable fuel standard now includes biodiesel. I expect that as petroleum companies have to add ethanol and
biodiesel to progressively larger shares of the fuel they supply, biodiesel will account for a significant percentage. I also expect that future state action on biodiesel will be more incentive-oriented and less mandate-oriented.That is true of Europe as well.

MR. PHILLIPS: Are you putting much emphasis on blending ultra-low sulfur diesel?

MR. GEBOLYS: That is just one more reason that a blender will move to biodiesel, because ultra-low sulfur diesel has lower lubricity characteristics. Biodiesel has good lubricity characteristics. If somebody is going to get renewable fuel standard credit and also get lubricity enhancement, a lot of dots start to connect and using biodiesel starts to make sense.

MR. RAKOWSKI: Richard Rakowski, Kidd & Company. I’m kind of a novice to this area. Focusing on the relative Btu value of biodiesel versus sugarcane-based ethanol versus gasoline, what price does crude have to reach before the alternative fuels become attractive even with the subsidies?

MR. FENNEMA:This is an area of heated debate. Most people believe that crude ethanol survives pretty well on its own when the price moves above $50 a barrel. On the biodiesel side, Gene is probably —

MR. GEBOLYS:The situation is worse than ethanol.

MR. FENNEMA: It is probably $80 a barrel.

MR. GEBOLYS: Continuing with a back-of-the-envelope analysis, the feedstock costs $2 before you transport it to the manufacturing plant, and before you convert it to biodiesel and transport the biodiesel back into the marketplace for sale. So on the back of the envelope, you can figure out that you need a price of at least $2.50 for diesel fuel.We are currently at $65 a barrel for oil, and the price of diesel fuel with oil at that level is $2.12 a gallon.Therefore, rough numbers suggest you need oil prices to reach $90 or $100 a barrel before biodiesel will be economic on its own.

MR. ALEXANDER: Dave Fennema, what expected returns are developers assuming in their business plans?

MR. FENNEMA: I have yet to see a pro forma that assumes an inadequate return. One thing we try to do is create some flexibility so that there is room to appeal to different investors and lenders. Everyone has his own idea about where the market is headed.The truth is, no one should view the future as doom and gloom.The biodiesel market relies today on subsidies.There is no need to apologize to equity investors or lenders for that.We have to model it.There is a lot of data available about soybean oil prices. The wild card is the petroleum industry. No one believed a year ago that we were going to have sustainable $40-plus barrel crude. Now most people will not go below $50 in their long-term assumptions.

MR. PETERS:When you consider that the capital cost per gallon of annual production runs  between 50¢ and $1.25, depending on whether you have a single-feedstock-batched plant or a multiple-feedstock-continuous plant like Lurgi makes, and you consider the very aggressive pro formas that we see, most of the pro formas show $1 a gallon of profit. I am not buying that. I assume when lending that the profit will be 80% less than that, but that’s just my philosophy.

MR. PHILLIPS: Gene Gebolys, do you sell your crude on a short-term, long-term or spot basis?

MR. GEBOLYS:We have done it all three ways.

MR. PHILLIPS: Is it possible to get a long-term contract for the glycerine?

MR. GEBOLYS:Yes. I wish I had done more of it. 

MR. GARDINER: I’m Kevin Gardiner from the UConn Biodiesel team with a question for Gene Gebolys. Does World Energy do some work with state and city departments of transportation?

MR. GEBOLYS: Yes.

MR. GARDINER: Do you have any statistics on the diesel needs or consumptions of any cities or states that you could share with us today?

MR. GEBOLYS: Is your question where they use a lot of it?

MR. GARDINER: Yes.

MR. GEBOLYS: We have contracts with state transportation departments in Ohio, New York, New Jersey, Connecticut, with Boston, and we also do a lot with the US military.The US Navy is the  single largest diesel consumer in the world.The overall size of the diesel market — whether your focus is a state or a city or the federal government — isn’t the key.The key is finding a fit in  subsets of that market. The diesel market is huge and getting bigger every day.

MR. KAUFMAN: Uri Kaufman, Evergreen Power. I have a question for Richard Fumoso. How much of the cost of biodiesel is the heat or steam that you use in the refining process, and could you put a biodiesel refinery next to a power plant and use the waste heat for that purpose? How much of a savings would there be if you do that?

