SCORECARD
Betting on biofuels
The industry is still in its infancy but evolving
rapidly. Companies that hope to compete must devise
their entry strategy now.
Billions of dollars, euros, pounds, and reais are
pouring into biofuels. High fuel prices and generous
regulatory support have given the industry healthy
margins and relatively short investment payback
times. Meanwhile, the triumphs of the first movers and
dreams of future growth are enticing companies in
industries from petroleum and agribusiness to
biotechnology, chemicals, engineering, and financial
services. And of course, the allure of a greener future
has raised the expectations of investors and
bystanders who hope that biofuels will help meet the
world's energy needs while lowering greenhouse gas
emissions.
Can biofuels deliver? The answer appears
contingent on fuel prices as well as three other
variables that directly influence the profitability and
environmental impact of biofuels: the cost and
availability of feedstock, government regulation, and
conversion technologies. All are in flux, so an
investment today is a bet on how these interrelated
factors will evolve. Feedstock costs vary tremendously
by region and could change significantly in the years
ahead. Governments may alter the industry's ground
rules to match changing priorities in climate change,
energy security, and economic development. The
energy, cost, and carbon efficiency of various biofuels
are already quite different,1 and new conversion
technologies could make them even more so-at
different rates in different regions. Decisions about
where to produce and distribute biofuels could have
dramatic implications for the feasibility of the
business.
Amid all this uncertainty, why enter now? In many
commodity industries, the winners are the latest
entrants, at the bottom of the cost curve-wielding the
newest, most efficient technologies. But waiting may
be a costly strategy in the nascent biofuel industry
because land and other essential resources are at a
premium.
Biofuel players should consider different ways to
mitigate the risks, but every strategy will require trade-
offs. Betting on a number of geographies and
technologies will make things more complex, for
example, but helps balance risk. Vertical integration,
though both complex and costly, may be essential in
helping to establish this young industry. Companies
that want to play should try to get a head start on the
difficult task of reducing the seemingly infinite number
of options to a feasible set of solutions.
A world of uncertainty
Not long ago, the biofuel industry was relatively
straightforward. Producers mostly used mature
technologies and local feedstock to supply domestic
markets with a single biofuel: bioethanol from
cornstarch (in the United States) and sugarcane (in
Brazil) or biodiesel from rapeseed oil (in Europe).
Now, as global demand increases, companies are
beginning to produce and sell biofuels in a number of
geographies-and that's when things start to get tricky.
In many industries, the factors affecting returns
vary geographically, and companies combine
locations accordingly. With biofuels, these factors are
particularly dynamic, often interconnected, and mostly
uncertain. Two of them-feedstock costs and
government regulation-are critical to any geographic
strategy today, and conversion technologies will
increasingly affect production costs as next-
generation processes become commercialized.
(Capital expenditures vary tremendously across
regions, but no more so in biofuels than in any other
industry.)
Feedstock costs and
consequences
Feedstock accounts for 50 to 80 percent of biofuel
production costs, so its price has a huge effect on the
producers' returns. In the United States, for example,
every dollar increase in the price of a bushel of corn
raises the production cost of bioethanol by $0.35 a
gallon and reduces the producer's operating margin
by 20 percent.2 Many different forms of biomass can
be used as feedstock, and costs vary hugely by
region. Fermentable sugars from Brazil's sugarcane,
for example, are less than half as expensive as those
from European sugar beets. Government subsidies
and alternative uses of feedstocks also affect
feedstock costs.
In many regions, rising demand threatens both
the cost and availability of feedstock. From 2003 to
2006, the percentage of the total US corn harvest used
to produce biofuels rose to 16 percent, from 12
percent. But now that the federal government has
adopted a goal of 35 billion gallons of alternative fuels
a year by 2017, the use of domestic corn-based
bioethanol to meet even half of this target would
require 40 percent of that year's expected harvest. Not
surprisingly, the cost of corn has soared: average
wholesale prices rose from $1.90 a bushel in 2005 to
$2.41 in 2006, and corn has regularly surpassed $4 a
bushel on the spot market since late 2006.
Other unintended consequences of greater
demand could bring a consumer backlash like the
one that broke out in Mexico when tortilla prices
skyrocketed because of bioethanol-related corn
shortages. Environmental concerns were also raised
after last autumn's burning of Indonesian forestland to
make space for palm oil crops that were linked to
increasing demand for biodiesel. The environmental
impact of other aspects of biofuel production,
including the widespread cultivation of fast-growing
jatropha (a plant that produces a toxic vegetable oil),
are unknown.
