“Biomass and Biochemicals: Benchmarking and Financial Analysis” Presented by Lawrence D. Sullivan

Zintro Webinar

Presented by Lawrence D. Sullivan, Project Management Consultant, Adjunct Professor at Trident Technical Collage and Principal with Lawrence D. Sullivan & Company Inc.

Presenter’s Note:
“Topic covers the key measures of financial models, like the capital asset pricing model or CAPM, used by financial analysts to review investments in private equity, public equity and other markets for new biomass, biofuel and biochemical projects and companies.”

About Lawrence D. Sullivan:
Larry Sullivan is a leading management and engineering consultant in oil, natural gas and biotechnologies used by the petroleum industry. He is a Top 2% Gerson Lehrman Group Member in the Council of Advisors where he consults with leading financial and industrial as well as governmental, legal and academic institutions.

He is an Adjunct Professor at Trident Technical College and a principal with Lawrence D. Sullivan & Company, Inc. with his partner, Carla M. Wood, Ph.D. They provide due diligence, expert witness and chemical engineering services to petroleum, biotechnology and advanced biomass, biofuels and renewable energy markets, companies and financial institutions.He earned his BA and MA in Geosciences at the University of Texas and Arizona State University, respectively.


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Enrique: Hello and welcome. My name is Enrique Levin, Co-founder and VP of Product at Zintro. Zintro is an online marketplace that helps connect companies with highly specialized consultants and other expertise providers for projects that range from one-hour phone consults to multi-month onsite engagements and even full-time jobs.

Today’s webinar, “Biomass and Biochemicals: Benchmarking and Financial Analysis” will be presented by Lawrence D. Sullivan. Larry is a leading management and engineering consultant in oil, natural gas and biotechnologies used by the petroleum industry. He’s a top 2% Gerson Lehrman Group member in the Council of Advisors, where he consults with leading financial and industrial, as well as governmental, legal and academic institutions. He’s an adjunct professor at Trident Technical College and a Principal with Lawrence D. Sullivan & Company Inc. with his partner, Carla M. Wood, PhD. They provide due diligence, expert witness and chemical engineering services to petroleum, biotechnology and advanced biomass, biofuels and renewable energy markets, companies and financial institution. He earned his BA and MA in Geosciences at the University of Texas and Arizona State University, respectively.

He completed graduate training at Texas A&M University in Planning and Geosciences with the Texas Department of Water Resources, writing [SP] the hazardous chemical waste regulatory plants. His career featured 14 years in Europe, Africa and the Middle East with Dresser Industries, Imperial Chemical Industries and DuPont’s oil and gas unit, Conoco. He completed his MBA and Refinery Engineering at Oxford’s St. Catherine’s College. He studied Corporate Strategic Planning at the London School of Economics.

We will include a couple of poll questions throughout the webinar. If you would like to ask Larry any specific questions, feel free to use the “Questions” section of your GoToWebinar control panel. Basically the top right corner of your screen, you’ll see a little orange arrow. Click on that and then you’ll see the “Questions” section where you can ask any specific questions. Larry will respond to questions after this presentation. We will also provide Larry’s contact information, so you can follow up or engage with Larry after this presentation, so stay tuned. Without further ado, I would like to turn it over to our presenter, Larry Sullivan.

Larry: Good afternoon. Thank you, Enrique and Chris for the help setting this up. I’ve been looking forward to working with Zintro on this type of webinar and we have now the opportunity to jump into this topic. They have read my background, so what has been happening in the way that I’ve looked at this has to do with a lot of petroleum management early in my career, about two-thirds where I was involved in the internal rate of return. Basically, the evaluation, the projects inside of large petrochemical and chemical companies. Then, I branched out a few years ago into biofuels, which is an emerging industry. Biotechnology, petroleum interfaces, you could call this, because of the remarkable things we’re seeing happening with biotechnology are beginning to impact and a larger market, of course.

The industry, as it matures and the theme today will be to benchmark an emerging industry, with some problematic issues, having to do with capital formation and execution of projects. Benchmarking it back to some sort of mature framework to see where the industry is headed. In a simple form, you can say if you get into this industry, are you going to make any money or not? That is a very profound question as the industry matures. I’ll be speaking in the context of the United States and Canada, but there has implications outside of the U.S., particularly, Brazil, the European Union and somewhat in Asia.

My background as it covered, 20 years upstream and downstream. That’s with the oil and gas industry. Upstream is called the exploration and production part and downstream is the refining and marketing part. I worked in field engineering, was trained later in business and refinery engineering.

The last 12 years has been primarily biofuels, biomass and biochemicals with very much early stage companies or startup companies. Earlier in my career, I had spent most of it outside of the United States. I’ve been speaking at conferences significantly . . . 25 conferences over the last ten years. Most of the work I do is through the Gerson Lehrman Group, some with Turner Mason and it has to do with either due diligence or financial evaluations. Most significantly, I think there was a bankrupt period in corn and ethanol in the United States and I was involved with petroleum refinery acquisitions of those stranded assets. We see today that the oil companies, petroleum companies have a significant stake in the corn and ethanol industry and a growing stake in other parts of the second generation. I also teach part-time at the local community college and enjoy that a whole lot.

