How to Beat the High Cost of Gasoline. Forever!
Stop
dreaming about hydrogen. Ethanol is the answer to the energy dilemma. It's
clean and green and runs in today's cars. And in a generation, it could replace
gas.
By Adam Lashinsky and Nelson D. Schwartz
January 24,
2006: 4:09 PM EST
(FORTUNE Magazine) -
You probably don't know it, but the answer to America's gasoline addiction could
be under the hood of your car. More than five million Tauruses,
Explorers, Stratuses, Suburbans,
and other vehicles are already equipped with engines that can run on an energy
source that costs less than gasoline, produces almost none of the emissions
that cause global warming, and comes from the Midwest, not the Middle East.
These lucky
drivers need never pay for gasoline again--if only they could find this elusive
fuel, called ethanol. Chemically, ethanol is identical to the grain alcohol you
may have spiked the punch with in college. It also went into gasohol, that 1970s
concoction that brings back memories of Jimmy Carter in a cardigan and
outrageous subsidies from Washington.
But while the chemistry is the same, the economics, technology, and politics of
ethanol are profoundly different.
Instead of coming
exclusively from corn or sugar cane as it has up to now, thanks to biotech
breakthroughs, the fuel can be made out of everything from
prairie switchgrass and wood chips to corn husks and
other agricultural waste. This biomass-derived fuel is known as cellulosic ethanol. Whatever the source, burning ethanol
instead of gasoline reduces carbon emissions by more than 80% while eliminating
entirely the release of acid-rain-causing sulfur dioxide. Even the cautious
Department of Energy predicts that ethanol could put a 30% dent in America's
gasoline consumption by 2030.
We may not have to wait
that long. After decades of being merely an additive to gasoline, ethanol
suddenly looks to be the stuff of a fuel revolution--and a pipe dream for
futurists. An unlikely alliance of venture capitalists, Wall Streeters, automakers, environmentalists, farmers, and,
yes, politicians is doing more than just talk about ethanol's potential.
They're putting real money into biorefineries, car
engines that switch effortlessly between gasoline and biofuels,
and R&D to churn out ethanol more cheaply. (By the way, the reason
motorists don't know about the five-million-plus ethanol-ready cars and trucks
on the road is that until now Detroit
never felt the need to tell them. Automakers quietly added the flex-fuel
feature to get a break from fuel-economy standards.)
What's more, powerful
political lobbies in Washington
that never used to concern themselves with botanical affairs are suddenly
focusing on ethanol. "Energy dependence is America's economic, environmental,
and security Achilles' heel," says Nathanael
Greene of the Natural Resources Defense Council, a mainstream environmental
group. National- security hawks agree. Says former CIA chief James Woolsey:
"We've got a coalition of tree huggers, do-gooders, sodbusters, hawks, and
evangelicals." (Yes, he did say "evangelicals"--some have found
common ground with greens in the notion of environmental stewardship.)
The next five years could
see ethanol go from a mere sliver of the fuel pie to a major energy solution in
a world where the cost of relying on a finite supply of oil is way too high. As
that happens, says Vinod Khosla,
a Silicon Valley venture capitalist who has become one of the nation's most
influential ethanol advocates, "I'm absolutely convinced that without
putting any more land under agriculture and without changing our food
production, we can introduce enough ethanol in the U.S. to replace the majority
of our petroleum use in cars and light trucks."
Filling up on ethanol isn't
new. Henry Ford's Model Ts ran on it. What's changing is the cost of distilling
ethanol and the advantages it brings over rival fuels. Energy visionaries like
to dream about hydrogen as the ultimate replacement for fossil fuels, but
switching to it would mean a trillion-dollar upheaval--for new production and
distribution systems, new fuel stations, and new cars. Not so with
ethanol--today's gas stations can handle the most common mixture of 85% ethanol
and 15% gasoline, called E85, with minimal retrofitting. It takes about 30%
more ethanol than gasoline to drive a mile, and the stuff is more corrosive,
but building a car that's E85-ready adds only about $200 to the cost. Ethanol
has already transformed one major economy: In Brazil nearly three-quarters of
new cars can burn either ethanol or gasoline, whichever happens to be cheaper
at the pump, and the nation has weaned itself off imported oil.
