Vinod Khosla at Milken Institute: Part I

Thanks to a reader for bringing this to my attention. Vinod Khosla (VK) just did a lengthy interview at the Milken Institute 2009 Global Conference. The interview was conducted by Elizabeth Corcoran (EC) of Forbes. You can see the video of the interview here:

Milken: Khosla on the Shift to Renewable Energy

I am going to listen to the interview, transcribe it, and comment on interesting/controversial exchanges. (If a transcript of this interview exists already, I haven’t seen it). I will strive to be as accurate as possible, but may paraphrase lengthy questions and answers. I will also try to provide links to all of the companies VK mentions. Any comments I make will be preceded by “RR” and will be in italics. I will also note the time into the video of each question so you can listen for yourself if you like.

In this first installment, VK discusses the role of government money, argues that these businesses need not be capital intensive if you make someone else will pay the capital (he explains his low-capital strategy, in which he has managed to outsmart everyone else in the energy business), and then discusses some of his solar investments.

First question from Elizabeth Corcoran (1:40 into the video): (RR: She first mentions that VK “hates the Prius” and promises to get into that later). The essence of this green revolution is built around a very interesting tension of private and government money. Whose money is really going to transform energy and transform this industry?

VK: I don’t think it’s built on government money. The only thing it can be built on is private money. The scale of the energy problem is so large that we cannot solve it with government money; there is not enough government money available. The only way we solve the energy problem and the climate problem is with technologies that achieve unsubsidized market competitiveness. There is not enough money in the world to subsidize oil replacement or coal replacement, or replacing automobiles. Besides, most of the most interesting markets in the world, the fast growing markets – India and China – don’t have these subsidies. The fact that we have government money maybe compensates for the fact that its competitors, fossil fuels, have had lots of subsidies too – and maybe continue to get larger subsidies than renewables get today. But it doesn’t matter. All those things will go away; will disappear at scale. So I challenge your premise to begin with.

EC (3:45): At the same time, let’s talk about how much money you have put into these technologies, and how much money they still need to achieve any kind of viable production scale. You have invested in quite a number of companies, and some of them are doing well; some of them are not doing so well. How much money does it take at this point to even conceive of having a production level cellulosic ethanol plant?

VK: I love these questions, because I can challenge her every single time. I disagree with the basic premise that it takes lots of money. If you look across our portfolio, 80% of our portfolio doesn’t need any more money that the typical venture start-up. (EC: Which is how much?) Somewhere between $30 million and $100 million to get going, whether it’s a chip start-up, semiconductor start-up, enterprise software start-up, a computer systems start-up – it’s about that range. These are very typical. Most of them are not as expensive as biotechnology which end up needing a billion dollars. And it’s not as cheap as a Web 2.0 start-up where two 23-year olds start something. But they are right smack in the middle of what venture capital has been doing. Among the remaining 20%, at least 15 of the 20 have strategies that make it very capital efficient; that means they don’t need much capital to build a plant; to be in the fuels business. And I can explain how. Then there’s a few that are very venture capital intensive. So yes, there’s a few, but that’s also true in the traditional venture business. So I don’t think there’s a difference, and this is a very common misperception.

EC (5:40): Just to cite one; perhaps one of the few, but I couldn’t help it – you have the CEO of Coskata saying it is going to take $400 million to get that plant up to production level.

VK: The question is, does Coskata need to build their own plants. (EC: They want to). They may want to – and they will – if the capital is available. If not, what do they do? They are using a Westinghouse gasifier. They let Westinghouse build the gasifier. They will just build the fermentation tank. All I am saying is strategies exist for people who are doing that kind of thing to have relatively low-capital outcomes.

(RR: I don’t understand this answer at all. Just because Westinghouse is building the gasifier doesn’t mean Coskata isn’t paying for it. It is a part of the capital cost of building their plant).

EC (6:40): These companies have said that unless they are producing on the order of 10 million gallons of fuel a year they aren’t really viable.

VK: Sure. And what do you think they will say when they ask for government money at low interest rates? Tell them “No, we don’t need the capital; we have a low cost strategy?” Look, to build demonstration plants you absolutely need money. What I am saying is most of these companies have strategies where – if the markets are great they absolutely can supercharge their growth with high amounts of capital – or they can take a lower capital strategy. You have seen that in biotechnology too. Biotech companies license some drugs and keep others for themselves. Exactly the same strategy is possible here.

(RR: Presumes you have something that has value for a licensee. A very heavy capital intensive venture with a marginal energy return isn’t going to be any more attractive to build for a licensee than for the company trying to license the technology).

EC (7:40): One more question on the capital side. The rumor in Silicon Valley is that you have been out pounding the doors looking for a billion dollar fund. Are you doing that?

VK: Actually, I can’t comment on that.

EC (7:53): And the rumor has been that you are not going to get there, because investors are scared. They are worried that they are not going to make a return when you have got companies that are doing a Series B round that is plus $100 million.

VK: Well, we will see what we want to do and where we get to. (EC: That’s hardly an answer). Let me put it this way. I don’t think I have attempted something that I have been unable to do in the past, and I don’t expect it to be different in the future. (RR: Big grin toward the audience).

(RR: I do expect it to be different, because I think VK has vastly underestimated the level of difficulty here. He believes his experience from the computer industry is applicable to technologies which in some cases have already been around for almost 100 years. But this isn’t the computer business and Moore’s Law is not in effect. As Geoffrey Styles argued in his latest column “If there is a Moore’s Law for energy, it has yet to be discerned, let alone quantified. In the early phases of any new technology, “experience curve” effects can emulate Moore’s Law-style improvements for a while. Then, as cumulative output grows the rate of change slows dramatically.”)

EC (8:25): Let’s go back to some of the specific technologies. You have made this teasing comment now that there are companies out there that are smaller – modest sized investments – that presumably you believe will have a big impact. Let’s talk about a couple of those. What are the ones that to your eye look the most promising, starting at the small level and going back up to the big guys.

