Cellulosic Biofuels: The Future Is When?

Cellulosic Biofuels: The Future Is When?

January 11, 2011

The US government has been encouraging production of ethanol from cellulosic materials, but the incentives are temporary in duration. Six Washington insiders and biofuel industry experts talked during a roundtable discussion, at an Infocast cellulosic biofuels summit in Washington in mid-November, about the outlook and what else the industry is asking the government to do to help it get off the ground. The following is an edited transcript.

The panelists are Jim Nussle, a former Congressman, chairman of the House Budget Committee and head of the Office of Management and Budget under President George W. Bush and currently president and chief operating officer of Growth Energy, Bob Dinneen, chief executive officer of the Renewable Fuel Association, Douglas Durante, executive director of the Clean Fuels Development Coalition, Dr. Matthew Carr, managing director of policy and industry in the environmental section of the Biotechnology Industry Organization, Dr. Candace Wheeler, biofuels lead in the global energy systems center at General Motors, and Wesley Bolsen, chief marketing officer and vice president for government affairs of Coskata. The moderator is Keith Martin with Chadbourne in Washington.

MR. MARTIN: Cellulosic biofuels plants have been built in the United States on a pilot scale, but we really have not seen commercial-scale projects yet. Brazil has quite a number of them. What is the hang up in the United States?

MR. BOLSEN: The capital markets. We have demonstrated that the technology works. The technology has moved out of the laboratory and pilot facilities into full demonstration scale, and the Department of Energy has funded several companies to do fully-integrated biorefineries as well.

What we are missing is movement from the US Department of Energy to issue loan guarantees. It has had the authority since 2005. The US Department of Agriculture is now stepping into that role.

The challenge is to get the first plant built on a commercial scale. This is first-of-kind technology, and there is risk. Banks are not willing to take technology risk. That is a role that the government needs to play and, to date, the government has not been out on the playing field.

MR. MARTIN: So the main challenge is to prove the technology works. Why have the Brazilians been able to do it, but we have not?

MR. BOLSEN: The Brazilians have not built full cellulosic commercial-scale facilities. There are exactly zero commercial-scale cellulosic ethanol facilities in the world. The Brazilians have produced ethanol from sugar cane, and they know how to do that extremely well.

MR. DINNEEN: If Brazil had in fact cracked the code to processing cellulosic materials commercially, we would not be having the difficulties we are having financing projects. They have not done it. Nobody in the world has done it. Nature put cellulose together so as not to break down very easily. I have seen ethanol being produced today from cellulose on a demonstration scale, but scaling up is the challenge.

In the economic environment today, it is difficult to get a loan for a car, never mind a couple hundred million dollars to build a new facility using a new technology relying upon a new infrastructure in markets that are not yet secure.

We need to get the loan guarantees up and running as intended by Congress. We also need to make some changes in tax policy to encourage investment. It is going to require a real commitment from Congress and the administration to make it happen, but I think that we can do it. We need to.

MR. MARTIN: There are a number of federal policy supports currently for cellulosic biofuels. They include the renewable fuel standard, or RFS2, loan guarantees, a producer tax credit, a tariff on imported fuels, a 50% depreciation bonus [Ed.—Congress increased the bonus to 100% in late December on equipment placed in service after September 8, 2010 through December 31, 2011.], sales to the Department of Defense and the ability to use master limited partnerships to own ethanol pipelines. Are there other important federal policy supports for this industry?

MR. DINNEEN: The RFS2 is not really a mandate as long as the Environmental Protection Agency is allowed to continue to adjust the levels downward. That particular support isn’t working as intended. The loan guarantee program has been broken and is not working as intended. The producer tax credit isn’t going to be useful to developers until they are actually producing, so the list that you just gave largely demonstrates the problem.

MR. MARTIN: Are there any other federal policy supports that should be added to the list?

MR. BOLSEN: The Department of Energy is looking at a reverse auction program under which the US government would buy cellulosic biofuel. The program was authorized in 2005, but has never been implemented. DOE was still hoping that it can get the program running and funded with more than $5 million.

MR. DURANTE: There is also a biomass crop assistance program that is run by the Department of Agriculture.