MR. FUMOSO: It depends on what you have. It takes a lot of steam to do the distillation  process. We can use the heat loss from a power plant to do that.There’s no question about that.

MR. KAUFMAN: If you make a gallon of biodiesel, is 5% of it steam or is it 10%?

MR. FENNEMA: It is a very small percentage.The best analogy is ethanol, where up to 30% of your variable costs might be natural gas today, maybe even higher with gas prices at $13.  Biodiesel is a different process. It is a very low pressure, low temperature process.

MR. KAUFMAN:What are the emissions from biodiesel compared to ethanol and compared to natural gas? How clean is the fuel? Assume you are using a clean feedstock such as virgin soybean oil? 

MR. GEBOLYS: It is a great fuel. It reduces greenhouse gas emissions that don’t matter today in the United States but eventually will. It reduces fine particulates very well, so that it reduces the asthma impact of diesel. It is a fuel that makes diesel engines run cleaner. How much cleaner? First of all, we would not compare it to ethanol because they’re not competitive technologies. Second, any emissions are based on a combination of three factors: the engine, the fuel, and then the condition of the engine and the condition of the fuel.

MR. KAUFMAN:There is not any particular NOx problem?

MR. GEBOLYS: Biodiesel used in an internal combustion engine increases NOx just slightly. In an external flame, like a boiler or burner, it reduces NOx.The jury is still out on gas turbines.There has not been enough research done on gas turbines yet.

Quality Issues

MR. ALEXANDER: Gene Gebolys, explain in more detail the quality issues that we have seen and what people are doing to eliminate them so that biodiesel can be adopted more uniformly.

MR. GEBOLYS:There is no way to make good business out of bad quality. So what that means in terms of where the business is and where it is headed is this. There is currently a very low barrier to entry, with the result that there are some very small plants — 500,000 to 1,000,000 gallons a year — and they are far too small to afford the fully-equipped laboratory that it takes to ensure quality.Therefore, they go without.This is a recipe for disaster.There is no way to make quality biodiesel without an appropriate plant.

MR. ALEXANDER: Is quality a major issue?

MR. GEBOLYS:Yes. It is a business issue. If somebody is going to buy from a 500,000 gallon plant, it looks like a 500,000 gallon plant. It is buyer beware. Bad product is never a good thing for any industry.We deal with relatively sophisticated fuel buyers, and relatively sophisticated fuel
buyers understand that if they want quality, they must buy quality.There is something called a BQ-9000 program that is being rolled out in biodiesel. It is a pretty sophisticated voluntary quality program for plant owners to participate in, and have their plants vetted through that process, and vetting runs all the way down through the distribution chain.There is not yet widespread participation in the program. But over time, I think that quality is just a business issue. If you do not produce a quality product on a consistent basis, the market will deal with you. Poor quality is not a long-term threat.

MR. ALEXANDER: Is there an issue beyond initial quality? MR. PETERS: Biodiesel will degrade, so you can’t store it forever. And it certainly makes a big difference if you have a multiple feedstock plant. Are you going to use one feedstock if you are delivering everything in Arizona, and are you going to use a different feedstock, a blended feedstock, if you deliver into Maine? The biggest problem is the temperature at which biodiesel gels. It gels — depending upon which feedstock it is — at a heck of a lot higher temperature than petrodiesel. Clearly you can use lower cost feedstocks, palm stearin or others, that you can get for a couple of pennies a pound less than you buy soy, but you better not use them in Maine in the wintertime.

MR. ALEXANDER:What about differences in quality standards for a producer in the United States who wants to take advantage of the higher prices for biodiesel in Europe and other export markets?

MR. PETERS:You had better meet the EC spec, because if you don’t do that, you can’t get the product into Europe. It is a pretty tough spec to meet. Some people say you can only meet it using rapeseed. I would say most of the plants in operation today in the United States can’t meet that spec.

MR. ALEXANDER: Does meeting the European standards require paying more for your feedstock or does it require a more sophisticated process, or both?

MR. FUMOSO:We don’t change our process.

MR. PAYANO: My name is Miguel Payano. I’m from Canal Step Management.Why buy a diesel blend if we can get away with straight vegetable oil?