VK: Let’s pick a company. We have a little company in our portfolio called PVT. (RR: See VK’s portfolio here). They can sit behind Sunpower solar panels or First Solar solar panels and triple the energy efficiency of the panel – without changing the panel – by utilizing the waste heat from the panel. My bet is that they will look more like a Web 2.0 start-up. For $15 million they will be a profitable company. That’s pretty rare in the venture business.

A lighting company – somebody like Soraa (RR: I can’t find a website for them) – LED lighting, massive market. Probably could be in the market for relatively small amounts of money. Pick a number – $25 million or less. So let me challenge you and tell you; in Cleantech, the phenomenon is, for most opportunities, the capital investment is the same as traditional venture capital, but the markets are 10 times larger and we have half the competition. Now, wouldn’t you prefer those markets? (RR: Sounds like an advertisement for the billion dollar fund he couldn’t talk about earlier).

(RR: VK smiles and looks at the audience, EC starts to ask another question, and then VK starts in again). How many markets do you see in the chip business, in the semiconductor business, or enterprise software, where the smaller end of the market is $5-$10 billion like in lighting? (EC: Not too many). Very few. Most enterprise software companies, or wifi companies – are going after markets that are hundreds of millions, maybe a billion dollars. Yet they need the same amount of capital. Guess which one is the better market to pick?

(RR: Depends on the margins, doesn’t it? Refining is a >$100 billion business in the U.S., but the margins are often very poor. This is partially what’s got so many ethanol producers in a bind. The energy markets are cyclical, and can suffer poor margins for extended periods. It doesn’t really matter how big the market is if margins in that market tend to be poor. Likewise, if the market is large but the barriers to entry are low – also a problem for the corn ethanol industry – then it will be hard to keep margins high before competitors show up in force.)

EC (10:33): Let’s talk about solar for a minute. You have a couple of solar investments. PVT you mentioned; Ausra.

VK: Yes. We have three solar companies. PVT is one I mentioned. Stion is another great example because everyone thinks photovoltaics are very capital-intensive. Yes and no. If you do it the dumb way, they are capital intensive. If you start manufacturing and redesigning your manufacturing line equipment, it will be. We chose to do two things differently. One, we are not touching the manufacturing process, so we can use other people’s equipment. For $6 million we were able to set up a pilot line because we bought 15-year-old equipment. We only innovated in the materials. This dramatically reduces the capital-intensity.

(RR: Seems to me that the potential flaw in the thinking that they will force others to do the capital-intensive stuff is the presumption that they will actually do it. If some of these technologies are so capital-intensive that VK won’t touch them, why would anyone else sink lots of money into them over the long-term?)

The second thing we did is said: There’s plenty of people in Nanosolar, MiaSolé and Konarka going after First Solar. Among the photovolaic market is Sunpower; high efficiency and high cost; First Solar; low efficiency and low cost; all of the start-ups competing with First Solar. Nobody wants to be high cost, low efficiency. So there is another quadrant, which is high efficiency, low cost. We decided to go after that. (RR: Wow, why didn’t someone else think of that. Instead of paying high cost for high efficiency, pay low cost for high efficiency. It has the sheer genius of 7-minute abs). And frankly, for $25 million dollars we have a pilot line running. We have very little risk, with very little capital. That gives us lots of options. Now you can say that photovoltaics are expensive, but you can pick the right strategy if you are knowledgeable about the trade-out you are making; if you make a change in manufacturing equipment you are going to have an expensive start-up.

Solar thermal is our 3rd start-up. Here is another great example of capital efficiency. They make these solar panels; these big mirrors that take concentrated light and turn it into steam. Building a power plant is $600 million, very capital intensive. That is an option for them. Last fall we decided the market wasn’t going to be good for project financing. They can sell $10-$15 million worth of gear, add two lines of solar to an existing coal plant, make it a little more green. And that’s what they are doing. They are doing equipment sales in $10-$15 million chunks to add to existing industrial processes where they don’t need power; or to existing power plants; whether they are coal-fired plants or natural gas plants. In small chunks, this becomes much lower capital-intensive. Looks just like Sun Microsystems manufacturing.

EC (13:40): (RR: Will pick up here in the next installment).

Vinod Khosla at Milken Institute: Part I

Thanks to a reader for bringing this to my attention. Vinod Khosla (VK) just did a lengthy interview at the Milken Institute 2009 Global Conference. The interview was conducted by Elizabeth Corcoran (EC) of Forbes. You can see the video of the interview here:

Milken: Khosla on the Shift to Renewable Energy

I am going to listen to the interview, transcribe it, and comment on interesting/controversial exchanges. (If a transcript of this interview exists already, I haven’t seen it). I will strive to be as accurate as possible, but may paraphrase lengthy questions and answers. I will also try to provide links to all of the companies VK mentions. Any comments I make will be preceded by “RR” and will be in italics. I will also note the time into the video of each question so you can listen for yourself if you like.

In this first installment, VK discusses the role of government money, argues that these businesses need not be capital intensive if you make someone else will pay the capital (he explains his low-capital strategy, in which he has managed to outsmart everyone else in the energy business), and then discusses some of his solar investments.

First question from Elizabeth Corcoran (1:40 into the video): (RR: She first mentions that VK “hates the Prius” and promises to get into that later). The essence of this green revolution is built around a very interesting tension of private and government money. Whose money is really going to transform energy and transform this industry?

VK: I don’t think it’s built on government money. The only thing it can be built on is private money. The scale of the energy problem is so large that we cannot solve it with government money; there is not enough government money available. The only way we solve the energy problem and the climate problem is with technologies that achieve unsubsidized market competitiveness. There is not enough money in the world to subsidize oil replacement or coal replacement, or replacing automobiles. Besides, most of the most interesting markets in the world, the fast growing markets – India and China – don’t have these subsidies. The fact that we have government money maybe compensates for the fact that its competitors, fossil fuels, have had lots of subsidies too – and maybe continue to get larger subsidies than renewables get today. But it doesn’t matter. All those things will go away; will disappear at scale. So I challenge your premise to begin with.