I agree with Bob Dinneen. If you look at that list, we just keep going back and trying to fix what is not working and throwing more stuff on top of it. Congress keeps asking, “Will this help?” It keeps throwing stuff at us with different definitions, requirements, stipulations and carve-outs and, by the time the regulations are done, it is clear that however well intentioned the effort was, it does not work.

MR. MARTIN: So we need to make what is already there work. Are there any meaningful programs or incentives at the state level?

MR. BOLSEN: The low carbon fuel standard in California. By requiring that fuels used for transportation in California have low carbon content, the state may do more to stimulate biofuels than the renewable fuel standard at the federal level because the California standard has teeth.

DR. CARR: California is not the only state looking at this. Several northeastern states and others are doing so, as well. The key will be how these programs are implemented. They could drive investment in cellulose or biofuels or they could scare away such investment. For example, if the programs impose a huge indirect land use change penalty, then the scales are tipped against biofuels but not against biomass power, with the result that biomass gets diverted into electricity generation.

Renewable Fuel Standard

MR. MARTIN: Let’s drill down further into the current incentives. Bob Dinneen, what is RFS2? Is it working? Is the industry seeking any changes in it?

MR. DINNEEN: In 2005, we worked with the oil companies to create the first ever requirement for them to blend a certain percentage of their fuel as renewable. It was a 7 1/2 billion gallon requirement and, at the time, a lot of folks said, “Oh my goodness, 7 1/2 billion gallons of fuel. How in the world can that small industry in the Midwest satisfy that demand?” We not only satisfied it, but we also blew past the targets in 2006. It was clear that the program had been an extraordinary success, and that there was far more that could be done.

In 2007, with a new Congress and new stakeholders at the table, we worked with the environmental community greatly to expand the first renewable fuel standard, and we were able to create a 36 billion gallon requirement that capped grain ethanol at 15 billion gallons and created this tremendous new market opportunity for 21 billion gallons of advanced biofuels.

The problem is that the 21 billion gallon requirement for advanced biofuels has several off ramps to it down which the Environmental Protection Agency has been too willing to exit. This makes it awfully hard to go to a bank and say, “I have this market,” when the size of the market keeps being reduced. It is hard to blame EPA if the production is not there, but it is a question of which comes first. You are not going to get the production until the mandates really mean something.

MR. NUSSLE: When policy makers are faced with a problem, they invent a program. Members of Congress can then go home and explain to their constituents that they did something. The result is that we end up with a patchwork of things, among them RFS2, but each of these programs requires tremendous follow through to make it work properly, and the policy has to remain in place long enough to achieve the objective.

A renewable fuel standard is important. This industry needs demand for its product and it needs infrastructure, whether it is flex-fuel vehicles, blender pumps or the ability to move product around the country. At the end of the day, that’s what has to be there—in addition to the interesting programs, loan guarantees, tax credits, mandates, standards and everything else that can be woven together—for the industry to work. The reason Brazil has done so well is it picked a strategy, stuck with it and is not deviating from the strategy until the mission is accomplished.

We, on the other hand, have various temporary measures that must be renewed periodically by Congress. We sit here now eleven months after the biodiesel tax credit has expired. We are on the precipice of watching the ethanol credit expire if both political parties don’t get their acts together in the next three weeks. This sort of repeated uncertainty undermines the effectiveness of the programs. [Ed.—Congress extended tax credits in late December for ethanol and biodiesel blenders and small producers through December 2011.]

MR. MARTIN: Candy Wheeler, does the auto industry view RFS2 as an effective stimulus for cars to move to ethanol and other biofuels?

DR. WHEELER: We are producing flex-fuel vehicles regardless of the RFS2. However, it would be very helpful to General Motors to have RFS2 hold and not have EPA take the off ramps as freely as it has done. The standard has teeth if we let it work. If we keep reducing it, then the bankers lose confidence, and we end up in a vicious cycle.

The Environmental Protection Agency does not want to set a standard that is impossible to reach, so it polls everyone in an effort to estimate likely cellulosic production each year, but if the target were set just a little higher than what producers say they plan to produce, there is a safety valve that is already built into the program under which parties can meet their obligations using RINs. You could take the money generated from the sale of RINs and invest it back into getting the pumps and other the infrastructure in place, so that the RFS2 could actually start to build the industry.