MR. PETERS: Let me speak from the practical standpoint of a guy who used to take vegetable oil and stick it in his diesel engine versus somebody who only runs biodiesel today. If I am living in Arizona, I would feel a heck of a lot more comfortable heating up my vegetable oil to get it to the viscosity level that it will flow through my fuel filter and into my injectors and thus into my engine. If I have the chance, at any time, that the heating system will break down and can no longer heat the vegetable oil, then I have a car that potentially can’t operate unless I run fully redundant systems.

MR. PAYANO:The other question was, who owns the CO2 credits if there are any from blending or production? 

MR. GEBOLYS: It is a matter of contract.We are working on a deal in Canada where CO2 credits are with the lender. In the US, they really don’t matter right now, but in the Canadian deal, it is just worked out contractually where they end up.

MR. HOAG: David Hoag, Capital International Research. This is probably for Jerry Peters and maybe Richard Fumoso. You suggested earlier that a certain level of biodiesel blend with diesel can run in engines without modifying the engines.With respect to a truck engine or other large-power engine, what are the quality issues or the viscosity issues or other issues that make it necessary to modify the engine at certain blends of biodiesel but not at lower blends? There was also a question about Btus earlier that I don’t think got answered.

MR. PETERS: I don’t think — with the larger scale engines — that you have to do any engine modifications at all to burn the entire range from 1% to 100%.There are plenty of large-scale engines that have operated, and continue to do so, at 100% biodiesel. I think that the biggest concern is the gel point of the biodiesel. It is that, rather than a matter of the engine needing much modification at all.That said, I don’t think you will see many engine manufacturers offer a 100% warranty on their engines no matter what you burn, because they are a conservative lot. But I don’t think any of the testing that has been done on reciprocating engines suggests that any modifications are required to burn 100% biodiesel.

MR. PHILLIPS: Gene Gebolys, do you know any manufacturers who are honoring warranties for biodiesel use?

MR. GEBOLYS:This is the central thrust of why biodiesel exists. Nobody is modifying engines to use biodiesel, and that goes back to the question about straight vegetable oil as well. Zooming way back, it appears to me and many others that the technologies of the future in the energy sector are hybrid technologies, whether they’re hybrid vehicle technologies or they’re hybrid fuel technologies.The only way a hybrid fuel works is if it works seamlessly in the fuel stream. Biodiesel at up to 20% can work seamlessly in the fuel stream.To my knowledge, nobody has ever voided a warranty for B20 use.There are engine manufacturers that don’t recommend using biodiesel blends above 5%, and there is still a fair amount of dancing that goes on between the engine manufacturers and the fuel suppliers. But it is a dance that has been going on for decades and decades between those two groups.The bottom line is you can certainly use biodiesel blends up to 20% throughout most of the developed world wherever distillate is used currently. And that is the fundamental reason why this technology has a future — because it is easy to use. The Future

MR. ALEXANDER:Where do our panelists see this market going?

MR. GEBOLYS:That is the million dollar question. Is there any room for anybody between big oil and big agriculture?

MR. ALEXANDER: Maybe you could frame the issue for people who are not familiar with the industry.

MR. GEBOLYS:Why would energy majors get into this? The main play for energy majors is they need to have access to biodiesel and ethanol over the long haul. Do they need to be in it to have access? That has yet to be seen. Do they have core competencies that translate well for biodiesel? That has yet to be seen.The distribution channel for biodiesel is very different than the distribution channel that the major oil players use, and the skill sets for this business are very different than the skill sets that make somebody successful at the high end of energy wholesale.

MR. FENNEMA: I would say that anytime you have an industry that still has this much of a subsidy base built around it, neither big oil nor Cargill nor ADM want to be the whole market. I don’t think the market is big enough for big oil to come in and take over yet.There are not enough dollars in it for big oil to get excited.