Government regulations
Whether through subsidies, import tariffs, or
research grants, government regulation has helped
drive both demand and profitability in the industry.
Because the energy policies of most nations are still
evolving, regulation is perhaps the greatest
uncertainty of all. Lower subsidies, for example, could
diminish profits. A production cost of about $2.90 a
gallon and a government subsidy of $1.81 a gallon
helped German producers to earn $0.42 for every
gallon of biodiesel in 2006. The role of taxpayer
money in creating new millionaires hardly went
unnoticed, and the government decided to eliminate
these subsidies, gradually, by 2012, replacing them
with a mandated blend rate (the percentage of
conventional fuel that blenders must replace with
biofuel). Blend rates guarantee producers a certain
level of sales, but the elimination of subsidies and the
fact that supply will likely exceed mandated demand in
the short term should depress margins. In such a
market, companies generate attractive returns only
when the cost curve is steep and lower-cost
producers operate under the price umbrella
established by marginal, high-cost producers. Since
vegetable oil, itself a globally traded commodity,
accounts for 80 percent of the production cost of
biodiesel, the biodiesel cost curve isn't steep.
Analogies with industries that have similar cost
structures suggest that biodiesel margins could fall by
80 percent from 2006 levels.
The impact of mandated blend rates is also
unclear. US regulators could set any ethanol blend
rate from 10 percent (the maximum suitable for
current vehicles) to 85 percent (the maximum suitable
for most flex-fuel vehicles).3 Minnesota, for example,
has mandated a 20 percent ethanol blend rate to take
effect in 2013. What's more, mandated blend rates
below 85 percent could be met either with the uniform
blending of biofuels at the mandated rate or with a
disproportionately high share of high-biofuel blends.
All of these regimes would increase overall demand,
but they could have vastly different effects on
bioethanol companies and on other businesses,
particularly car manufacturers. For now, car
companies can keep selling vehicles with current
engine designs, but some already plan to offer more
flex-fuel vehicles, which use high-concentration
biofuels, conventional fuels, or a mix of the two. Of
course, the way carmakers deal with these issues will
influence their other product-development decisions,
especially for different low-carbon approaches, such
as hybrid or hydrogen-fuel-cell cars.
Other policies are also in flux. With some
exceptions,4 current biofuel regulations in the
European Union and the United States protect
domestic producers, but these policies-especially
import tariffs-may change. Regulators increasingly
recognize that current trade policy, which taxes
imports of ethanol but not of petroleum, may not serve
the goal of energy security. As evidence amasses
confirming sugarcane ethanol's importance for
reducing carbon emissions,5 regulators may ease
restrictions on its importation.
The impact of new conversion
technologies
New conversion technologies are going to cut overall
production costs. Regional variations will either
validate geographic strategies for biofuels-or turn
them on their heads.
New conversion technologies are going to
cut overall production costs; regional variations will
either validate geo-graphic strategies for biofuels or
turn them on their heads
Take, for example, bioethanol, produced when
microorganisms such as yeast ferment sugars into
ethanol. Next-generation technology will allow
producers to use the sugars that make up cellulose
(the main structural component of plants). Cellulose
is found in all manner of vegetation, so cheap
feedstocks-such as corn stover, sugarcane stalks
(bagasse), and high-yield "energy crops" like switch-
grass, energy cane (a relative of sugar cane), and
wood-will become important feedstocks. The
technology involves "pretreating" feedstocks physically
or chemically and then using enzymes to digest the
cellulosic components to release the fermentable
sugars. For every step, competing technologies are
under development.6 Each could lead to different
production processes, biorefinery designs, and costs.
When this "lignocellulosic" technology becomes
commercially viable-as early as 2010, by some
estimates-the savings in costs and carbon
emissions will vary by feedstock. Since feedstocks
vary by region, their costs could change a region's
attractiveness to producers. Consider these
examples:
- Today biofuel production in China is
uncompetitive, because feedstock costs are relatively
high. Cellulosic technology, however, could lower
production costs to as little as $0.60 a gallon, from
about $1.80, making Chinese bioethanol one of the
world's cheapest biofuels.
- In the United States and Brazil cellulosic ethanol
production costs won't be much lower than today's
corn- and sugarcane-based ethanol costs. Facilities
processing cellulosic material thus will likely
supplement rather than replace older ones, though
cellulosic technology would have a significantly better
energy balance when compared with the corn ethanol
currently produced in the United States.