The existing program does not really have teeth on the vehicle side. We have made a commitment to have 50% of our portfolio using flex fuel by 2012. That was contingent upon having the infrastructure in place. We have not seen the infrastructure develop, but we continue to try to meet that goal anyway.

MR. MARTIN: Matt Carr, is the industry working for any changes in RFS2, other than to try to prevent further back sliding?

DR. CARR: There have been a lot of calls to reopen RFS2 to make sure that the program is running the way it should.

If you look at the cellulosic mandate—and I really do say that it is a mandate because the EPA is required to set its volume at least at the level of projected production—if the volumes are produced, they must be blended. There is also a waiver provision within the cellulosic bucket that says there will be a price support provided to cellulosic biofuels in the event of a waiver. Thus, within that cellulosic bucket, there are two mechanisms that are supposed to provide support to cellulosic biofuels.

I don’t think the Department of Energy understands this. The Environmental Protection Agency doesn’t understand it. We have to make sure that the agencies understand how this program is intended to work, so as to ensure consumption of cellulosic biofuels.

MR. DINNEEN: I just want to go back briefly to something Candace said because it is really important. General Motors has done a phenomenal job working with the industry, and the company’s commitment to have 50% of its vehicles be flex fuel by 2012 is really important. I wish other companies would follow its lead.

She mentioned the need for infrastructure. We brag in the industry about the fact that we have 3,085 pumps, and there are more blender pumps coming every day, but we have only had a UL-certified E85 or a UL-certified blender pump now for about three months.

I hope that the infrastructure follows much more quickly. One of the tax incentives on which the industry has focused besides the volumetric ethanol excise tax credit is the infrastructure credit that is also set to expire at the end of this year, but if we get that incentive extended with UL-certified pumps, Candace, do you think that infrastructure is going to be deployed a bit more rapidly now? [Ed.—Congress extended a tax credit for installing blender pumps in late December through the end of 2011, but at a lower dollar level than applied in 2009 and 2010.]

DR. WHEELER: The UL holdup was a significant issue, and now that has been resolved, we should see things start to move forward. Blender pumps are a good option because they allow us to have a whole wide range of concentrations.

MR. MARTIN: What is UL?

MR. BOLSEN: Underwriters Laboratory. They stamp the pumps to say, “This pump has been certified.” Another significant action was the announcement by US Agriculture Secretary Tom Vilsack that the government will fund 10,000 blender pumps in the next five years. There is room for it in the existing budget. These are really meaningful measures. You hear the automakers saying they need such measures. You hear the Coskatas of the world saying they need something past E15. We need to get to E30, E40, E85 both in blender pumps and flex-fuel vehicles. Let’s not expect General Motors to stand up alone and make flex-fuel vehicles without the infrastructure to allow demand for such vehicles to grow.

Federal Loan Guarantees

MR. MARTIN: Let’s move next to what seems from your descriptions like a vast reservoir of disappointment —- the federal loan guarantee program. What is the Department of Energy program? What is the Department of Agriculture program? What are these agencies authorized to do?

MR. BOLSEN: DOE has authority to guarantee repayment of up to 80% of the debt on certain energy projects. There are two different DOE programs: a section 1703 program guarantees debt on projects that use innovative technologies. Borrowing under it is through an arm of the US Treasury called the Federal Financing Bank. There is also a section 1705 program that guarantees debt on projects that use commercially-proven technologies. Under that program, you arrange a loan from a private lender, and the government guarantees the lender that it will be repaid.

MR. MARTIN: Are there separate loan guarantees through the Department of Agriculture?

MR. BOLSEN: Yes. The department was given authority under the 2008 farm bill to guarantee loans of up to $250 million per project for, among things, cellulosic biofuels projects. You negotiate the loan from a bank, and then the department applies a guarantee to it. However, at most 60% of the loan is guaranteed for loans above $125 million.

MR. MARTIN: This industry has a problem getting to commercial scale and proving the technology. Until it does so, no banks will lend. The DOE loan guarantee program seems exactly the ticket because the federal government will lend until the projects have proven themselves. Why has this program been such a disappointment?