EC (3:45): At the same time, let’s talk about how much money you have put into these technologies, and how much money they still need to achieve any kind of viable production scale. You have invested in quite a number of companies, and some of them are doing well; some of them are not doing so well. How much money does it take at this point to even conceive of having a production level cellulosic ethanol plant?

VK: I love these questions, because I can challenge her every single time. I disagree with the basic premise that it takes lots of money. If you look across our portfolio, 80% of our portfolio doesn’t need any more money that the typical venture start-up. (EC: Which is how much?) Somewhere between $30 million and $100 million to get going, whether it’s a chip start-up, semiconductor start-up, enterprise software start-up, a computer systems start-up – it’s about that range. These are very typical. Most of them are not as expensive as biotechnology which end up needing a billion dollars. And it’s not as cheap as a Web 2.0 start-up where two 23-year olds start something. But they are right smack in the middle of what venture capital has been doing. Among the remaining 20%, at least 15 of the 20 have strategies that make it very capital efficient; that means they don’t need much capital to build a plant; to be in the fuels business. And I can explain how. Then there’s a few that are very venture capital intensive. So yes, there’s a few, but that’s also true in the traditional venture business. So I don’t think there’s a difference, and this is a very common misperception.

EC (5:40): Just to cite one; perhaps one of the few, but I couldn’t help it – you have the CEO of Coskata saying it is going to take $400 million to get that plant up to production level.

VK: The question is, does Coskata need to build their own plants. (EC: They want to). They may want to – and they will – if the capital is available. If not, what do they do? They are using a Westinghouse gasifier. They let Westinghouse build the gasifier. They will just build the fermentation tank. All I am saying is strategies exist for people who are doing that kind of thing to have relatively low-capital outcomes.

(RR: I don’t understand this answer at all. Just because Westinghouse is building the gasifier doesn’t mean Coskata isn’t paying for it. It is a part of the capital cost of building their plant).

EC (6:40): These companies have said that unless they are producing on the order of 10 million gallons of fuel a year they aren’t really viable.

VK: Sure. And what do you think they will say when they ask for government money at low interest rates? Tell them “No, we don’t need the capital; we have a low cost strategy?” Look, to build demonstration plants you absolutely need money. What I am saying is most of these companies have strategies where – if the markets are great they absolutely can supercharge their growth with high amounts of capital – or they can take a lower capital strategy. You have seen that in biotechnology too. Biotech companies license some drugs and keep others for themselves. Exactly the same strategy is possible here.

(RR: Presumes you have something that has value for a licensee. A very heavy capital intensive venture with a marginal energy return isn’t going to be any more attractive to build for a licensee than for the company trying to license the technology).

EC (7:40): One more question on the capital side. The rumor in Silicon Valley is that you have been out pounding the doors looking for a billion dollar fund. Are you doing that?

VK: Actually, I can’t comment on that.

EC (7:53): And the rumor has been that you are not going to get there, because investors are scared. They are worried that they are not going to make a return when you have got companies that are doing a Series B round that is plus $100 million.

VK: Well, we will see what we want to do and where we get to. (EC: That’s hardly an answer). Let me put it this way. I don’t think I have attempted something that I have been unable to do in the past, and I don’t expect it to be different in the future. (RR: Big grin toward the audience).

(RR: I do expect it to be different, because I think VK has vastly underestimated the level of difficulty here. He believes his experience from the computer industry is applicable to technologies which in some cases have already been around for almost 100 years. But this isn’t the computer business and Moore’s Law is not in effect. As Geoffrey Styles argued in his latest column “If there is a Moore’s Law for energy, it has yet to be discerned, let alone quantified. In the early phases of any new technology, “experience curve” effects can emulate Moore’s Law-style improvements for a while. Then, as cumulative output grows the rate of change slows dramatically.”)

EC (8:25): Let’s go back to some of the specific technologies. You have made this teasing comment now that there are companies out there that are smaller – modest sized investments – that presumably you believe will have a big impact. Let’s talk about a couple of those. What are the ones that to your eye look the most promising, starting at the small level and going back up to the big guys.

VK: Let’s pick a company. We have a little company in our portfolio called PVT. (RR: See VK’s portfolio here). They can sit behind Sunpower solar panels or First Solar solar panels and triple the energy efficiency of the panel – without changing the panel – by utilizing the waste heat from the panel. My bet is that they will look more like a Web 2.0 start-up. For $15 million they will be a profitable company. That’s pretty rare in the venture business.

A lighting company – somebody like Soraa (RR: I can’t find a website for them) – LED lighting, massive market. Probably could be in the market for relatively small amounts of money. Pick a number – $25 million or less. So let me challenge you and tell you; in Cleantech, the phenomenon is, for most opportunities, the capital investment is the same as traditional venture capital, but the markets are 10 times larger and we have half the competition. Now, wouldn’t you prefer those markets? (RR: Sounds like an advertisement for the billion dollar fund he couldn’t talk about earlier).

(RR: VK smiles and looks at the audience, EC starts to ask another question, and then VK starts in again). How many markets do you see in the chip business, in the semiconductor business, or enterprise software, where the smaller end of the market is $5-$10 billion like in lighting? (EC: Not too many). Very few. Most enterprise software companies, or wifi companies – are going after markets that are hundreds of millions, maybe a billion dollars. Yet they need the same amount of capital. Guess which one is the better market to pick?

(RR: Depends on the margins, doesn’t it? Refining is a >$100 billion business in the U.S., but the margins are often very poor. This is partially what’s got so many ethanol producers in a bind. The energy markets are cyclical, and can suffer poor margins for extended periods. It doesn’t really matter how big the market is if margins in that market tend to be poor. Likewise, if the market is large but the barriers to entry are low – also a problem for the corn ethanol industry – then it will be hard to keep margins high before competitors show up in force.)

EC (10:33): Let’s talk about solar for a minute. You have a couple of solar investments. PVT you mentioned; Ausra.