So my wife advises me . . . she has a completely different background. PhD in cell biology, biochemistry. Worked in human genetics and has transferred over outside of human genetics. Postdoc in a medical school, NIH work, a professor of medical school and then Patton Wall. Since her retirement, she has advised and worked a lot with me and the Gerson Lehrman Group and has actually served as an expert witness in biotechnology cases because of her background.

So what is the theme today? We’re going to be looking at the Capital Asset Pricing Model which is a standard business school type of question that is asked of the students. How do you evaluate an industry? What kind of models? Lots of models that are out there that are used to evaluate an industry, both in mature industry and emerging industries. Basically is part two there, which is Return on Capital Employed. The investment community deploys capital into the industries and then they look to get a certain return. There is a lot of transparency, particularly in these basic industries. So we’ll be looking at the extracted industry, which is a primary industry for some people. We’re going to look at sort of a second stage, which is basic chemicals, but it also has an extracted element, just like growing crops or mining chemicals or mining ores. Finally, we’re going to look at the conversion of the raw materials into some kind of intermediates, either fuels, your basic building blocks. In the petroleum industry, petrochemical, it’s the seven building blocks of aromatics and oliphants.

Now, I’m not doing original research. I’d like to reference here early on some significant work done. First of all, BizStats is an excellent format. What they do is they mine back to what I’m saying here. They mine into IRS and SEC databases. Without the names of the companies, obviously. Then they develop pretty significant databases that you can go into to look at the financial performance of . . . in the old days, used to be called SIC–Standard Industrial Classification. But today, it’s more open and you can just call the industry what it is. It’s never easy, as you know. The first thing in business school you often run into is “What business are you in?” Everybody knows that McDonald’s is not in the hamburger business; they’re in the property business. So that is really what BizStats does. It’s a foundation and I use it a lot here.

The most significant work I’ve seen to date was last year by ICCT; they call it the International Council on Clean Transportation. They did a similar report on the risk involved in second generation biofuels. Nextant, one of the big consulting groups, has issued a lot in the feedstock. I’ve focused on feedstocks over the last few years and I like what they do in that work. Finally, Lux Research here did this in our references. Because I think it’s important, too, it’s very current and it looks at the price of raw materials; a subject that I’ve been struggling with for quite a few years. I’ll cover that a few times as we go into the presentation here. That’s basically to tell you what I’m going to tell you. I’ll tell you, then we kind of review what I’ve told you.

Now, the Capital Asset Pricing Model is a very common one. It can be used to look at equity and debt. It can be varied a lot. Basically, what it involves here is a market will be moving. For example, if I have money in the market, I could just simply put it in the S&P and get my . . . whatever, 8% a year. In other words, you can look at how the market moves and if a single company or a sector moves with the whole market, then that would be 1.0. That is a risk-free investment in some ways.

Now, what I do is use a risk-free because of education in the United Kingdom, but in the United States, it is the same thing with Treasury bonds. Here in England, it’s perpetual bonds. That would be your risk-free rate.

So the model you can look at there. Basically, you look at the market return, the Beta and then you come up with a premium. Or in some cases, no premium if you’re investing in something that is going much higher than the market, which in many ways, is the ideal case.

So the ICCT report was the first one I found. It is significantly stated that the drop in value of a number of IPOs over the last few years, has required that investors who continue to look at the space, are asking for a higher return. In other words, the Beta moved down significantly, thus resulting in investors. So I recommend the ICCT report as the foundation here, with the original research in this area.

Now, let’s take a look at the industries. The one I like first and I’ll go through them and you can pick them through a number of different ways in BizStats. So let’s look at 2011, oil and gas extraction. This is a typical last part under notice important, the data is for a typical $1 million to $5 million asset class exploration firm. This is a couple of guys in Dallas with a good bank loan and a couple geologists and they leased some land out in West Texas and they drill a few wells. They go to town; they find oil, they sell the company or sell the wells; something like that. This is your high-risk, high-reward and you can see that the reference here is 11. BizStats collects stuff so you can look at a 12, but not necessarily a 13. So there’s a lead or lag time back into the data.

This is your ideal high risk/high reward formula and you can see that return on the net worth. You see the inventory turnover, the ratio. So this would be a picture of a small E&P firm based in Texas or in North Dakota, drilling a dozen wells a year and probably liquidated the company in a few years once the stock goes up or the value of the company goes up. It was a good year, so you can see that.

Now, forestry and agriculture, I lumped them together because I want to see them parallel. I had the opportunity a few years ago to move out of biomass from annual crops into biomass from perennial crops. In other words, moving from corn and soybeans and switch grass, things like that. Into crops that have a very long lead time; forestry has a 20 . . . even more lead time before you actually get your return.

This is a little different. I’m looking at LLCs here, but MLPs are destined to come into this market in some form. That’s why I stuck it in there. Even though they don’t exist today, they do in petroleum; the earlier sector there.

This would be the Ma and Pa. That’s what I call this. $500,00 to $1 million in assets. This would be your farmer cooperative member. Cattle ranchers, that’s the typical American cattle rancher has a kind of asset base. Independent forestry owners and small-time miners. It does not include processing companies, which is ADM, Cargill, Bunge. It certainly does not include a separate category that looks at land ownership through what’s called REETs–Real Estate Investment Trusts. Because that has implications on not being a corporation, but passing through different kinds of payout channels. The largest landowners in the United States for this kind of work now is Plum Creek and Hancock. You’ve got to put them to the side.

