Navigant Research Blog

In Ethanol, Cellulosic Coming To Push out Corn

— October 20, 2014

The last few months have been big for cellulosic biofuels in the United States.  The first of three commercial-scale cellulosic ethanol plants to come on line this year, Project Liberty, opened in Iowa in September.  In July, the U.S. Environmental Protection Agency (EPA) expanded the definition of the cellulosic biofuel pathway to include biogas used for transportation via compressed natural gas (CNG), liquefied natural gas (LNG), or electricity.  At full capacity, Project Liberty will produce 25 million gallons annually; the two other plants scheduled to open this year will run at 25 and 30 million gallons, respectively.  If the plants are successful, this could be the beginning of cellulosic ethanol supplanting corn-based ethanol’s hold in the U.S. biofuel market.

Cellulosic ethanol’s major advantage over corn-based ethanol is that its feedstock is organic material waste rather than food/grain.  This avoids controversial issues regarding food vs. fuel, and minimizes the conversion of arable land to farm land, which experts contend makes cellulosic ethanol far more environmentally sustainable and less politically divisive than corn-based ethanol.  The disadvantage of the fuel is that it’s ethanol.

Flat Gas

Ethanol’s end market is gasoline, primarily used for light duty vehicles in the United States and Brazil.  It can only supply up to 10% of the fuel in a vast majority of the vehicles in use in the United States due to regulatory constraints and reluctance on the part of automakers and fuel retailers to adopt higher ethanol-gasoline blends.  If gasoline consumption in the United States was growing, this aspect wouldn’t be a problem, but it’s not.

In Navigant Research’s reports, Global Fuels Consumption and Light Duty Vehicles, it is estimated that light duty vehicles account for 94% of gasoline consumption in the United States.  Over the next 10 years, the light duty vehicle fleet will become far more energy efficient, thanks to vehicle electrification, vehicle lightweighting, and engine downsizing.  The end result is that the amount of gasoline-ethanol blends consumed in 2023 will likely be 12% less than 2014 levels.

The Cellulosic Edge

Consumption of ethanol is driven by the Renewable Fuel Standard (RFS), which mandates specific volumes of biofuels be blended into the fuel supply.  The standard is adjusted each year to reflect anticipated industry production volumes by biofuel pathway, so that biofuel producers can be assured their product will be purchased by blenders.

Given cellulosic ethanol’s sustainability appeal over conventional ethanol, and the limited market in which these pathways compete, and despite the high cost of cellulosic compared to conventional ethanol, it’s likely that annual adjustments to the RFS will ensure that cellulosic production feeds into the U.S. fuel pool at the expense of conventional ethanol.  That means that the EPA may be inclined to lower conventional ethanol mandates against increases in cellulosic capacity – making cellulosic more valuable to blenders than conventional ethanol.  As a result, conventional U.S. ethanol will likely become an export fuel, going to foreign markets that currently make up a little over 45% of the global market.

 

Solar Subsidies Attract Financial Schemes

— October 20, 2014

Arizona Public Service (APS) and Tuscon Power have recently come under a lot of scrutiny for their proposed rate-based solar programs.   The complaint from private sector companies is that rate-basing (i.e., the utility practice of raising funds for capital investments by increasing electricity rates) would create an uneven playing field in the solar industry, because rate-basing a capital expenditure gives utilities a guaranteed rate of return.  As SolarCity’s VP Jonathan Bass put it, “If there were ever a reason for a regulatory body to exist, it would be to stop a state-sponsored monopoly from unfairly competing against the free market in an entirely new industry.”

That’s hard to argue with.  However, I would add that another reason for a regulatory body to exist is to stop the free market from abusing the subsidies that are so crucial to an entirely new industry.  In the spirit of fair-minded analysis, let’s take a closer look at the solar industry and at how level the playing field actually is.

Pump and Dump

First, let’s examine the solar developers (SolarCity, Vivint, SunRun, Clean Power Finance, etc.) whose solar lease and solar loan programs are responsible for catapulting the industry into the period of rapid growth we’re seeing today.  Critics argue that solar developers base their business models around building solar arrays on the cheap and claiming an inflated fair market value (FMV) of the systems.  The FMV is supposed to reflect the fair price of a system, and it’s ultimately used by the government to determine the monetary value of the 30% income tax credit (ITC) that goes back to the owner of the system.  Ironically, the FMV is becoming increasingly difficult to determine as more solar companies are vertically integrating, which has made the true system costs less transparent.

For systems that are being leased (which are most systems), the owners and thus recipients of the ITC are actually third parties.  These third-party owners tend to be financial institutions, such as Morgan Stanley, Goldman Sachs, Credit Suisse, Google, and Blackstone, that are constantly looking for tax credits, and they have found a slam dunk as financiers of residential and commercial solar arrays.  Typically, the developers bundle a group of solar customers together into a tranche (essentially a bucket of leases), which is then backed by the third-party ownership groups.  The financial firms own the leased systems for 5 years and then dump them, but not before taking advantage of the Modified Accelerated Cost Recovery System (MACRS), which is a method of depreciation that allows third-party owners to recoup part of their investment in the solar equipment over a specified time period (5 years) through annual deductions.  Basically, MACRS represents an additional subsidy, with a net present value of 25% of the initial investment.