VK: Yes. We have three solar companies. PVT is one I mentioned. Stion is another great example because everyone thinks photovoltaics are very capital-intensive. Yes and no. If you do it the dumb way, they are capital intensive. If you start manufacturing and redesigning your manufacturing line equipment, it will be. We chose to do two things differently. One, we are not touching the manufacturing process, so we can use other people’s equipment. For $6 million we were able to set up a pilot line because we bought 15-year-old equipment. We only innovated in the materials. This dramatically reduces the capital-intensity.

(RR: Seems to me that the potential flaw in the thinking that they will force others to do the capital-intensive stuff is the presumption that they will actually do it. If some of these technologies are so capital-intensive that VK won’t touch them, why would anyone else sink lots of money into them over the long-term?)

The second thing we did is said: There’s plenty of people in Nanosolar, MiaSolé and Konarka going after First Solar. Among the photovolaic market is Sunpower; high efficiency and high cost; First Solar; low efficiency and low cost; all of the start-ups competing with First Solar. Nobody wants to be high cost, low efficiency. So there is another quadrant, which is high efficiency, low cost. We decided to go after that. (RR: Wow, why didn’t someone else think of that. Instead of paying high cost for high efficiency, pay low cost for high efficiency. It has the sheer genius of 7-minute abs). And frankly, for $25 million dollars we have a pilot line running. We have very little risk, with very little capital. That gives us lots of options. Now you can say that photovoltaics are expensive, but you can pick the right strategy if you are knowledgeable about the trade-out you are making; if you make a change in manufacturing equipment you are going to have an expensive start-up.

Solar thermal is our 3rd start-up. Here is another great example of capital efficiency. They make these solar panels; these big mirrors that take concentrated light and turn it into steam. Building a power plant is $600 million, very capital intensive. That is an option for them. Last fall we decided the market wasn’t going to be good for project financing. They can sell $10-$15 million worth of gear, add two lines of solar to an existing coal plant, make it a little more green. And that’s what they are doing. They are doing equipment sales in $10-$15 million chunks to add to existing industrial processes where they don’t need power; or to existing power plants; whether they are coal-fired plants or natural gas plants. In small chunks, this becomes much lower capital-intensive. Looks just like Sun Microsystems manufacturing.

EC (13:40): (RR: Will pick up here in the next installment).

New Renewable Energy Map

About to hop a plane for Europe, but wanted to share with you a new map from the NRDC that I think is extremely cool:

Renewable Energy Map for the U.S.

I like this map for two reasons. First, it shows the renewable energy possibilities across the country (solar, wind, cellulosic biomass, and biogas). But second, you can filter by planned and existing facilities for wind, advanced biofuels, and biogas. (However, I think some of the ones that they have called “existing” are not yet producing anything). There are a lot of small facilities that I have never heard of, and need to investigate when I have some time.

Offline now for a day or so as I make the journey back across the pond.

Book Review: Oil 101

Oil 101, by Morgan Downey, is without a doubt the most detailed and comprehensive book I have ever read on the oil industry. In fact, I am not aware that another book like this even exists. This is not an opinion piece, nor is it a peak oil book. It is a collection of factual information covering all aspects of the industry. From oil in the ground to product in the tanks (and everything in between) – this book contains everything you could ever want to know about the industry. I like to think I know quite a bit about different areas of the industry, but I still managed to learn a lot from this book.

It doesn’t matter if you are a complete novice or already know quite a bit about the industry; there is something for everyone in this book. Downey displays a deep understanding across all sectors of the industry. For instance, if I didn’t know better I would have guessed that the refining chapter was written by someone who had spent an entire career in the refining industry. The only books on refining that I have read that were more comprehensive were those written specifically as technical guides for running a refinery. Other areas are covered in similar detail.

There is no aspect of the industry left uncovered. The book starts with a brief history of oil, and then dives into fundamentals like assays, chemistry, exploration and production, refining, transport, storage, and reserves. There is a separate section on the oil markets that really gets into layers of the onion that I didn’t even know existed. One thing this section did for me was disabuse me of any notion that I ever want to trade oil futures (unless of course I have someone like Morgan Downey advising me).

The material in the book has already generated a number of essay ideas for me, as I learned a lot of new information. A few examples:

• There are 500,000 producing oil wells in the U.S., 80% of which produce 10 bpd or less. Still, this accounts for 20% of U.S. production.
• There are 1600 retail stations selling compressed natural gas (CNG) in the U.S., which is in the same range as the number of stations selling E85.
• 20% of new transit buses in the U.S. run on CNG.
• There is an actively traded freight forward market, in which you can purchase tanker routes (e.g., Ras Tanura to Yokohama)
• Valero, the largest U.S. refiner, is not a member of the API.

One of the things that surprised me is that I didn’t spot more factual errors in the book. After all, this book is primarily a collection of a great many facts. With so many facts listed, I expected to find quite a few errors. I did not, although I did find a couple.

On page 194, Downey writes that the RVP of ethanol is 19 psi and is much more volatile than conventional gasoline. Actually, the RVP of ethanol is 2.3 psi. However, when blended with gasoline, ethanol behaves as if it had a much higher RVP. The reason for this is that ethanol is slightly polar, and doesn’t mix ideally with nonpolar gasoline. This means that ethanol does raise the RVP of gasoline when it is blended, contrary to what would be expected for a nonpolar blending component with a 2.3 psi RVP. So one could argue that when you are doing blending calculations the “effective RVP” of ethanol in gasoline is much higher than gasoline – but the true RVP is quite a bit lower.

In that same section Downey shows a table (Table 9-10) that states that the nationwide RVP for winter gasoline is 11.5 psi. However, in places where winter temperatures are quite cold, the allowed winter RVP is as high as 15 psi. (Since atmospheric pressure is about 14.7 psi, that means that your winter gasoline can boil if kept until summer). I covered some of these issues in Refining 101: Winter Gasoline.

There are a couple of other items to note. First, the book is not referenced, which meant I was often left wondering about the source of a specific fact. (Presently, this involves me e-mailing Morgan and asking for a source). Second, while the book is almost exclusively just factual information, there were a couple of occasions in which Downey injected his opinion. One instance occurs on page 277, where he is discussing oil shale, and writes that it is “a clear net waste of energy.” Another case occurs on page 317 where he writes “the so called hydrogen economy is mere hype…” While I happen to agree with him on both counts (at least the way things presently stand), these were instances where he departed from the agnostic style employed throughout the rest of the book.