Again, you can see that agriculture is doing well. At 27%, forestry is doing very well. But look at the return on assets. That’s a little lower simply because the asset base does not have the same kind of view that petroleum assets have. Petroleum, I like to say is the 3-D. You can drill a well and the oil reservoir under the earth has height, it has width and it has depth. So it’s three-dimensional.

Now, the surface assets, which is corn or in this case, trees, would have a two-dimensional kind of element to them. Not as significant. So I’m trying to take a geographic view that surface, renewable and sustainable is one kind of thing. Mining and petroleum, where you extract from the earth, is another kind of thing.

A little aside here. I had the opportunity to go to school in Texas where the permanent university fund is made up of petroleum assets. Those assets are unable to be changed or unable to be touched by the political class there. Same in Norway, a little bit in Holland. In other words, if you extract a resource from the ground, then that depreciation or depletion has to be accounted for. So if you grow corn on a field, you take care of the land, you can grow corn on the field in perpetuity. But if you take oil and gas out of the ground, then some of the assets have to be put into a fund to replace what is a depleting allowance there. So we won’t go into that too much, but it is one of the fundamental differences in the two industries.

Now, over here in basic mining and chemical, it’s a much lower return and I worked for ICI’s core alkali business and was familiar with that. Really, you’re talking about very basic raw materials. Sodium chloride both in the ground and then taken out, sodium hydroxide, sodium itself, chlorine, soda ash, bicarbonate and in some degree, sulfur or sulfuric acid, both synthetic and mining. This is really not in the area of petrochemicals or titanium dioxide. When I was with Conoco and DuPont, that was one of DuPont’s biggest business, as well as ICI.

So this is an extracted industry . . . or it has elements of extraction, but it also has elements of conversion. For example, if you mine sodium chloride, you can separate the sodium and chlorine and sell those in various forms. There is that dimension here of both raw material and conversion.

Okay, petroleum refining, where I spent time with Conoco, is really doing well. But this is not an easy area to evaluate. The way BizStats works, they don’t necessarily break out the independent refineries. For example, in the United States, that would be Tesoro, Valero, Koch. These companies have arms-length relationship; they buy crude oil in the market and they convert it into products.

Now, BizStats doesn’t really break out the integrated companies, but if you go into the integrated companies’ SEC filings, often, you can see some breakout. Exxon said refining, recently, was different than the upstream. Now, some of the oil companies have sold, they’ve broken up. But you don’t see that necessarily with the big super-majors; Shell, ExxonMobil, Total, BP. They still have the E&P part and they still have the refining part. Of course, other companies are beginning to break them out, both in Europe and in the United States. They have that independent refiner business that I mentioned earlier.

This does not cover something . . . I think it’s important to state at this point. There are a number of state-owned enterprises in China, Brazil and Norway, for example, that are also traded in New York and in London and other places where the government still owns a substantial amount of the company, but some of the equity is traded and some of the data course is out there, too.

Now, the refinery class here is $100 million to $500 million value, which is sort of a typical U.S. refinery. There is a gap in this market between $5 million and $50 million to $100 million. Smaller refineries have not always been evaluated well in this. That’s a sort of separate question, the size of the refinery.

Now, Delta Airlines purchased a refinery recently and the numbers are beginning to come out, because they’re a new entry to the refinery industry. So they’re publishing their data differently because their primary business model is aviation or people with [SP] seats. They begin to talk now about how they make money or not and it has to do with hedging. The CEO said “We’re hedging the jet fuel purchases.” Jet fuel is about 32% of Delta’s cost to do business, so you can see how significant that is.

Now, this gets into conversion here. Basically, this is where someone, arms’ length, would buy an intermediate . . . like an oliphant polypropylene producer would be buying propylene or ethylene being purchased to make polyethylene. It’s not always easy to break these companies out, but BizStats has a number of ways that you can look at it here. I didn’t really put an asset class here, but it’s just an illustration of the lower return . . . a point that’s going to come up a few times here, is that there’s a lower return and conversion than there is in the extracted industry and there’s elements of risk and reward. When I was with Conoco, the refineries where fixed in place. You’d know the costs going in, you’d know the asset, you’d know the cost of the prices . . . the product coming out. That’s a very different business model than going and leasing land in the North Sea through the government of Norway and spending hundreds of millions of dollars to drill oil wells and then not finding oil or having something happen or finding too much oil and having some pressure from the government to give your assets to the government.

The business models in petroleum are here. The conversion is really the petrochemical industry, which has had, historically, a lower return than the exploration or even the refining. I’ll come back to that, the difference between petrochemicals and refining in a minute.

Now, let’s change our direction here now that we have this foundation. There was a significant error made by the United States government a few years ago. They had predicted that gasoline, which is a commercial product in the United States, would continue to grow something like 2% or 3% a year. Suddenly, in 2006 in California, we all know that tomorrow happens today in California, that it went south. We can see then, a revised projection from ’07 to ’13.

Now, that is different than what’s called middle distillate refinery, which is diesel and kerosene. There, in the ’07 and in the ’13 projections are not quite as dramatically different. This has caused a number of problems within both the renewable fuel standard and in a lot of other aspects of the market, meaning we have a situation developing where no one expected this to happen. It’s driven by many factors and I won’t go into them. Other to say that Internet shopping and better cars and electric vehicles and on down the line.