And have you heard about
GM's yellow gas caps? In the next few weeks the auto giant is set to unveil an
unlikely marketing campaign drawing attention to E85 and its E85-ready cars and
trucks like the Chevy Avalanche. They will sport special yellow gas caps, and
if you already own such a vehicle, GM will send you a gas cap free. California governor and
Hummer owner Arnold Schwarzenegger is backing a ballot initiative that would
encourage service stations to offer ethanol at the pump. Even big oil companies
like Royal Dutch Shell and Exxon Mobil are funding ethanol research. Says Beth
Lowry, GM's vice president for energy and environment: "People's perception
used to be 'The agricultural lobby is very interested in it.' Now people are
waking up and saying, 'This isn't just about the Midwest.
This is about the U.S.
as a whole.' " Adds Daniel Yergin,
one of the country's top energy experts: "I don't think I've seen so many
kinds of renewable energy fermenting and bubbling as right now. The very
definition of oil is broadening."
Not that ethanol will
replace gasoline overnight. There are 170,000 service stations in the U.S.; only 587
(count 'em!) sell E85. To refine enough ethanol to
replace the gas we burn (140 billion gallons a year) would require thousands of
biorefineries and hundreds of billions of dollars.
Yet one of capitalism's favorite visionaries is convinced that very soon
filling up on weeds and cornhusks will be no more remarkable than tanking up on
regular. Says Richard Branson, whose Virgin Group is starting
an ethanol-inspired subsidiary called Virgin Fuels: "This is the
win-win fuel of the future."
BARRELS FROM BUSHELS
In Decatur, Ill.,
nobody is waiting around for the future; demand for ethanol from corn is
booming right now. This grain-elevator-dotted town is home to agribusiness
giant Archer Daniels Midland, which makes it the
capital of the old-school heavily subsidized U.S. ethanol industry. On a blustery
January day, the air is thick with fog, sleet, and condensation from the corn
mills on the 600-acre complex next to ADM's corporate
office. Outside the ethanol plant, the air smells like grape juice gone bad.
Inside, with its giant vats and fermentation towers, the biorefinery
resembles a winery, but it's much noisier.
ADM used to call itself
"Supermarket to the World." Today, reflecting its emergence as an
alternative-energy supplier, it boasts of being "Resourceful by
Nature." The company created the corn-ethanol industry when Jimmy Carter
asked it to in 1978--the oil-shocked President wanted a homegrown alternative
to gasoline. ADM now pumps out more than a billion gallons of ethanol per year.
While the fuel accounts for just 5% of the company's $36 billion in annual
sales, analysts estimate that it generates 23% of ADM's
operating profit. Says Allen Andreas, the courtly 62-year-old CEO: "We've
always been feeding people and looking for better alternatives; now we're doing
the same thing in energy."
ADM aims to be a big player
in what Andreas calls the shift "from hydrocarbons to carbohydrates."
But for now it's ignoring E85 and cellulosic ethanol
in favor of keeping pace with demand that is already booming. Corn ethanol's
main use is as an additive that helps gasoline burn more efficiently. ADM sells
nearly its entire output to oil companies, which use ethanol as a substitute
for MTBE, a petroleum-based additive that is toxic and is now banned in California and 24 other
states. With two billion gallons of MTBE still in use annually and 25 states
that have yet to ban it, the ethanol industry could grow 50% simply by
replacing MTBE.
In September, ADM announced
a nearly 50% expansion project, or 500 million new gallons of annual production
capacity. Archrival Cargill is belatedly ramping up ethanol production, and new
entrants are using private capital to build ethanol plants. The only publicly
traded pure-play ethanol maker, Pacific Ethanol of Fresno, plans to build five
plants in California
and has raised a total of $111 million, including $84 million from Bill Gates.
(For a guide to playing the ethanol boom, see Investing.) All told, the planned
projects represent a nearly $2.6 billion investment and will increase U.S. ethanol
capacity by 40%.