MR. GEBOLYS: If you are in the crush business, what you need to ensure is that there is a biodiesel industry. You don’t need to ensure that you are in the biodiesel industry. If you are, you have to have core competencies that lend themselves to being better than the next guy in that business. Clearly being basic to feedstock is helpful, but one of the keys to success in the biodiesel business is distribution. And being basic to feedstock doesn’t necessarily give you a significant strategic advantage in the marketplace. I ultimately think that the large crushing operations will do what they can to ensure there is a healthy business in the United States, and they will be very active in supporting biodiesel producers both in Washington and from a supplyof-oil point of view.Will they stake out sole participant status in that business? I don’t think so. In fact, I expect them to focus hard on core competency, which is in crushing, and not on downstream energy distribution.

MR. KAUFMAN: Uri Kaufman, Evergreen Power.What have you heard about research into cheaper feedstocks, and in particular have you heard anything about algae being a viable feedstock?

MR. PETERS: I have heard of acid breakdown systems. I have heard of gasification. It turns it into gas and then into biodiesel. A conventional edible oil-based biodiesel project is hard enough to get financed. So to take it one step further and suggest there is the possibility anytime soon that something using other than edible oils can be used to produce biodiesel, I don’t think there is any money yet to finance that.

MR. ALEXANDER: Studies suggest that biodiesel demand will grow to more than a billion gallons a year. How do we find enough feedstocks to produce that much biodiesel?

MR. PETERS: It is the same issue as with ethanol.We are quickly approaching the limits of corn as a viable feedstock at an economical price to make ethanol.Where do we go from there? We go to cellulosic ethanol. No large-scale plant has been built yet, and ethanol is five years ahead of where biodiesel production is today.Will it happen? Of course you will have, at some point, to find alternatives to edible oils in order to be able to be the low-cost producer of biodiesel. I have to think that the problem is five or 10 years away.

MR. GEBOLYS: Agricultural markets will shift around to opportunity, and as that surplus starts to go away, the soy complex today is driven by a meal-driven demand, not an oil-driven demand. Depending on what happens to demand for oil, the soy complex shifts around to that.There will be alternative feedstocks as a complement to soybean oil. Soybean oil is going to be the baseload feedstock in this country for the foreseeable future, but there will be alternative feedstocks. Over time, people will move to higher-oilyield varieties of beans.There are lots of responses to a macro-economic model that has more than 240 million gallons of biodiesel demand in it.

MR. McKENNA: John McKenna. I’m with Hamilton Clark. We are an investment bank for energy technologies.When we make investments in hybrids and drive systems and diesel engine efficiencies, we talk to the fleet managers at FedEx and Pepsi/Frito-Lay. Have you had any experience with the fleet managers with centrally-fueled vehicles that are the ultimate big market for this, and if so what kind of reaction have you had?

MR. GEBOLYS: Great question. I suspect that I am the only one who has spent countless hours with these guys.World Energy is a company that is driven by backwards revenue streams.We exist to catch revenue streams and then supply those revenue streams.The fleet managers make those decisions.The original driver for the industry was fleet requirements, and transportation is still the vast majority of the market. Increasingly, energy companies matter, but this business was built going directly from biodiesel supplier to fleet manager, and then almost by accident energy companies have emerged in the middle.When you’re selling a BTU at a premium, somebody had better value that. For a long time, biodiesel has been a premium market in the United States over the price for diesel fuel.

MR. ALEXANDER:Where are the best places in the United States to build a new biodiesel plant?

MR. PHILLIPS:That’s an age-old question. Biodiesel has a lot of parallels with ethanol. Do you build the plant near the feedstock, or do you build the plant near the destination of its end use, or do you put it somewhere in between that can take advantage of its location to both the feedstock and the end product? There is no right answer.We see plants being built right in the middle of the most intense soybean production in the United States, and we see them being built where no soybeans are grown within 500 miles.

MR. PETERS: Biodiesel is a little less dependent than ethanol. Corn is a little harder to move than soybean oil. But these are both highly logistical decisions. No matter where you are, transportation of either the feedstock or the output will be a significant factor.

MR. FUMOSO: First, there is no technology risk.We have been doing this for decades, so I believe that it is a non-issue. The construction risk is handled by our company.We are a direct-hire construction company.We look at the site specifics, the labor pool, the productivity of that labor pool,
and before we put out a fixed-price bid, we fully understand how best to mitigate the risks.

MR. ALEXANDER: Does Lurgi offer a turnkey contract with a guaranteed schedule and guaranteed performance?

MR. FUMOSO:We provide a guarantee /