Over here, we see the resurgence of the jet fuel industry in some ways. We see trucking being a significant factor in the United States, still. Rail is very congested and trucking is not as congested.

So that would lead, the question then, if you’re in a biofuel business and you see this market diminishing, going south, do you really want to do that? If you make ethanol, why not sell out to the potable ethanol market to make whisky or something? Or in the case of something like butanol, why would you want to sell butanol to go into gasoline at $3 a gallon when you can find a petrochemical market that might offer you more return in terms of the pricing and the return on your investment? So this has led to a lot of companies in this space to look at biochemicals, rather than biofuels.

Now, I’d like to jump into this first generation . . . the success, I call it the “success story.” The “Show Me State” is Missouri; that’s the logo for the state. There is a great story to be told about the success here. This is not even a corn state, that’s why I get excited. It’s not Iowa, It’s not Illinois.

So they had 8 million acres 100 years ago, now they’ve got somewhere around 3 million acres. So they have depopulated the farming industry to a great degree over more than 100 years.

The price of their product–and this is not normalized, this is just the raw price–over time has gone up. We can get that charts on that later if you want, relative to inflation.

Here is the concluding two slides. The reason this has happened is because–and I chose Missouri because Monsanto is based there–it’s driven by bushels per acre. 20 bushels an acre for corn; now, somewhere up to 160. Monsanto says we’ll get 300 in the big corn states before you know it. That’s the big six seed makers through genetics, can offer a better and better yield per acre.

Of course, over here, the “Show me the money,” i.e., “Look at this.” Corn farmers over a long period of time couldn’t make a living, left the farm, went to the city. Government policy through U.S. foreign policy is not for that to happen and sure enough, it’s a success by all measures, as you can see of the revenue to the state going from less than $500 million up to $2 billion.

So let’s look then at where these guys are headed. The corn producers have done well and so have the petroleum; i.e. oil producers. However, the negative is that the natural gas producers have not done well and this means we have to take a look at this disconnect.

It’s important to say at this point that the ratio between oil prices and natural gas prices have been 10:1 over a 40 to 50-year rise up until about 2009 and ’10. If you were to run a power plant on an energy-only basis and you could run that power plant on crude oil or natural gas, then the ratio between the two is 6:1.

What has happened, starting about, really, in the 2005 and going up, you had a spike here and then down and now a spike and then down. But natural gases, because of overproduction, have drifted down. Prior to this, meaning this period here if you were to talk to petrochemical companies that need natural gas to be low, they would say “We need to leave the United States because we can’t make a living with high natural gas prices.” Sure enough, those same companies are now looking at remaining in the United States and foreign companies: Shell, Cecil [SP] others BASF, to go down the line . . . many external companies have come into the market to make petrochemicals in the United States. There has been a resurgence of the petrochemical industry.

Now, let’s talk here about the routes to the market. This is a very standard slide looking at two ways to arrive at these building blocks; I call them the seven building blocks and it’s not easy to calculate, exactly, which one is which. But generally, you’ll hear the seven building blocks. What it means is methane itself, from a natural gas well, could be made into ammonia or it could be made into gas-to-liquids, through Fischer-Tropsch process. These are very fundamental. Or it could be burned to make electricity in a power plant. So that’s the driver for methane, which is kind of separate here.

Now, to arrive at the oliphant, you have to look at two ways. Europeans have traditionally . . . when oil and natural gas are linked in the 10:1 or a 6:1 ratio, Europeans had a slightly competitive difference on the negative side relative to the United States which has always had a strong natural gas market and even stronger today, depending, of course, on which you’re side in.

Now, crude oil in the refinery; the methane from the crude oil can be taken out, but that tends to be used to run the refinery or cannibalize from the crude oil to use for furnaces and boilers. So methane is not noted at this point because it’s actually consumed internally. Or if the methane is low, then the refiner would take methane and use it and not cannibalize as much crude oil, given the price difference between the two.

Now, from that naphtha and gas oil, you can go into steam cracking, both in the refinery or separately within a petrochemical or ethylene cracker unit. It’s a separate business. Now, you get ethylene, propylene, benzene would be extracted, butadiene and other byproducts. So that’s your 1, 2, 3, 4, 5, 6 and 7 and that would be your BTX; benzene, toluene and xylene. So this is a sort of model to keep in mind of what drives the value chain.

You can see that somewhere around 7% of any refinery product could be diverted to the petrochemical market. It’s not necessarily significant in that a refinery could consume somewhere about 5 to 8% of its product to cannibalize their 5 to 8% and then go into the higher-value markets at 7% on top of that cannibalization. Before long, you realize that there’s not a lot of big volume that can be done in this market. This was a struggle that Conoco and DuPont faced more than 20 years ago. That even if Conoco was able to extract a lot of value from the refineries, it was not significant in the total business between the two companies. DuPont had been moving away from these basic building blocks and into biotechnology models anyway.

So this is just one that gives you a good background on where the value chain is. It’s very significant here because you’re going directly from the methane, which would be here, into cracking and into ammonia or into other types of products; ammonia being probably the primary one here. Then down the line here, this would go to the polymers and plastics. Then here, into polymers and plastics also.