MR. NUSSLE: The technology is just part of the story. Many people in this room have been at this a long time. They can make ethanol and alcohol out of anything. They can take your old tie and eventually break it down. The bigger piece of the story is the market. If you have a market for the output, then the economics will work. The challenge for all of us is to get that message out. We need the basic infrastructure so that there can be a market for the output. Until that happens, the loan guarantees are helpful, but they are only part of the story.

MR. BOLSEN: I would love to have Jim Nussle back in charge of the Office of Management and Budget. We do not have a commitment as a country to remove our dependence on oil. Every one of us in this room is responsible for not telling the story. Job growth, economic growth and rural development come from biofuels. You can put up windmills and solar facilities that help reduce our dependence on coal and natural gas. It is fantastic to have China making these wonderful solar cells and wind turbines and shipping them back into our country. Biomass is local. Biofuels are local. They are rural industries. They create jobs that cannot be exported. You don’t ship your corn stores to China and have them ship back fuel. This is about long-term economic growth and jobs for this country. We have missed this story.

MR. MARTIN: I think we got the message.

MR. BOLSEN: This town has not gotten that message.

MR. MARTIN: Let me give you some statistics about loan guarantees. To date, the Department of Energy has written four loan guarantees and issued 16 commitments. Projects have to start construction by September 2011 to qualify for guarantees. Is the program in danger of running out before anything significant is done for biofuels?

MR. DINNEEN: Earlier this week, Jonathan Silver indicated that three biofuels projects are in the pipeline. Part of the problem is structural. Companies are competing for a pot of money. Among the competitors are wind, geothermal, solar and other renewable technologies that have been proven and do not carry the technology risk that cellulosic producers do. DOE has tended to focus on power generation. The program was also intended to provide some risk management for the fuels industry.

The memo that leaked from the White House in October that was critical of the program focused on power generation. There was not a single reference in it about the impact of this program on fuels. We are constantly having to remind DOE that, “Hey, we are out here, too.” Look, I’m an optimistic person. I have been in this industry for 23 years. You can’t be anything but an optimist if you have stuck with it for so long a period of time. I remain optimistic that at some point, DOE will do a loan guarantee for a biofuels project.

Cellulosic Producers Credit

MR. MARTIN: Let’s move next to the tax credit for cellulosic biofuels. Matt Carr, how much is the credit and when does it expire?

DR. CARR: The 2008 farm bill provided a tax credit of $1.01 per gallon of cellulosic biofuels produced minus the ethanol blender tax credit and small producer ethanol tax credit. The big challenge with this program is that it is expiring in 2012, and we are not likely to see many commercial projects completed by that time. Therefore, the credit is not of much value when talking to investors in an effort to raise money for projects.

There is a complementary accelerated depreciation benefit that was authorized in the same bill.

The industry is trying to extend both incentives for at least four years to provide greater certainty for investors. It is also asking for flexibility to be paid the credit value by the Treasury in cash, like the refundable section 1603 grants for which other renewables like wind and geothermal qualify. The grant program has been tremendously effective. It is another example where the focus has been on the power sector but not on other emerging technologies that are part of the larger renewables picture. We need parity for fuels.

MR. MARTIN: Jim Nussle, how likely are these tax credits to be extended and, if so, how long? The Republicans have taken over the House. They have a mandate to cut spending and reduce the deficit.

MR. NUSSLE: My crystal ball worked until 1997 and then it broke. It is hard to predict what will happen in the next three days let alone the next three months or two years. There is no question that the deficit and the pressures of the debt will come to bear, but exactly where things will settle is unknowable at this point. The House of Representatives is only part of a matrix of the House, Senate and President.

MR. MARTIN: Do you think the odds of an extension are lower in the next Congress that will take office in January 2011 than they are this year?

MR. NUSSLE: Yes, and I worry about that. Anyone who wants to know what the playing field may look like should consider the challenges the biodiesel tax credit has faced since 2009, and you will have a glimpse of what the future may look like. These credits used to be routinely extended. They are now routinely debated and controversial and not extended, and that’s a very troubling prospect if you are looking for enough certainty to attract long-term investment.

MR. DINNEEN: If the tax credits for biofuels are not extended in late 2010, then you will begin to see a crumbling of the foundation and that will not bode well for any of us. These tax credits are an incentive that marketers and refiners depend on today in order to make ethanol a cost-competitive component of their motor fuels. The tax credits will be critically important when cellulosic ethanol enters the marketplace.