Others Agree

As I write this, there are 17 reader reviews of this book at Amazon. All 17 gave the book 5 Stars, which is pretty impressive. These reviews are a testament to the wealth of information in the book. Dave Summers (Heading Out) reviewed the book at The Oil Drum a couple of months ago, and wrote that this book would be one of the select few to occupy a spot on his desk “because it has a vast reservoir of the small, but invaluable, snippets that provide that useful addenda that help in understanding a story.”

Last month David Henson, President of Choren USA, came to visit me in Dallas and I happened to have the book sitting on my kitchen table. David picked it up several times, and finally said in his charming Australian accent “This is really great stuff! I have to pick up a copy.” I told him that I hadn’t read it yet, but in the three weeks since then I managed to finish it (I read when I fly, and over the 3 weeks I have flown a lot). To this date I have never known of David to be wrong on an issue pertaining to energy, and found his assessment of the book to be spot on as usual.

Conclusion

To conclude, if you want to understand the oil industry, Oil 101 will tell you what you need to know. In fact, “Oil 101″ will be my stock answer from now on for anyone who wants to learn more – whether you know nothing or already feel like you are well-informed. Likewise if you want a very good reference book that deals with even the most esoteric information (e.g., like the differences in various grades of asphalt, or the differences between hydraulic fracturing and thermal recovery). In fact, I would even strongly recommend the book to anyone who had just gone to work for the oil industry and wanted a detailed understanding of how the entire oil supply chain works.

Book Review: Oil 101

Oil 101, by Morgan Downey, is without a doubt the most detailed and comprehensive book I have ever read on the oil industry. In fact, I am not aware that another book like this even exists. This is not an opinion piece, nor is it a peak oil book. It is a collection of factual information covering all aspects of the industry. From oil in the ground to product in the tanks (and everything in between) – this book contains everything you could ever want to know about the industry. I like to think I know quite a bit about different areas of the industry, but I still managed to learn a lot from this book.

It doesn’t matter if you are a complete novice or already know quite a bit about the industry; there is something for everyone in this book. Downey displays a deep understanding across all sectors of the industry. For instance, if I didn’t know better I would have guessed that the refining chapter was written by someone who had spent an entire career in the refining industry. The only books on refining that I have read that were more comprehensive were those written specifically as technical guides for running a refinery. Other areas are covered in similar detail.

There is no aspect of the industry left uncovered. The book starts with a brief history of oil, and then dives into fundamentals like assays, chemistry, exploration and production, refining, transport, storage, and reserves. There is a separate section on the oil markets that really gets into layers of the onion that I didn’t even know existed. One thing this section did for me was disabuse me of any notion that I ever want to trade oil futures (unless of course I have someone like Morgan Downey advising me).

The material in the book has already generated a number of essay ideas for me, as I learned a lot of new information. A few examples:

• There are 500,000 producing oil wells in the U.S., 80% of which produce 10 bpd or less. Still, this accounts for 20% of U.S. production.
• There are 1600 retail stations selling compressed natural gas (CNG) in the U.S., which is in the same range as the number of stations selling E85.
• 20% of new transit buses in the U.S. run on CNG.
• There is an actively traded freight forward market, in which you can purchase tanker routes (e.g., Ras Tanura to Yokohama)
• Valero, the largest U.S. refiner, is not a member of the API.

One of the things that surprised me is that I didn’t spot more factual errors in the book. After all, this book is primarily a collection of a great many facts. With so many facts listed, I expected to find quite a few errors. I did not, although I did find a couple.

On page 194, Downey writes that the RVP of ethanol is 19 psi and is much more volatile than conventional gasoline. Actually, the RVP of ethanol is 2.3 psi. However, when blended with gasoline, ethanol behaves as if it had a much higher RVP. The reason for this is that ethanol is slightly polar, and doesn’t mix ideally with nonpolar gasoline. This means that ethanol does raise the RVP of gasoline when it is blended, contrary to what would be expected for a nonpolar blending component with a 2.3 psi RVP. So one could argue that when you are doing blending calculations the “effective RVP” of ethanol in gasoline is much higher than gasoline – but the true RVP is quite a bit lower.

In that same section Downey shows a table (Table 9-10) that states that the nationwide RVP for winter gasoline is 11.5 psi. However, in places where winter temperatures are quite cold, the allowed winter RVP is as high as 15 psi. (Since atmospheric pressure is about 14.7 psi, that means that your winter gasoline can boil if kept until summer). I covered some of these issues in Refining 101: Winter Gasoline.

There are a couple of other items to note. First, the book is not referenced, which meant I was often left wondering about the source of a specific fact. (Presently, this involves me e-mailing Morgan and asking for a source). Second, while the book is almost exclusively just factual information, there were a couple of occasions in which Downey injected his opinion. One instance occurs on page 277, where he is discussing oil shale, and writes that it is “a clear net waste of energy.” Another case occurs on page 317 where he writes “the so called hydrogen economy is mere hype…” While I happen to agree with him on both counts (at least the way things presently stand), these were instances where he departed from the agnostic style employed throughout the rest of the book.

Others Agree

As I write this, there are 17 reader reviews of this book at Amazon. All 17 gave the book 5 Stars, which is pretty impressive. These reviews are a testament to the wealth of information in the book. Dave Summers (Heading Out) reviewed the book at The Oil Drum a couple of months ago, and wrote that this book would be one of the select few to occupy a spot on his desk “because it has a vast reservoir of the small, but invaluable, snippets that provide that useful addenda that help in understanding a story.”

Last month David Henson, President of Choren USA, came to visit me in Dallas and I happened to have the book sitting on my kitchen table. David picked it up several times, and finally said in his charming Australian accent “This is really great stuff! I have to pick up a copy.” I told him that I hadn’t read it yet, but in the three weeks since then I managed to finish it (I read when I fly, and over the 3 weeks I have flown a lot). To this date I have never known of David to be wrong on an issue pertaining to energy, and found his assessment of the book to be spot on as usual.