Now, let’s talk about the fundamental economics of these discussion points that I’ve been working you towards here as the audience. So if you’re an economist or a business analyst inside one of these large companies; either a petrochemical company, chemical company or a refining and marketing type of company, you’re going to look at this. You would benchmark first against what are the world-class? This would be BASF in Germany, completely integrated facilities, be at arms’ length in supply.

Shell is fully integrated from the wells to the refineries, to the petrochemicals. Same with ExxonMobil. Then you have to use Saudi Aramco. Now, Saudi Aramco’s numbers will never be transparent simply because it’s a state-owned enterprise and very privately held by the sort of powers to be in Saudi Arabia. They don’t publish a lot of data on what they do. But you can extract from a number of different sources how they do. So this would be your foundation. This is the world-class.

So if you build a petrochemical plant in Southeast Asia, Singapore or you build one in Europe or you build one in the United States or South America, then you would look to the return in these type of plants to lease your foundation. To understand where you would be relative to where they are. There are three, four examples here. Saudi Aramco, very close. BASF is a world-class. Of course, Shell and ExxonMobil have the upstream and downstream part of the business.

Now, if you build a standalone plant . . . some of these like BASF above, then you would be purchasing the intermediates and depending on where you are in the world, this is a geography question, you could be advantaged or disadvantaged. That would be the case of, we have now, $4 natural gas in the United States, $8 natural gas in Europe and somewhere above $10 natural gas in Southeast Asia and Asia. This is why this disconnect with natural gas becomes so critical to understand.

Now, the historic refinery business, return on the investment over 40 years has been averaging . . . that number is 9.3. Lo and behold, it’s somewhere around [SP] the S&P. So this not a bad business to be in. The reason you look at the 40 years is because they’ve had times when it has been very much in the teens and twenties. Then times when it’s gone south and negative and there have been very many players out there opportunistically working in the market and with some degree of wisdom and luck, have actually acquired refinery assets when the market was very bad and now own them when the market is good. So this doesn’t tell you a lot other than it tracks the market in that sense. So that would be your foundation.

Now, historic petrochemicals that are standalone have been much higher at 16. But it is only 5 to 7% of the fuel market. This is where I like to caution market. Now, the fuel market has a known return up there. If you say “I’m not going to make fuels, I’m going to make petrochemicals because there’s a better return on my investment,” you also have to calculate in that you’re dealing with a market that is much smaller at 5 to 7% the size of the fuel markets and there’s very few producers, very few buyers. The implication there is that you have to know what you’re doing more than you are in the fuel markets. The fuel markets are very developed and if you make fuel in the Amsterdam/Rotterdam area or if you make fuel in the Gulf Coast, then you have lots of ways to sell that fuel.

But if you make butadiene in Amsterdam or if you make butadiene in the Gulf Coast of America, you would then have much fewer buyers and much fewer sellers. The implications there is you’ve got to know more what you’re doing and those markets are mature, too. That’s always of concern when I hear people say “Well, we’re not going to make biofuels. We’re going to make biochemicals because we can make a lot more money.” Yes and no, so there is my caution. Now, how do I know that? 35 years in the business.

Most integrated refinery/petrochemical plants have a return on investment between the two since the locations can vary widely with returns. That would be . . . SABIC is a good case study. That is the petrochemical firm in Saudi Arabia distanced itself somewhat from Aramco, the exploration, production, refining and marketing forum. SABIC has a little bit more transparency because of joint ventures overseas than Aramco.

Okay, moving on, now, the question then becomes this. “Can you make a bio-refinery and have a good return on the equity or the investment?” Yes and no. For example, the case study that I love to talk about is Minnesota Corn Processors. They built a wet mill in Minnesota and by the mid-1990s, when corn prices were high, they decided not to sell to their own wet mill, but to sell the market where they could get more money and it caused a bit of collapse of the business then the ADM acquired that and that that asset.

So yes, you can make returns. It just depends on how integrated you are in terms of raw material. Do you have a known amount of raw material at a known price within the proximity, as I mentioned earlier with the petrochemical. Are you a world-class player or not? That would be the question.

Now, we do have very good analogues in the United States and the European Union for a bio-refinery. People say “Well, we’ve got to make a bio-refinery because the world needs them.” Well, they exist. They’re very well-developed business units and you can see them here. Nature Works with Cargill, corn wet milling and the European Union, Chemrec/UPM or MeadWestvaco in the United States. These are companies that buy either raw materials or make the raw materials and then convert them into biological products. That is an excellent one.

So back to the Minnesota Corn Processors case study on cooperative wet mills and in soybean crush mills. So farmers have done well in soybean crush mills if they stay away from large, integrated multinationals who I’ve mentioned earlier, what they call the “ABCD companies.”

So fund managers who would then begin to look at this industry and it’s an odd business to look at because you’re looking at agriculture and you’re looking at energy. Are they linked? Yes. Recently, I heard a presentation about the linkage between soybean oil, canola oil and palm oil to petroleum over the last ten or so years. So there is a lot of analysis being done and recently, you could see sell-offs. So when petroleum crude prices had been dropping, a sell-off of biotechnical-type firms simply because of the perceived connection.

Well, the perceived connection is probably an accurate look at this market. Remember, the first thing in statistics is correlation does not always tell you what you think it tells you. So you can correlate petroleum prices and vegetable oil prices or corn prices, even, to try to come up with something, but that’s not always the case.