The Treasury Steps In

So between the 30% ITC and the 25% MACRS, the owners should be getting a 55% subsidized investment; but with the inflation of the FMV, it turns into a much larger subsidy, on the order of 80%.  Then consider the high rate of return (up to 15%) that investing in solar offers on top of all these subsidies, and it starts to sound pretty good to be a solar financier.  Solar developers readily admit that their business models are dependent on government subsidies, but this sounds like manipulation of those subsidies.  Indeed, this practice is currently under investigation by the Department of the Treasury.  While the developers claim they haven’t done anything wrong, if the government tightens the rules around the ITC or tries to recoup the inflated subsidies, it could be a major blow to the solar industry.

What’s more, the developers themselves don’t seem to be reaping the rewards of their innovative business models that have brought solar to the masses.  If anything, they seem to be bearing all the risk while the third-party owners reap most of the profits.  Is there some merit to rate basing solar?  In my next blog, I’ll examine this question.

 

Epic Electric Transmission Crosses the Rockies

— October 14, 2014

One of the most ambitious high-voltage transmission system and utility-scale energy storage projects in history is happening in the American West.  Designed by Duke American Transmission in a partnership with Pathfinder Renewable Wind Energy, Magnum Energy, and Dresser-Rand, the massive plan was recently announced.  As I have discussed in a previous blog, the utility-scale wind generation projects in progress across the High Plains and the Midwest are epic, to say the least.  Transporting this energy to major population centers such as Los Angeles represents major challenges and huge transmission system investments.  The intermittency of the wind resource needs to be managed, as well.  That is why this proposal represents some very creative thinking and engineering.

Driving cross-country from San Francisco to Northern Wisconsin on I-80, I began to better understand the massive geographical challenges that transmission utility planners and operators face.  The idea of moving twice the power that the Hoover Dam in Nevada produces from Chugwater, outside of Cheyenne, Wyoming, to Southern California includes building high-voltage direct current (HVDC) transmission lines across mountain passes up to 11,000 feet in Wyoming, and slightly lower passes in Nevada and California.  These lines will take years to fund and build, creating significant opportunities for major suppliers like ABB, which recently announced new 1,100 kV HVDC transmission system capabilities.

Salt Storage

The other really striking part of this announcement is the grid-scale storage project, which proposes to excavate salt caverns in central Utah and use them to store the wind energy as huge volumes of compressed air, serving as a massive battery, larger than any storage system ever built.  Compressed air would be pumped into these caverns at night, when wind power generation is peaking, and discharged during the day during periods of higher demand. 

The proposal is currently going through what may be endless approval processes at the state and federal levels, but a decision could come as soon as 2015.  In many ways, this new and novel proposal reminds me of the Pacific Gas and Electric (PG&E) Helms pumped storage solution that has been operating since 1984, storing Diablo Canyon’s nuclear output at night by pumping water up into a lake and then discharging it through turbines for peak generation.  The Duke project could be an epic feat of American power engineering to rival Hoover Dam itself.

 

Bioenergy Transition: The Challenge Ahead

— October 13, 2014

Despite the relative abundance of biomass as a fuel source in many places, the bioenergy industry has failed to gain the traction as a cornerstone renewable resource that many envisioned just 5 to 10 years ago.  Facing stagnant industry growth, the industry is in desperate need of a shot in the arm from policymakers.

Baseload biomass plants, for example, were especially hard hit by the restricted lending and general economic malaise of recent years.  Commercial installed capacity was historically much higher than wind and solar power combined, but it has been eclipsed by wind generation sources in recent years.  Global installed capacity currently stands at an estimated 3% of global generating capacity.

The European Union (EU), which envisioned a broad surge in bioenergy power and heat production to deliver its 20-20-20 goals, expects to achieve just 83% of its target by 2020.  A combination of market forces, weakened policy support, contentious debate over the sustainability of bioenergy, and the relative success of wind and solar has stifled investment across the industry.  Contending with similar but more severe headwinds, growth for the bioenergy industry in the United States has been mostly nonexistent.

New Openings

With the regulatory vice tightening on carbon-emitting power producers in the past year, however, the opportunities to co-fire diverse biomass feedstocks in coal-burning plants or switch these plants over to dedicated biopower production looks to be shaping up as an attractive proposition again.  As a feedstock, biomass remains a compelling option for reducing carbon emissions from centralized power plants because it eliminates the need for a significant overhaul of existing hardware.

Unfortunately, while recent policy and regulatory developments in the EU and United States look promising on paper, they are unlikely to give the industry the boost it needs in the near term.

Under its framework for climate and energy policies presented in January 2014, the European Commission called for 27% renewables by 2030.  Meanwhile, the Environmental Protection Agency’s (EPA’s) proposed Clean Power Rule in the United States is a potentially positive development for the bioenergy industry.  Yet, biomass will need to be recognized under the Clean Air Act as a renewable source of energy, with a favorable carbon profile when compared to fossil fuels, for the industry to gain significant traction.

Cost Gains

Longer-term developments look more positive.  According to a recent McKinsey Insights article, bioenergy in Europe has the potential to lower the levelized cost of energy (LCOE) by up to 48% by 2025 through gains like boiler efficiencies and greater plant standardization.  Although the relative abundance of cheap coal and softer emissions regulations in the United States (relative to Europe) require greater LCOE gains to reach price parity with coal-based generation, these developments would be positive for bioenergy development in both regions.

For bioenergy to capitalize on these positive trends, logistical challenges related to the collection, aggregation, transportation, and handling of biomass will need to be overcome.  Higher growth will depend on breakthroughs in carbon densification processes for biomass resources, for example, and the increasing commoditization of biomass feedstocks (including the expansion of the international trade in pellets) for power production.

 

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