Tom Konrad CFA
There are many proposed solutions to the liquid fuels scarcity caused by stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies. Some will be good investments, others won’t. Here is where I’m putting my money, and why. This first part looks at biofuel strategies for replacing oil.
World oil supplies are stagnant, and in the not-so-distant future will begin to decline. If economic growth continues, demand for oil will increase as well. This will lead to a long term rise in oil prices, which will only stop if 1) high oil prices or other factors stop or reverse economic growth, or 2) we find some way to use much less oil for the same amount of economic activity. Each of these scenarios will have winners and losers. In other words, investment opportunities.
Substitution
The most obvious strategy for dealing with peak oil is substitution. If we can find another form of energy in place of oil, then our economy can grow without more painful adjustments. These strategies are among the most popular, because they hold out the hope that we’ll be able to transition with a minimum of pain. That is wishful thinking. There will be a market for petroleum substitutes, but those substitutes are likely to be more expensive and supply-limited than oil currently is. We will have to adapt in other ways as well as using substitutes.
The leading substitutes include
- Biofuels and Biochemicals
- Electric vehicles
- Hydrogen
- Natural Gas
Biofuels and Bioplastics include a whole range of technologies which convert plant and animal matter into useful substances similar to the extremely useful transportation fuels, chemicals, and plastics that we currently get from oil.
Only some biomass is easy to convert into fuels, like sugars and starches into ethanol, and oils into biodiesel. But it is no coincidence that such biomass is also useful as food. We eat these things because our bodies can easily convert them into useful energy. We don’t eat wood chips or grass because they are difficult to digest and convert into energy. Biofuels substitution strategies all essentially involve diverting biomass from somewhere else in the economy (or land on which to grow the biomass from other forms of agriculture) to producing oil substitutes. The more inputs we divert, the more expensive the products we might have used those inputs for become. This produces a commodity squeeze, when the inputs become more expensive but the price for the output is set by the oil price. Such a commodity squeeze led to the current problems in the corn ethanol and biodiesel industries.
Fortunately, we currently have a lot of biomass in our economy that is currently wasted. Waste oil can be easily converted into biodiesel, and companies are looking at ways to convert the various components of Municipal Solid Waste into ethanol or other biofuels. Municipal solid waste has a lot of biomass in it, but its uneven nature means that it’s hard to convert into ethanol. Some of the best such waste is industrial food waste because it is othen quite uniform, and homogeneity makes it easier to convert into fuels.
Although we are an extremely wasteful society, the amount of waste that can usefully be converted into oil substitutes is small relative to the amount of oil we currently use. That means that as conversion technologies are developed, there will be a scramble for useful feedstock to convert to biofuels. Since the limiting factor for biofuels is likely to be feedstock, the companies most likely to benefit from a trend towards biofuels are the people who own the feedstock. For example, corn farmers have done much better out of the ethanol boom than the ethanol producers. Although many ethanol firms have filed for bankruptcy, and the ones that survived are barely profitable, corn acreage and prices are still high compared to 5 years ago.
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| Monthly corn price chart from tradingcharts.com |
Conclusion
The best biofuels investments are likely to be the companies that own or can produce the feedstocks. I particularly like the companies that own or control municipal waste, since it’s currently free or even has a negative price (i.e. people will pay you to take it off their hands.) That’s why Waste Management (WM) was one of my Ten Clean Energy Stocks for 2010. I also like forestry companies, since they currently produce forestry waste that could become a valuable feedstock for cellulosic ethanol, or simply be co-fired in existing coal plants to generate electricity without net carbon emissions.
I’ll take up some of the other substitution strategies in the next part of this series.
DISCLOSURE: Long WM.
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I’d be inclined to take your statement a bit further and suggest that biofuel companies should probably be avoided unless they control their own feedstocks. I’ve had a good deal of unpleasant experience with biofuels and the biggest problems are uncorrelated commodity price risks on the feedstock and product ends of the processing plant. When they work in your favor life is good. When they turn against you life gets miserable very quickly.
I concur with your central thesis and Mr. Petersen’s comments.
Having said that, I would expand your scope a bit.
It seems reasonable that, longer term, electric utilities may get into the biofuel game. If algae is ultimately a successful fuel source, as I expect it will be, a source of concentrated co2 may be very desirable. As it happens, utilities generally have a substantial source of the stuff. Further, their plants are frequently located in areas that can provide the hundreds of acres needed for an algae facility.
You might also want to expand your substitution sources. For example, natural gas can augment oil in several ways. Certainly it could be used directly, preferably in trucks. However, it can also be converted to liquid “oil”. Here I am specifically not referring to LNG. Rather, this is conversion a’la the FT method. Historically such facilities have been very large and expensive, thus of limited use. New developments suggest that such facilities could be dramatically reduced in size and cost. If successful (we should know within two years), the target for this equipment is the natural gas that is presently flared or injected back into the earth. This wasted gas is a very large resource. Satellite images clearly show major flaring, particularly in Russia. A recent estimate places the potential for liquid produced from stranded gas to be sufficient to power Germany.
It also seems likely that oil consumption by industrial users will decline if prices increase substantially. Certainly we can anticipate electric utilities to nearly eliminate use of oil. A possible beneficiary of such action, in addition to renewables, could be nuclear or fuel cells.
We might also expect the marine transport to change.
From an investment perspective, it seems that one of the likely outcomes of high priced oil will be the reduction in use & value of US based oil refineries. Long term puts (LEAPS) on refiners may be a play.
I would add two additional substitution thoughts.
In the Northeast USA oil finds substantial use for heating. With an increase in the price of oil and the large differential in cost per btu, conversion to natural gas seems likely in many cases. Aggressive conversion could have a meaningful impact on US oil consumption and apply pressure to diesel oil prices as diesel and heating oil are very similar.
Although it is still a very small market, the market for wood pellet based heating is developing rapidly. This further supports your appreciation for forestry firms.
John- agreed – the *only* good biofuels investments are feedstocks.
Alegra- also agreed on the other options for substitution… I’m currently on part IV of this series dealing with CTL and GTL.
I should probably do an algae one, too. I’m expecting to run this series to 8 or 10 articles, because my favorite peak oil investments are not substitution at all, and I already have ideas for 6 or 7 substitution options.
Stay tuned.
Consider my antennae tuned, particularly as substitution is not my first (or second) choice either.
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