So petrochemicals from natural gas and condensates are advantaged and they are low molecular weight. That price that you see today represents that low molecular weight. You then see petrochemicals from crude oil, not natural gas, are disadvantaged and that is due to a high molecular weight or an energy density. Some people will say “Well, finally, we’re selling diesel at a price that represents the BTUs per pound compared to gasoline or ethanol,” which are lower in BTUs per pound and have a lower price.

But the other driver there is with low natural gas, you can compress that and go into the diesel market. So you’re seeing some advantages and disadvantages being played with here in the United States. Particularly if you can get LNG into the trucking market, that really excites truckers because diesel is so high and LNG is so low. The data between the two or the distance between the two certainly drives a price-sensitive industry like trucking. So I encourage you to look at what’s happening in that market.

Now, let’s look at the other side. Lipids, which are a vegetable product, they are fatty acids. They are seeking very high value in their markets, too. Given that they’re correlated with petroleum, as noted earlier, that’s possible.

Now, we see a number of companies doing this. Amyris, Solazyme and off to Brazil, simply because what you have there is low-cost sugar. In other words, a low molecular weight material. You can process that Amyris with yeast and in the case of Solazyme, algae, to come up with a high molecular weight material and get into better-valued markets. So that’s a driver there, too, what I see exciting in biofuels. Sort of leak from the low molecular/high molecular weight and make some money that way.

The question is, Amyris and Solazyme, over time, will become mature and the question is how much . . . where will they fit into these return on equity models or return on the business assets?

Now, the low-cost suppliers . . . unfortunately in the United States and Canada are not in this game. We’re low-cost in natural gas, but unfortunately, we’re not low-cost in palm oil and we’re certainly not low-cost in sugar. Brazil is low-cost in sugar. The United States/US/EU/Canada constrained fatty acid markets to some degree, although the U.S. produces soy and Europe and Canada produce canola and rape. Generally, the sugar market in the United States is not the world market for quotas and protections. That’s a separate topic there, but it is ironic to me that we are advantaged in natural gas, but disadvantaged in sugar and to some degree, fatty acids.

So really, I’ll conclude here on this point is that there is a race to build molecular weight and Elevast is a good company that I’ve studied in this market here. To sort of build a particular kind of molecular weight from low-cost materials. That would be wood, not necessarily sugar. Or sugar, depending on the market you’re in, if sugar is available and petrochemicals. In other words, to try to start with something that’s low and avoid any kind of expensive material on the intermediate stage and then try to come up with a higher-value chain. This is the drivers and you can see the return.

Really, I’m benchmarking on existing and trying to project that into what will hopefully happen in the maturity. In other words, when the biotechnology, biofuels or biomass industry in a few years becomes mature and established. Where you have a lot more public companies and they begin to perform in certain ways. Will they perform like the benchmarks I’m setting here or not? That is the question.

So let me kind of work with my conclusions now. I certainly would like to say that the analysts that I work with are remarkable and they like to use a lot of models. They’re very interested in this space. That’s what they say. The two things that I talk to them, they say “We’re interested in this space, Mr. Sullivan and we have this risk . . . we have this appetite for risk.” In other words, they quickly say “We’re interested in this space and here’s the kind of risk we like to undertake. These would be financial analysts with either equity funds, hedge funds, even some venture capitalists. But primarily, equity funds and hedge funds. Capital Asset Pricing is good as used as any. There’s others out there.

Now, historic data and benchmarks such as BizStats allow people like me to advise the fund managers. What they like, of course, then, besides the fact that they have an interest in the area and they have models and they have a mandate to spend their money on investments where they’re much higher than say the S&P markets or refining markets, they want much higher returns, as you know. Transparency is the key term that they like to use. They want to see through these industries. They want to know what are the raw materials? What is the capital expenditure, the CapEx, the OpEx and what is the product going to sell for? We see this all the time.

So to review, [inaudible 00:41:38] equity and sort of a modeling. Petroleum extraction has done well in the last few years and you can see that. Now, it’s getting very nervous, as you can tell, at $70 something per barrel.

Cooperative . . . and I focus here on cooperative. Not a lot of public pure plays except a few PDIX [SP] and GPRE. In the cooperative agriculture and certainly within forestry, there has been some pretty good returns, too. Capable of continuing those kind of returns, depending on how the assets are managed. This is the renewable business, whether you’re making renewable food or renewable forestry. It has to be sustainable.

Oil and gas extraction is not sustainable, it’s not renewable. That’s the fundamental point of that, looking at that industry, talking about it.

Basic chemicals begin to drop of somewhat. Petroleum refining looks very good, but that’s only a quirk in time. Historically, they’ve been more in the 10% range, like the one above and below. Then, the conversion to petrochemicals.

The reason I put it in this rank order is to sort of say . . . a question that I’ve been struggling with as an analyst. If you were to make a raw material near a plant and you analyze the plant and he analyzes you as a raw material, who’s going to really make the money? Is it going to be the raw material producer or is it going to be the company converting the raw material? Or in some cases, will the company converting the raw material also buy the land and grow the product like we see with the cooperative farming? Farmers that own three ethanol plants. Or would the landowner with the trees or with the crops, the biomass, go into the business of converting the product and trying to add value?