Conclusion

To conclude, if you want to understand the oil industry, Oil 101 will tell you what you need to know. In fact, “Oil 101″ will be my stock answer from now on for anyone who wants to learn more – whether you know nothing or already feel like you are well-informed. Likewise if you want a very good reference book that deals with even the most esoteric information (e.g., like the differences in various grades of asphalt, or the differences between hydraulic fracturing and thermal recovery). In fact, I would even strongly recommend the book to anyone who had just gone to work for the oil industry and wanted a detailed understanding of how the entire oil supply chain works.

More Brazilian Ethanol Whoppers

I have written previously about Brazil’s “ethanol miracle,” and the tendency of the media and various advocates to ignore facts and embrace hype:

Lessons from Brazil

Vinod Khosla Debunked

There are two take home messages from those essays. First, ethanol provides a small fraction of Brazil’s transportation fuel, not 40% as is often reported. Second, the gap between supply and demand is gaping in the U.S., but very small in Brazil. Hence, ethanol is able to play a larger role in Brazil simply because Brazilians don’t use nearly as much energy as does the average American.

But it is coming up on 3 years since I updated the numbers, and I have been asked how the numbers in Brazil stack up now. In fact, several people have pointed to the claims in the following recently-published report, now picked up and repeated without anyone bothering to do any critical examination of the numbers:

Clean Energy Trends 2009

In 2008 the global biofuels market consisted of more than 17 billion gallons of ethanol and 2.5 billion gallons of biodiesel production worldwide. For the first time, ethanol leader Brazil got more than 50 percent of its total national automobile transportation fuels from bioethanol, eclipsing petroleum use for the first time in any major market.

Big statement. Ethanol reportedly eclipsed “petroleum use for the first time in any major market.” The only problem is that it isn’t true. In fact, the full report itself has a little disclaimer that immediately falsifies the above claim: “(not including diesel)”. And there’s the rub. Diesel is certainly “petroleum”, and it amounts to over 50% of the transportation fuel in Brazil. The other thing is that Brazil is not the “ethanol leader.” The U.S. already produces substantially more ethanol than does Brazil, so Brazil may be “an ethanol leader”, but bear in mind as you read this story that the U.S. already produces about 50% more ethanol than does Brazil. (Brazil is #2).

I suspect if one is fluent in Portuguese, they can go and dig up all of this information for themselves at the Brazilian Ministry of Mines and Energy (Ministério de Minas e Energia). Alas, I am not and must therefore try to dig up the information as I can find it in English.

My starting point is this 2006 presentation that the Ministry of Mines and Energy delivered. At that time, the breakdown of vehicle fuels in Brazil (by volume) was 53.9% diesel, 26.2% gasoline, 17% ethanol (which works out to be 10% by energy content) and 2.9% natural gas. The diesel number is unlikely to have changed much, but I will try to update.

According to History and policy of biodiesel in Brazil, diesel consumption in Brazil is approximately 40 billion liters per year. Per this story (in Portuguese), diesel consumption grew by 11.5% in 2007, while gasoline grew by 2.9% and ethanol grew by 56%. This report states that in the first half of 2008, ethanol and gasoline sales were neck and neck: 2.4 billion gallons of gasoline and 2.38 billion gallons of ethanol (but that ethanol volumes had passed gasoline in specific months).

Two things are often not made explicit when these numbers are reported. First, a large fraction of the ethanol in Brazil is hydrated, meaning it contains 5% water. So 100 liters of hydrated ethanol contains 95 liters of ethanol. Second, due to the energy difference, the comparison above of 2.4 billion gallons of gasoline and 2.38 gallons of ethanol is not comparing apples to apples.

But if we throw together the numbers we have (and ignore the lower energy content for ethanol), we find that in the first half of 2008 we had 2.4 billion gallons of gasoline and 2.4 billion gallons of ethanol, plus 5.3 billion gallons of diesel (40 billion liters per year converted to gallons in 6 months). Natural gas also accounts for several hundred million gallons. Just accounting for volumes of ethanol, gasoline, and diesel, we find that ethanol is contributing 2.4/(2.4+2.4+5.3) = 23.8% by volume, which is a far cry from the claim that it has eclipsed petroleum use. Correct for the lower energy density (diesel is 130,000 btu/gal, gasoline 115,000, and ethanol 76,000) and you find that ethanol is contributing 16% of the transportation energy. Also note that we haven’t considered the fact that a good portion of the ethanol has water in it, nor that natural gas is also in the transportation mix (both of which will drop the ethanol contribution to under 15%).

None of this is written to demean the contribution ethanol has made in Brazil. I think ethanol can be an important, (even) sustainable solution for many tropical countries, and I like the sugarcane ethanol model. Where we get into trouble is trying to extrapolate that to the rest of the world. By grossly stretching the truth and suggesting that ethanol has now surpassed petroleum usage in Brazil, we set up false expectations. People hear these things, and then wrongly think that 1). Brazil used ethanol to become energy independent; 2). We in the U.S. can follow their example. It just isn’t so.

As I have said before, if we want to emulate Brazil, we need to cut our oil consumption by 75%. There is simply no way we can emulate their ethanol model without making huge changes in the amount of energy we use.

Delusional Thinking

I read a story this morning on California’s new low-carbon fuel standard, and there were some bits in there that either amount to delusional thinking, or worse to purposely misleading people:

California’s low-carbon fuel standard has oil companies anxious

Here are the bits that raised my eyebrows:

The petroleum industry and some economists say the new standard adopted by the state Air Resources Board on Thursday will cost motorists billions, because blending gasoline will become considerably more complicated.

But state officials and environmentalists say the “low-carbon fuel standard” will actually save Californians money by reducing oil consumption and ushering in a competitive new era of biofuels and electric vehicles.

A big problem, she [Dorothy Rothrock] said, is that the air board’s standards will limit the use of corn-based ethanol in gasoline – leaving refiners with a major hurdle.