- In Europe cellulosic technology could lower
production costs enough to threaten companies
producing beet (or wheat) ethanol with current
methods.
Governments can help to advance technologies,
but not without risk. In 2006 the government of Spain
allocated $29 million to finance a joint Spanish-
Argentine biodiesel research project. Likewise, the US
Department of Energy recently announced $385
million in grants to six different cellulosic ethanol
research projects. Technology could make it practical
to use biobutanol, a molecule that outperforms
ethanol as a premium gasoline replacement.
Biodiesel, though far from cost competitive with
regular diesel today, could in time be produced from
jatropha, which provides a low-cost vegetable oil and
can be cultivated on marginal land. Biomass-to-liquid
(BTL) technology, a gasification process long used to
convert coal into fuels, could eventually make it
possible to produce high-quality synthetic diesel and
gasoline. Most of these new technologies have yet to
prove that they can be cost competitive. However,
farsighted governments should avoid policies that
favor today's technologies at the expense of
tomorrow's.
Continued Next Week
Source: McKinsey & Co. 2007
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Greetings!
- Betting on Biofuels
- Diners Invited to Rate and Review Salt Lake &
Park City Restaurants
- Economic notes
- Eating out leads
Bob Springmeyer
Bonneville Research
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Economic Notes: |
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- Global business confidence
- Global business confidence weakened a bit in
early June, particularly in the U.S. This stands in
contrast to other U.S. economic data released last
week covering activity during the month of May,
including stronger job growth and better
manufacturing activity. While sentiment is still well
above its low point very late last year, it continues to
suggest that growth remains stuck at best at the low
end of its potential. Pricing pressures also continue to
spurt higher, as higher energy and other commodity
prices are having an impact. Financial and business
service firms and South American businesses are the
most optimistic. Vehicle manufacturers, real estate
firms, and European businesses are the least
upbeat.
- US Science graduate studies see revival
in numbers
- The number of US students going to graduate
school for science and engineering hit an all-time
high in 2005, offering a glimmer of hope to
policymakers and business chiefs who have
lamented that Americans are not interested in
science.
- Semiconductor Billings
- In April, global semiconductor sales were valued
at $19.92 billion on a three-month moving average
basis, for a year-ago rise of 1.6%. On a month-ago
basis, sales fell by 2.1% in April compared to March.
On a month-ago basis, sales dragged in all areas
except Japan, where sales held at $3.87 billion.
- Productivity and Costs
- As expected, productivity growth for the first
quarter was revised much lower. Nonfarm business
productivity grew 1.0% (SAAR), compared to 1.7% in
the preliminary release. This revision was due to a
much lower estimate of output. Growth in unit labor
costs saw an enormous upward revision, from 0.6%
(SAAR) to 1.8%; this was a bigger upward revision
than the consensus expected. The larger-than-
expected upward revision to unit labor costs will add
to inflation concerns.
- Wholesale Trade (MWTR)
- Wholesale inventories rose 0.3% in April, in line
with consensus estimates. March inventories got
revised up to a 0.4% increase from the estimated
0.3% increase. Sales were strong again increasing by
1.3% following March's upward revision from 1.8% to
2.1%. The inventory-to-sales ratio fell lower again in
April; it stands at 1.12 after being downwardly revised
from 1.14 to 1.13 in March.
- MBA Mortgage Applications Survey
- Mortgage demand decreased 1.7% in the week
ending June 1. Purchase applications increased 1.5%
and refinance applications decreased 6.3%. Holiday
seasonal adjustments have an impact, but generally
the decline in the weekly index signals the market has
little strength, considering recent trends that would
increase the number of mortgage applications filed
with MBA members.
- Chain Store Sales
- Chain store sales rose a modest 2.5% in May,
well above April's revised 1.9% decline (previously -
2.4%), but only modestly above the March-April
average of 2%. Sales were supported by improved
weather while record gasoline prices were the biggest
drag.
- Wholesale Clubs and Drug Stores Lead
May Sales
- Wholesale clubs lead in May sales growth
Wholesale clubs reported the most sales growth, at
about 6.5%, according to the International Council of
Shopping Center's index. Drug stores reported an
average 5.3% sales increase for May, and department
stores showed a 2.2% increase, while apparel chain
store sales dropped by 0.6%.