Other major players are
making long-term ethanol bets. Ford is working with VeraSun,
a startup in South Dakota,
to promote E85 fueling stations. Shell is the primary backer of Canada's Iogen, which
is attempting the first large-scale production of cellulosic
ethanol--the kind made from cornstalks and grasses--at a pilot plant in Ottawa (see following
story, "Biorefinery Breakthrough"). Exxon
Mobil has pledged $100 million to Stanford
University for research
into alternative fuels. The oil giant's new CEO, Rex Tillerson,
visited the campus last year to hear what researchers are cooking up. Biology
professor Chris Sommerville says the change in the
industry is palpable: "I went to six scientific conferences on biofuels last year; the previous 29 years I didn't go to any."
The biggest
alternative-fuels player of all, of course, is Uncle Sam. Oil refiners receive
a 51-cent tax credit for every gallon of ethanol they blend into their
gasoline. That alone will cost taxpayers more than $7 billion over five years,
estimates the Congressional Budget Office. The U.S. has also funded research into biodiesel, which uses deep-fryer grease and other nontoxic
ingredients to replace regular diesel fuel. (See box at left.) But ethanol will
never really take off unless consumers demand it, and while the U.S. industry still relies on taxpayer largesse,
Brazil
has leaped to the next step: a profitable free-market system in which the
government has gotten out of the way.
HOW BRAZIL BEATS THE U.S.
Near the prosperous farm
town of Sertãozinho, some 200 miles north of São
Paulo, the fuel that will fill the tanks of nearly three million Brazilian cars
in a few months is still waist-high. Lush sugar-cane fields
stretch as far as the eye can see, interrupted only by the towering white mills
where the stalks of the plants will be turned into ethanol when the harvest
begins in March.
Brazil boasts the biggest economy south of Mexico, and
with annual GDP growth of 2.6%, it is a powerhouse you might expect to consume
growing amounts of oil, coal, and nuclear energy. But Brazil also
happens to have the perfect geography for growing sugar cane, the most
energy-rich ethanol feedstock known to science. And so, for Brazil's 16.5
million drivers, there is ready access to what's known in Portuguese as álcool at nearly all of the country's 34,000 gas stations.
"Everyone talks about alternative fuels, but we're doing it," says
Barry Engle, president of Ford Brazil.
Ethanol accounts for more than 40% of the fuel Brazilians use in their cars.
While oil frequently has to
be shipped halfway around the world before it's refined into gasoline, here the
sugar cane grows right up to the gates of Sertãozinho's
Santa Elisa mill, where it will be made into ethanol. There's very little
waste--leftovers are burned to produce electricity for Santa Elisa and the
local electrical grid. "The maximum distance from farm to mill is about 25
miles," says Fernando Ribeiro, secretary general
of Unica, the trade association that represents
Brazilian sugar-cane growers. "It's very, very efficient in terms of
energy use."
Although Brazilians have
driven some cars that run exclusively on ethanol since 1979, the introduction
three years ago of new engines that let drivers switch between ethanol and
gasoline has transformed what was once an economic niche into the planet's
leading example of renewable fuels. Ford exhibited the first prototype of what
came to be known as a flex-fuel engine in 2002; soon VW marketed a flex-fuel
car. Ford's Engle says flex-fuel technology helps avoid problems that had
plagued ethanol cars, such as balky starts on cold mornings, weak pickup, and
corrosion.
Consumers loved flex-fuel
because it meant not having to choose between ethanol and gas models--memories
were still fresh of the 1990 sugar-cane shortage, when ethanol-car owners found
themselves, well, out of gas. Today "nobody would buy an alcohol-only car,
even with tax incentives," says sales manager Rogerio
Beraldo of Green Automoveis,
a sprawling dealership in São Paulo.
"Brazilians are traumatized by our earlier experience, when supplies ran
out. But with flex-fuel, there's no risk of that."