Yet the Air Resources Board, in approving the low carbon standard Thursday, dismissed forecasts of higher costs. The board’s staff contends that when the standard is fully operational, in 2020, Californians will save about $11 billion a year.

“It’s the reduction in the use of petroleum,” said board spokesman Dimitri Stanich.

We could argue about whether the new standard is a good idea, but that’s not the purpose of this essay. What should be beyond dispute is that it will cost consumers more money. It may in fact reduce oil consumption and usher “in a competitive new era of biofuels and electric vehicles.” But it will do so not by mandating new technology that is magically more cost-effective than the status quo, but instead by making fuel more expensive.

Where are gasoline blenders supposed to get these low carbon fuels, given that corn ethanol has been declared taboo with the new standards? Why, it’s the old reliable ethanol from switchgrass:

Refiners and entrepreneurs will have plenty of time – and economic incentive – to make inexpensive biofuels, hydrogen-based fuels, even ethanol from such “cellulosic” materials as switchgrass.

Plenty of time? They have until 2020 before the rules are fully phased in. And economic incentive? How does that work, given that the new rules are supposed to save consumers money? Where does the incentive come from, if not higher prices for the new, ‘low carbon’ biofuels?

Of course I knew that we have been trying to commercialize cellulosic ethanol for decades, but Robert Bryce recently pointed out that this was in fact known technology as far back as 1921:

Consider this claim: “From our cellulose waste products on the farm such as straw, corn-stalks, corn cobs and all similar sorts of material we throw away, we can get, by present known methods, enough alcohol to run our automotive equipment in the United States.”

That sounds like something you’ve heard recently, right? Well, fasten your seatbelt because that claim was made way back in 1921. That’s when American inventor Thomas Midgley proclaimed the wonders of cellulosic ethanol to the Society of Automotive Engineers in Indianapolis. And while Midgley was excited about the prospect of cellulosic ethanol, he admitted that there was a significant hurdle to his concept: producing the fuel would cost about $2 per gallon. That’s about $20 per gallon in current money.

So, what we have failed to achieve in the past 90 years will be easily achieved in the next 10? Keep in mind that we knew how to convert switchgrass into ethanol not long after the Wright Brothers made their first flight. Since that time, airline travel has become a major commercial enterprise, and we have even managed to put a man on the moon. Cellulosic ethanol still toils away in the lab or at very small scale demonstration plants. The reasons are fundamental, and even if commercialization occurs, it will only be very marginally commercial for those fundamental reasons. And we all know what happens to marginally commercial ventures in the cyclical energy business: Volatility wipes them out.

Having said that, there are some possible bright spots in the new standard. Corn ethanol producers will have a strong incentive to reduce fossil fuel inputs to improve their greenhouse gas score. Sugarcane ethanol production in the U.S. will now have more attractive economics (it gets a better score than corn ethanol with the new standard). But the reason for both is that these fuels will now command a premium, as gasoline blenders search for something to replace corn ethanol. Costs will absolutely, positively go up. Not that there is anything wrong with that, as I think higher costs will lead to some of the intended benefits. But let’s not lie to people about the costs.

A New Approach to Biogasoline

My ideal microbe for biofuel production would consume garbage, excrete gasoline, and die if it escapes into the wild. Excretion of longer chain hydrocarbons like gasoline would enable a less energy-intensive separation, because the product would phase out of water. LS9 is exploring this sort of pathway via microbes, and Virent is trying to do the same thing catalytically.

It is quite a challenging problem, but should be technically viable. And a company that can achieve an edge in this space could really dominate the biofuels arena. As I have said, it is difficult, but Holy Grail research.

Today a new and quite novel approach was announced in the Journal of the American Chemical Society:

Synthesis of Methyl Halides from Biomass Using Engineered Microbes

Professor Christopher Voigt and his team at UC San Francisco are researching a multi-pronged approach to the problem. They are using a bacterium that was discovered at a landfill in France to consume cellulose and convert it to acetate. (This was exactly what I did in graduate school, except we were using microbes from the stomachs of cattle to convert cellulose into acetate. After all, the stomach of a cow is a cellulose conversion factory).

Once acetate is produced, Professor’s Voigt’s team utilized a yeast to convert the acetate into a methyl halide. The beauty of this approach is three-fold. First, the acetate poisons the bacterium as the concentration builds, but the yeast prevents that by consuming it as it is produced. Second, the product comes off as a gas, simplifying the separation of the product from the aqueous solution. Finally, methyl halides can be converted into gasoline catalytically.

So what’s the catch? Generally the yields and reaction rates via these sorts of approaches are too low to be economically viable. This means that even if you have something that phases out of solution (or a gas that bubbles out in this case) the reactor(s) may need to be enormous to produce commercial quantities of product. Another potential issue here is the possibility that other gases are produced along with the methyl halides, potentially requiring a separation after all. Finally, methyl halides have never been turned into gasoline at large scale. If the economics were attractive, we would probably be using this process to convert natural gas into gasoline.

Still, this is a very interesting approach and an avenue that appears to be worthy of much more research.

Finally, hat tip to a reader for bringing this story to my attention earlier today.

Additional Reading

Lab finds new method to turn biomass into gasoline

Yeast and bacterium turned into gasoline factory

Californians engineer microbes to produce methyl halides

Implications of the CARB Ethanol Ruling

A number of people have written or commented regarding the California Air Resources Board (CARB) ruling that is expected on ethanol later this week. Treehugger had the story:

Corn Ethanol Worse than Oil? California Rules Yes

In what would certainly be a huge blow to the US’ formidable corn-ethanol industry, the California Air Resources Board is readying a report that says ethanol is worse than oil in terms of greenhouse gas emissions. According to the Daily Climate, the California regulators are prepared to go as far as to declare that biofuels cannot help the state fight climate change–could this be the beginning of the end for ethanol?

So, what does this mean? The article above has a different interpretation than my own:

What’s especially interesting about all this, however, is that such a groundbreaking finding will probably have a major impact at the national level as well: Obama is leaning towards establishing a national emissions standard, so California’s report is bound to form something of a precedent. Which spells bad news for the corn industry.