- Wal-Mart launches prepaid payment
card
- Wal-Mart will offer a Visa-branded prepaid
payment card that will be issued by GE Money and will
work almost anywhere Visa cards are accepted. The
creation of the prepaid payment card is the next
natural step for the company, which offers check-
cashing and bill-paying services. It hopes that the new
venture will appeal to customers without bank
accounts.
- Oil and Gas Inventories
- Crude oil inventories rose by 0.1 million barrels
for the week ending June 1, according to the Energy
Information Administration, below expectations of a
0.3 million barrel build. Gasoline stocks surged by 3.5
million barrels, well above expectations of a 1.4
million barrel build. Refinery activity fell, but surging
gasoline imports helped bridge the gap. Distillate
inventories rose 1.9 million barrels, above
expectations. This release will likely help put some
bearish pressure on prices.
- Challenger Report
- Companies announced cuts affecting 71,115
workers in May. Cuts increased slightly over April and
were one-third higher than in May 2007. Still, so far
this year, cuts are 8.5% below the same period in
2006. In May, the computer industry led all others with
13,631 cuts. This was followed by automotive and
government/non-profit.
- Consumer Credit (G19)
- Consumer credit increased in April by a modest
$2.6 billion to $2.429 trillion. The details of the report
showed that the latest jump in consumer credit was
solely driven by a slight gain in nonrevolving credit,
which increased 2.4% at an annual rate. In a bit of a
surprise, revolving credit fell 0.5% at an annual
rate.
- Ford brands improve on vehicle quality
- The quality of Ford Motor vehicles has improved
markedly over the past year, according to JD Power
and Associates' latest annual survey of North
American design and production.The survey ranks
Honda lowest overall among non-luxury brands.
- Weekly Natural Gas Storage Report
- Underground storage of natural gas increased by
110 billion cubic feet during the week ending June 1.
This was slightly above expectation, which had called
for a 107 bcf build. Inventories are now 20.4% above
the five-year average. This report is likely to have a
modestly bearish effect on prices.
Source: Economy.com, ICSC SmartBrief &
Financial Times
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This Weeks Leads: |
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Food Leads:
- Famous Famiglia
- Famiglia - DeBartolo, LLC trades as Famous
Famiglia at 63 locations throughout AZ, CA, FL, HI, IL,
MA, MD, MI, MN, NC, NJ, NV, NY, OH, PA, TN, TX, VA
and Washington, DC.
- The pizzerias occupy
spaces of 600 sq.ft. to 2,500 sq.ft. in entertainment,
power, tourist and strip centers.
- Plans call for 24
openings nationwide and in Mexico and China during
the coming 18 months.
- Typical leases run seven
to 10 years.
- A vanilla shell is required.
- Preferred cotenants include McDonalds, Panda
Express and Starbucks.
- Competition is cited as
Sbarro Pizza.
- For more information, contact
- Giorgio Kolaj,
- Famiglia-DeBartolo, LLC,
- 199 Main Street, 8th Floor,
- White Plains, NY
10601;
- Web site: www.famousfamiglia.com.
- The Montana Mills Bread Company &
Java Joe's Cafe
- The Montana Mills Bread Company also doing
business as Java Joe's Cafe operates 21 locations in
NY and PA.
- The bakeries occupy spaces of 1,200
sq.ft. to 2,700 sq.ft. in freestanding locations.
- Plans call for 20 openings in the coming 18
months.
- Expansion opportunities are sought in
CT, NY, OH and PA.
- The company prefers
supermarkets, coffee shops, banks and post offices
as cotenants.
- Preferred demographics include a
population of 50,000 residing in a three-mile radius
earning an average annual household income of
$60,000.
- A vanilla box is required.
- For more information contact
- Richard
Gunn,
- Gunn Consulting,
- 95 Highland Avenue,
- Buffalo, NY 14222;
- 716-885-8001;
- Fax 716-
885-8002;
- Web site: www.montanamills.com.
- Krispy Kreme
- Krispy Kreme Doughnut Corporation operates 177
locations nationwide and in Canada.
- The donut
stores occupy spaces of 4,000 sq.ft. to 5,000 sq.ft. in
freestanding locations and power centers.
- Expansion opportunities are sought across North
America.
- Preferred demographics include a
population of 100,000 residing in a five-mile radius
earning an average annual household income of
$40,000.
- The company is expanding both
company-owned and franchised stores.
- For more information contact
- Steve Jones,
- Krispy Kreme Doughnut Corporation,
- 370
Knollwood Street, Suite 500,
- Winston-Salem, NC
27103; 336-725-2981;
- Fax 336-726-8253;
- E-
mail: sjones@krispykreme.com.