Now, where we see the issue coming up that I refer back to the ICCT work and the conclusions of Lux, what’s happened is that the market wants a much higher return to be shown, than as previously. This is causing the disconnect.

Because of the IPOs that have gone out there and gone south, –and the Betas changed. Which means the Capital Asset Pricing Model says “You need a higher return than you might have thought a few years ago.” That would be much higher hitting 20%. DuPont had a 17.5% IRR. Basically, when I was there . . . you can see, the market was higher. Of course, these are venture funds and they are naturally going to want higher returns.

If they cannot see those higher returns, they might shun this space and that puts a problem. The government has to step in and fund a lot of this. Now, all we say in my talks that food and agriculture and energy are the business of government because the government has an interest in protecting these industries and everybody should know that. Whether it’s the European Union, Brazil or the United States. The farmers and the oilmen to some degree get some degree of protection, which is a contentious point always.

So with that high return do to the Beta problem and the Capital Asset Pricing Model, then you’re seeing investors shunning this space to some degree. Part of it was premature IPOs that probably should not have gone out there way too early in the cycle.

Finally, the Lux work and ICCT work, I highly recommend it. If you have the chance to read into that, you’ll find some quite interesting conclusions.

So I want to thank you for the time and I enjoyed talking about this topic. It’s a difficult one. I’d appreciate the opportunity to take some questions.

Enrique: We have a question by Terry. Terry asks “Can you comment on the risk of new technologies?”

Larry: Yes, I think that’s very much what they call the “Valley of Death” here and it’s very commonly talked about. This is where the government has a role to play. As you know, the government played a role in new technology with petroleum early in the cycle of petroleum.

So an argument could be made . . . if I have a new biochemical technology, the market shuns my technology, then I could go to the government and say “I need loan guarantees” or “I need grants” or “I need some kind of incentive to develop that.” We’re seeing that today with the Defense Procurement Act announcing that three bio refineries would be built under the DPA for a biofuel product. That’s the government subsidy with the nuclear industry would not be where it’s at today without significant government involvement and the same with petroleum.

So it kind of goes back to what I’m saying there. That in fundamental industries like oil and gas . . . historically, not today so much, or in industries like agriculture, both in the past and today, you see a government hand . . . the invisible hand of government, right?

So the government is there and I like that idea. If the technology is risky, the market doesn’t like it. Particularly an equity fund and a hedge fund and venture capitalists, particularly. The big difference is that where do VCs come into play? Well, they tend to invest in unknown technologies and hope to make high returns compared to private equity or hedge funds.

So yes, the government has a role to play, whether it’s the European Union, the United States, the Canadian government or even Brazil. So yes, I think that it’s definitely implicit to what I’m saying here. Is that if the market won’t support this, then the government has to. The question is, how long does the government stay in and then when does the government exit? We know about the United States government in the 1950s with the steel industry or the automobile industry in 2008 and 2009. The United States government will step in and protect certain industries depending on the politics at the time. You won’t see them protecting the steel industry today, but they would protect the automobile industry.

In this industry, because it’s an infant industry, petroleum is mature, you’ll see that disconnect between the two. Is that a good answer to the question?

Enrique: I think it’s a great answer. Thank you very much, Larry. We have a couple more questions that came in. “What do you predict for the future of biochemicals in the U.S., looking into the crystal ball ten years from now?”

Larry: Well, ten years from now, depending on the mandates, the industry has suffered with mandates. One example I like to use is this. When the 1960s . . . an oil bust in the United States occurred. Very few people know in the ’50s and ’60s, the price of crude oil went down. The low prices in the United States meant that the petroleum producers in the United States went to the government hand in hand and asked for quotas to keep out low-price Middle East oil and gas, oil in this case. By the 1970s when the prices had boomed again, then the government came and said “We’re going to put a windfall profits tax on you.

So I see this industry in that context. In other words, there’s a lot of support for the industry now. It will mature. There will be consolidation . . . there will be bankruptcies, of course. There will be consolidation and maturity. Once maturity arrives, then profit can be had. Not sure what levels, I’m looking at the last page here. Probably in the 10 to 15 range, maybe more.

If the profits were to be very high in the future, then the government would try to claw back money. That’s been my experience in Europe and in the United States with support. Sometimes, you have to be careful about that support.

But to look in the crystal ball to look forward, yes, the industry will consolidate, it will mature. The petroleum companies will probably buy a lot of the assets if they’re stranded, that they did that before. That’s good because you don’t want a plant sitting empty in the Midwest; you want somebody to buy it, run it. Whether it’s Exxon buying it and running it or farmer co-ops at this point. Nobody knows.

The question then is once it’s mature, where will the industry go from there? The industry has to evolve and that’s too far. I’d say in ten years, it’ll mature and have decent returns. Beyond that, I can’t say.

Enrique: Thank you, Larry. We have another question by Eddie. “How is the market eyeing Brazil in biofuels?”

Larry: Well, Brazil is different. Petrobras sent to me something I’ll always remember. I went down there to sell them biodiesel technologies and they said that the ethanol industry in Brazil was a landed gentry from years and years of sugarcane plantations and that Petrobras–i.e., the government–did not look positively upon them. So a left-wing government, right? But a good left-wing government.