My own interpretation comes from a previous CARB ruling that had zero impact on what the EPA ultimately decided to do. This one is from 2005:

Senator Feinstein Renews Call for Federal Oxygenate Waiver for California

The California Air Resource Board (CARB) researched this issue at length and found that ethanol-blended gasoline does not help California meet the goals of the Clean Air Act as it relates to reducing ozone formation, particularly during the summertime, and, in fact, ethanol actually increases the emission of pollutants that cause ozone during the summer months.

In September 2004, CARB sponsored a study by the Coordinating Research Council (CRC). The CRC issued a report entitled Fuel Permeation From Automotive Systems. The study was designed to determine the magnitude of the permeation differences between three fuels, containing MTBE, ethanol, or no oxygenate, in the selected test fleet. The study found that emissions increased on all 10 vehicle fuel systems studied when ethanol replaced the MTBE. In fact, the ethanol blended gasoline caused emissions to increase by 65% when compared with MTBE blended gasoline, and by 45% when compared with non-oxygenated gasoline.

In a November 2004 report, CARB staff issued a preliminary analysis of increased emissions due to ethanol blended gasoline. The staff reported that “on-road vehicles hydrocarbon emissions increase[d] by 40-50 tons/day, statewide, [in] 2004.” CARB staff is currently working on a final analysis of the impact of ethanol blended gasoline on emissions.

So what happened? The EPA said “too bad.”

EPA Upholds Reformulated Gas Requirement in California, New York, and Connecticut

On June 2, 2005, EPA denied requests made by the states of California, Connecticut and New York for a waiver of the oxygen content requirement of the RFG program. The Clean Air Act includes specific guidelines for when EPA may grant a waiver from the Congressional mandate that RFG contain oxygen. States must provide to EPA clear evidence that the oxygen content requirement will prevent or interfere with their ability to meet the National Ambient Air Quality Standards (NAAQS). EPA determined that the petitions submitted by California, Connecticut and New York fail to meet the waiver requirements outlined in the Clean Air Act.

If the previous ruling was that California didn’t have good enough evidence to warrant the waiver (and last time they had lab data in hand), I don’t see any way that they are going to get any slack this time. My prediction is that this won’t have any impact on the ethanol mandates. It might slow down a rush to increase the percentage of ethanol allowed in gasoline (ethanol proponents want to see this ramped up to 15%, and that might be a tougher sell now). There is also more recent precedent than California in 2005; the EPA recently turned down a request by Texas Governor Rick Perry for partial relief from the mandate.

As expected, the Renewable Fuel Association took exception to CARB’s findings, presenting a 117-page document that disputes the ruling. I have not had time to browse through the document, and present it here merely for information.

Beyond Fossil Fuels

Through at least this week, my posting will continue to be sporadic. I have been traveling a lot the past couple of weeks, and this week (Thursday April 23rd) I head to Kansas City to give a talk that will be partially about biofuels and partially about acetylated wood:

Economic Forum – Biofuels, Biobuildings, and Beyond

After that, I think things will settle down for a little while. I am back in Europe next week, and I usually have more time for writing then (since my family isn’t there, I write in the evenings).

For now, there is an interesting series of articles that will be published this week at Scientific American:

Beyond Fossil Fuels: Energy Leaders Weigh In

Here is the line-up:

Monday, April 20:
Eric McAfee, chairman and CEO, AE Biofuels
Gerald Grandey, president and CEO, Cameco Corporation (uranium production)

Tuesday, April 21:
Barry Cinnamon, CEO, Akeena Solar
Aris Candris, president and CEO, Westinghouse Electric Company (nuclear)

Wednesday, April 22:
Alan Hanson, executive vice president, AREVA (nuclear)
Harrison Dillon, president and chief technology officer, Solazyme (microbial fuel production)

Thursday, April 23:
David Crane, president and CEO, NRG Energy (nuclear)
Leon Steinberg, CEO, National Wind

Friday, April 24:
John Melo, CEO, Amyris (renewable fuels)
Daniel Kunz, president and CEO, U.S. Geothermal

Monday, April 27:
John McDonald, CEO, ExRo (wind)
Sanjay Pingle, president, Terasol Energy (biofuels)

Tuesday, April 28:
William Johnson, president, chairman and CEO, Progress Energy (nuclear)
David Mills, founder and chief scientific officer, Ausra (solar thermal)

Wednesday, April 29:
Bob Gates, senior vice president for commercial operations, Clipper Windpower
David Ratcliffe, president, chairman and CEO, Southern Company (nuclear)
Lucien Bronicki, chairman and chief technology officer, Ormat Technologies (geothermal)

The first question and answer from McAfee’s interview:

What technical obstacles currently most curtail the growth of biofuels? What are the prospects for overcoming them in the near future and the longer-term?

The conversion and commercialization of cellulose inputs into fuel ethanol is a significant technology obstacle to the growth of the ethanol industry as a mainstream fuel. A number of companies are currently working on cellulosic technologies, and great strides have been made, but a gap remains between technology advances and full commercial deployment. Much of this challenge exists around two factors—scalability and cost. Science is no longer the primary gating issue—it’s now a matter of investment and resource allocation.

While I agree with the first part on the technological obstacles for commercialization of cellulose into ethanol (I simply don’t believe it will ever happen), I think the last sentence can be misleading. When one says that science is “no longer the primary gating issue”, that implies that recent scientific advancements have enabled the technology. However, the science has not been the issue for almost 100 years. As Robert Bryce points out in The Cellulosic Ethanol Delusion, conversion of “straw, corn-stalks, corn cobs and all similar sorts of material we throw away” was known technology in 1921.

The issue is simply the same as it was back in 1921: Biomass has a low energy density, and the cellulose is not easily converted. These factors worsen the energy balance, and there isn’t an easy way around this fact. (Gasification, as I have argued, is a way around some of the issues, but we are talking about a different animal from hydrolysis.)

Coming Up

As soon as I get some breathing room, I am going to do a book review for Oil 101- which I finally finished reading, and then to write an essay on the implications of being wrong.