Tariff

MR. MARTIN: Bob Dinneen, another public policy support is the tariff at the US border that must be paid on imported ethanol. How much is the tariff? How long does it remain in place?

MR. DINNEEN: It is 54¢ a gallon. It was intended to offset the tax benefit that refiners and marketers get when they use ethanol, whether that ethanol is imported or domestic. The notion of having an offsetting tariff is so that the United States does not end up subsidizing already highly-subsidized ethanol produced someplace else. It is there to protect the taxpayer and not the industry. We import a fair amount of ethanol when the market conditions are right. Right now, we are exporting a fair amount of ethanol because of market conditions, so the tariff does not really have an impact on world trade. It does have an impact on making sure the US taxpayer is not subsidizing a foreign product. I believe as long as there is a market-based incentive available to refiners and marketers to use ethanol, there will be an offsetting tariff. Do you need to coordinate those so that they match up more directly? Sure. We have supported that. But I don’t believe you will see the tariff go away as long as the market-based incentive exists.

MR. MARTIN: What would happen if the tariff were lifted? Do you think we would see a flood of Brazilian ethanol, for example?

MR. DINNEEN: Not in today’s marketplace because of where the world price is for sugar. Brazil is having a difficult time meeting internal demand.

MR. DURANTE: There is also nowhere to put the ethanol whether it is cellulosic ethanol, corn ethanol or Brazilian ethanol. Ethanol prices are down, and no one is getting rich off ethanol. Bob Dinneen is right. Complaints from foreign producers about the tariff are the single biggest red herring I have seen in my more than 20 years here. The idea that if it was not for the tariff, foreign producers would be coming in to save the day is preposterous. Without the tariff, they would receive the benefit of a federal tax break plus whatever other incentives they get in their own countries.

Government Sales

MR. MARTIN: The next public policy support is potential long-term sales to the Department of Energy, the Army, Navy and Air Force. How important are such sales? What type of contract is it possible to get and at what price?

MR. BOLSEN: Contracts do not run longer than five years currently. We need to see the government signing contracts that run longer. There is also some confusion about a rule that one government agency cannot guarantee another agency’s obligations.

DR. CARR: There is a growing appreciation at the Defense Department that oil dependence is a national security issue. Several branches of the military have expressed a desire to test or buy advanced biofuels. We need to get authority for the Defense Department to enter into long-term contracts. I hope that the department will also play a role in helping to get these commercial biorefineries constructed because it is in the national interest to do so.

MR. MARTIN: This seems pretty important. Once the industry gets past the challenge of demonstrating the technology works, it will still face the challenge of signing up long-term offtake contracts. It is hard to finance a project unless you can show a long-term offtake contract that banks can evaluate.

Candy Wheeler, let me come back to you. We talked about a number of federal policy supports. We talked about the RFS2 loan guarantees, producer tax credit, the tariff, the 50% depreciation bonus and the possibility of long-term contracts with the Defense Department. You mentioned that building out infrastructure is probably the most important thing from the standpoint of General Motors. Of these other items, how do you rank them? Which is most important?

Wish List

DR. WHEELER: It is hard to rank them. They are all pieces of the puzzle that need to fit together. That said, getting those first plants built is critical, so the loan guarantees need to be in place. Having the RFS2 target hold and be consistent is also critical to helping to get those first plants built. Those are the two real keys to moving things forward.

MR. MARTIN: Wes Bolsen, some of the panelists suggested there is something of a confusing patchwork of programs, and the government might do better to focus on getting the existing programs to work rather than to add more. Sander Levin, who is chairman of the House tax committee this year and who will be replaced as chairman in 2011 by Dave Camp, also from Michigan, proposed, as part of an extenders bill he released in late July, to allow a 30% investment tax credit for cellulosic biofuels projects and to direct the Treasury to pay the value in cash. Is this an industry priority?

MR. BOLSEN: Absolutely. Each of us is in a different spot. Chairman Levin proposed extending the production tax credit past 2012 and allowing it to be traded for an investment tax credit that would be payable in cash.