They wanted to stimulate biodiesel and to make biodiesel work in rural areas because their gasoline market was going south because of ethanol and they didn’t have a lot of diesel in the country, so they wanted to work, Petrobras does, in the biodiesel and diesel area.

What’s happening now is with petroleum going down . . . remember, in Brazil, you’ve got a car that can take either one. So depending on a free market . . . Brazil is a free market, right? You can fill up with ethanol or you can fill up with gasoline or some mix of the two and go your way.

I’m always worried about Brazil in the sense that without a lot of support, the sugarcane industry can struggle. It’s driven by weather, which is outside their control. It’s driven by government that might not be that positive about the landed gentry. You never know, it’s a left-wing government, but it’s a good government, everybody says.

I can’t have a crystal ball on Brazil. I know they’re suffering. They have opportunities to come in the U.S. market which is good on the California low fuel standards, but generally, they haven’t come into the U.S. that much in the last few years.

Enrique: Thank you very much, Larry. We have another question by Seth. “What specific countries do you see as the most aggressive and optimistic in biofuels?”

Larry: The most aggressive, probably would be, right now, Argentina and Indonesia. Argentina because of soy being taxed at one rate and biofuels being taxed at another. So they try to keep the biofuels stimulated. Indonesia has done the same thing based upon palm plantations and palm oil. That would be the difference.

The United States and Canada tend to have an all-carrot type of incentive program, some mandates. We’re going to struggle the next few weeks here with the EPA in the U.S. situation. But the U.S. will probably stabilize once the renewable fuel standard this year is released and the chickens come home to roost, so to speak, in the agriculture.

I like the Brazil, somewhat, but certainly Argentina and Indonesia. The World Trade Organization doesn’t like that type of nonsense. But what they’re doing is they’re trying to stimulate their industry, no different than any country does in agriculture. Make it easier to export the biodiesel than the soybean oil or the palm oil that’s kept in the country. But you have to convert it to biodiesel to export it.

Those two stand out. The United States and Europe will go about their standard ways of doing things. Can’t say much more than that. The United States has got too much flux to make an opinion that’s strong now about where the federal government will go.

Enrique: Thank you, Larry. We’re going to go with one more question. We have a couple more, but we’ll have to follow up with those after the call; we’re running out of time. So the last question from Matthew. “What is your opinion of the direct biological conversion of methane in the U.S. to basic or higher-valued [inaudible 00:54:00] given the low price?”

Larry: The conversion of methane in the United States for ammonia or gas to liquids or some product, in other words, reforming it into hydrogen and carbon monoxide. In the United States, it’s a very good business because you get cheap methane, crack it into ethylene . . . sorry, you can get natural gas which has a certain percentage of methane in it. You crack it, use the natural gas for other purposes.

But the standard model in the United States is either methanol or ammonia. If farming acres continue to be large, than ammonia is going to be in-demand and methanol is somewhat of a constricted market in the U.S. But I would say, probably, the true measure of what’s going to happen would be to look at two things. One, what happens with Sasol in Louisiana relative to Shell who said they didn’t want to do GTL. If anybody knows how to do it, it’s Sasol and Shell. Sasol said “Yes, we’re going to do it. We’re going to do oliphant detergent-type products and not GTL fuels,” which is more value-added detergent intermediates.

The next one would be more problematic. If the United States government decides to use natural gas as a weapon against Putin and Ukraine, then to accelerate export of LNG through Europe . . . have kind of come to the rescue. I’m always reminded that when I went to Europe in 1980, Reagan . . . in 1981, President Reagan said he did not want the Russians and Europeans to build a pipeline and he tried to stop it against GE and Dresser Industries, where I worked and a few other companies. The Europeans said “No, we’re going to build a pipeline.” Reagan said “If you build a pipeline, the Russians will use it against you someday.” Sure enough, 30 years later, that happens.

The situation with natural gas in the United States . . . if it continues to remain low, it will be a boon for the petrochemical industry to make world-class products and export which is good for the United States. Question is that if it continues at a low price, will the drillers for natural gas be able to make enough money to continue drilling for natural gas? Most of them will go over to oil. Now, they’re seeing oil drop; I don’t know if they would move back to natural gas, but we’ll see. That’s a free market in those kind of products.

Enrique: I’m just going to follow up, Matthew has a follow up to his question. He meant biological conversion, other higher-valued [inaudible 00:56:36].

Larry: Well, normally, if you have methane, you make ammonia with a high pressure reaction. But that’s the standard in the ammonia process. It’s been around for a long time.

If you take methane to try to use the bugs . . . ICI, when I was working there abandoned that business. BP had ownership of Purina with the intent to make single-cell protein. In other words, there’s too much natural gas in the market cheap and you can convert it to single-cell protein and a number of companies that I was associated with had that business. I wasn’t in it; it didn’t make sense of converting fuels into food. But you never know, it might happen again.

Enrique: Thank you very much, Larry. Could you share your contact information with the audience so they can reach out to you in case they have any questions or they want to engage in any way?

Larry: Yeah, the first page.

Enrique: Thank you very much. Larry, basically, on behalf of Zintro and our over 160,000 members, thank you so much for sharing your insights. We will be sharing this presentation as a recording in the upcoming week, so stay tuned to your e-mail. This closes today’s presentation. I wish you all a very nice day and thank you very much for attending.

Larry: Thank you. I appreciate the time.