- Bill Knapp's
- Bill Knapp's Michigan, Inc. trades as Bill Knapp's
at 49 locations in MI and OH.
- The family-oriented
restaurant occupy spaces of 4,500 sq.ft. to 5,600 sq.ft.
in end cap and freestanding locations.
- Expansion
opportunities are sought in MI and OH. Leases
running 10 to 15 years are typical.
- For more information contact
- John
Bowman,
- Bill Knapp's Michigan Inc.,
- 110
Knapp Drive, Battle Creek, MI 49015;
- 616-968-
1121;
- Fax 616-964-0333.
- American Cafe & Tia's Tex Mex
- SRG Inc. trades as American Cafe and Tia's Tex
Mex at 68 locations nationwide.
- The American
Cafe occupies spaces of 3,100 sq.ft. to 4,500 sq.ft. in
regional centers and freestanding locations.
-
Expansion opportunities are sought nationwide except
in CA, MO, ND, OR and SD.
- Tia's Tex Mex
occupies spaces of 4,200 sq.ft. to 6,000 sq.ft. in
regional centers and freestanding locations.
-
Plans call for three to four openings in the coming 18
months and expansion opportunities are sought in the
eastern U.S. and TX.
- Preferred demographics
include a population of 100,000 residing in a five-mile
radius earning an average annual household income
of $40,000.
- For more information contact
- James
Carmichael,
- SRG Inc.,
- 150 West Church
Street,
- Maryville, TN 37801;
- 865-379-5700;
- Fax 865-379-6830.
- Houlihan's and Darryl's Restaurant
- Houlihan's Restaurant Group trades as
Houlihan's and Darryl's Restaurant at 126 locations
nationwide.
- The restaurants occupy spaces of
5,200 sq.ft. to 7,200 sq.ft. in strip and specialty centers
and freestanding locations.
- Expansion
opportunities are sought in St. Louis, MO; Kansas
City, MO; KS; Chicago, IL; NY, NJ and Philadelphia, PA.
- For more information contact
- David
Rockaway,
- Houlihan's Restaurant Group,
- 2
Brush Creek Boulevard,
- Kansas City, MO 64112;
- 816-756-2200;
- Fax 816-751-8396.
- Roadhouse Grill
- National Retail Group of Florida trades as
Roadhouse Grill at 83 locations in FL, GA, LA, MS, NC,
NY, OH and SC.
- The restaurants occupy spaces of
7,500 sq.ft. in mixed-use centers, end cap and
freestanding locations.
- Expansion opportunities
are sought east of the Mississippi River especially
upstate, east and central NY, southern OH and
northern KY.
- For more information contact
- Mick Owens,
- National Retail Group of Florida,
- 6600
Andrews Avenue, Suite 160,
- Fort Lauderdale,
- FL 33309-2134;
- 954-957-2600;
- Fax 954-
969-5432.
- Hartz Chicken Buffet
- Hartz Chicken Buffet operates 42 locations in MS
and TX.
- The restaurants occupy spaces of 2,000
sq.ft. to 3,000 sq.ft. in strip and specialty centers and
freestanding locations.
- Expansion opportunities
are sought in the existing markets.
- For more
information contact
- Bill Knight,
- Hartz
Chicken Buffet,
- 14451 Cornerstone Village, Suite
250,
- Houston, TX 77014;
- 281-583-0020;
- Fax 281-580-3752.
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Diners Invited to Rate and Review Salt Lake & Park City Restaurants |
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ZAGAT SEEKS CRITICS FOR 2008
AMERICA'S TOP RESTAURANTS GUIDE
Vote at www.ZAGAT.com to Share Your
Experiences Today
Want to be a restaurant critic? Zagat Survey today
announced that is now conducting its online survey of
Salt Lake City area restaurants to be included as part
of the 2008 America's Top Restaurants guide. Avid
diners are encouraged to vote at ZAGAT.com to share
their thoughts and opinions about the dining scene in
Salt Lake City.
Surveyors are asked to rate and review
restaurants based on their Food, Decor, Service and
estimated meal cost. Those who cast their votes by
July 8 will receive a free copy of the Zagat Survey 2008
America's Top Restaurants guide when it is
published.
Surveying is simple and free. After logging onto
ZAGAT.com, surveyors can submit feedback at their
convenience, save reviews to complete at their leisure
and even revise votes if opinions change.
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