When we talk about how to get facilities financed, how about taking the decisions out of the hands of DOE and USDA and letting the market decide which technologies to support and having tax parity between fuels and other types of renewable energy?

MR. MARTIN: Bob Dinneen, we heard Candy Wheeler say one thing the government should do is build more infrastructure. We only have so many gasoline pumps that can pump gas with ethanol blends. Is this a place where the federal government can help and, if so, how?

MR. DINNEEN: Certainly it can and in a couple ways. One is to extend the tax incentive that I talked about earlier for installing new pumps. The other is to tap some existing federal funds that the states could use to create programs to encourage installation of more pumps capable of pumping E85.

DR. WHEELER: The UL certificate that we discussed earlier is a big step. It was hard to get service station owners to put something in that wasn’t certified for use. However, a lot more will have to be done to get to higher levels of ethanol usage. We are never going to get to 36 billion gallons by doing things incrementally. We need to go to higher-level blends like E85. In order to get a large number of flex-fuel vehicles into the market, the pumps must be available so that people can get the fuel they need for those vehicles. There are more than eight million flex-fuel vehicles on the road in the United States today, but 90% of those do not have an E85 pump anywhere in their zip codes.

MR. MARTIN: And the way to get more pumps is through tax credits?

DR. WHEELER: That’s one way to do it. Another way is to have the states partner in the effort. Brazil is an interesting example in that all of its service stations have an E85 pump if not an E100 pump. Sweden has fully distributed pumps. It is not important to have every station have an E85 pump. Just getting pumps evenly distributed at 10,000 or 20,000 stations would be enough to get traction.

MR. MARTIN: Jim Nussle, the Republicans will have 56% of the House and 47% of the Senate in 2011 and 2012. As we discussed earlier, they are trying to reduce the federal deficit. Are there ways to help the industry that do not require spending money? Tax credits, as you said earlier, may be a tough sell.

MR. NUSSLE: What this industry needs most is certainty. There have been too many fits and starts. Regardless of what the policy is—and we all have our own ideas of what that policy ought to be—the government needs to stick with it to provide some certainty in the marketplace. Part of the reason why there is so much more capital sitting on the sidelines today is we don’t know what will happen in the next number of days to several weeks, let alone the next year or two. What Washington should do is settle on a plan and then make it clear that the plan will remain in place for a number of years.

MR. DINNEEN: Keith, you suggested a couple times that because the Republicans will have more power in the next Congress, the policy is likely to change. Ethanol biofuels and energy security have never been partisan issues. We have strong friends on both sides of the aisle.

Will there be new pressures on all of Congress to address fiscal responsibility? Absolutely. We welcome that debate because the investment that the taxpayers have made in the federal ethanol program has been an extraordinary success in terms of creating jobs. Every $1 invested by the federal government has returned $7 to the taxpayer through reduced farm program costs and increased in corporate tax collections. We welcome the debate and don’t see any issue with the changes in Congress.

MR. MARTIN: Bob Dinneen made an important point. These issues divide not along partisan lines but more along geographic lines. That is also true of the renewable energy debate generally. Also, the Senate has been the battleground for almost everything in the last two years. That dynamic will not change in the new Congress. Whether the House is controlled by Democrats or Republicans, it has had to swallow hard and accept whatever can get through the Senate.

Are there any significant issues in play at the administrative level in the federal government that the industry is watching closely?

MR. DURANTE: There were problems at DOE. We have seen some helpful changes there in attitude. Let me give you an example. A year and a half ago, there was absolutely zero, no interest whatsoever by anyone at DOE to put federal money toward blender pumps. The idea was that ethanol is a mature market that does not require such support. Then there was an acknowledgement that government support may be needed to get service stations to deploy pumps that can dispense E85. The industry said E85 is great, but there may be other grades we want use in the middle that would require a blender pump. About a month and a half ago, an assistant secretary at DOE said in a letter to block grant recipients that such grants funded with Recovery Act money can be used for blender pumps.

Another important regulatory development at the agency level is the effort by the Environmental Protection Agency to reduce greenhouse gas emissions. It could be a big help depending on how it is done. The key is to give credit for the greenhouse gas reduction in higher-level blends like E85.

MR. NUSSLE: I may have sounded a little pessimistic at times today, so let me tell you where I