With Brazilian ethanol
selling for 45% less per liter than gasoline in 2003 and 2004, flex-fuel cars
caught on like iPods. In 2003, flex-fuel had 6% of
the market for Brazilian-made cars, and automakers were expecting the
technology's share to zoom to 30% in 2005. That proved wildly conservative: As
of last December, 73% of cars sold in Brazil came with flex-fuel engines.
There are now 1.3 million flex-fuel cars on the road. "I have never seen
an automotive technology with that fast an adoption rate," says Engle.
Ethanol's rise has had
far-reaching effects on the economy. Not only does Brazil
no longer have to import oil but an estimated $69 billion that would have gone
to the Middle East or elsewhere has stayed in
the country and is revitalizing once-depressed rural areas. More than 250 mills
have sprouted in southeastern Brazil,
and another 50 are under construction, at a cost of about $100 million each.
Driving to lunch at his local churrasco barbecue spot
in Sertãozinho, the head of the local sugar-cane
growers' association points to one new business after another, from
farm-equipment sellers to builders of boilers and other gear for the nearby
mills. "My family has been in this business for 30 years, and this is the
best it's been," says Manoel Carlos Ortolan. "There's even
nouveaux riches."
The key to Brazil's
success is that consumers are choosing ethanol rather than being forced to buy
it. Brazil's
military dictators tried the latter approach in the 1970s and early 1980s, by
offering tax breaks to build mills, ordering state-owned oil company Petrobras to sell ethanol at gas stations, and regulating
prices at the pump. This bullying--and cheap oil in the 1990s--nearly killed
the market for ethanol until flex-fuel came along. The regime wasn't good for
much, says consultant Plinio Nastari,
but it did create the distribution system that enables drivers to fill up on
ethanol just about anywhere.
Even though the U.S. will never be a sugar-cane powerhouse like Brazil, investors now view Rio
as the future of fuel. "I hate to see the U.S.
ten years behind Brazil,
but that's probably about where we are," says one shrewd American
freethinker, Ted Turner.
ETHANOL FINDS A GODFATHER
There are venture
capitalists, and then there's Vinod Khosla. A co-founder of Sun Microsystems and a partner at Kleiner Perkins, he was an early backer of Juniper
Networks, whose technology helped end decades of dominance by traditional
telecom manufacturers. A lean, 50-year-old native of India, Khosla
says, without a hint of modesty, "I love the challenge of breaking
monopolies."
Frustrated that Kleiner Perkins wasn't taking enough risks after the
dot-com crash, Khosla opted out of Kleiner's most recent fund and started his own group, Khosla Ventures. He'd been dabbling in environmentalism but
never expected to become an investor. Brazil's
success, however, made him wonder about ethanol's U.S. potential. "I spent two
years trying to convince myself that this was never going to be more than
another minor alternative fuel," he says. "What I discovered was that
ethanol might completely replace petroleum in this country. And
a lot of countries. This was a great shock to me."
Pretty soon Khosla was surprising plenty of others. He put together a
PowerPoint presentation, "Biofuels: Think Outside the Barrel," which he fires up on a moment's
notice. He has made the pitch on ethanol to the President's Council of Advisors
on Science and Technology and elsewhere in the White House. He is also behind California's upcoming
ballot initiative to fund a subsidy for gasoline retailers that add E85 fuel
pumps. "Getting distribution going is the real problem," says Khosla. "We need to increase blending and then
introduce E85 pumps, and the possible will become the probable."
His conversion to energy
investing is part of a Silicon Valley trend,
as VCs seek the rapid growth and giant markets that computers once offered. VantagePoint Venture Partners in San Bruno, for instance, established a fund
called New Energy Capital that invests in ethanol, wind power, and other energy
projects. Nth Power, a San Francisco
energy-investment firm, estimates that $700 million of the $21 billion flowing
into venture funds last year were earmarked for "clean technology"
startups.
CELLULOSE NIRVANA
No one, not even a
professionally optimistic VC, thinks we're anywhere near getting rid of
gasoline. The oil superstructure is simply too efficient and too entrenched to
just go away. Nor could corn ethanol generate enough fuel to run America's cars,
pickups, and SUVs. Already ethanol gobbles up 14% of the country's corn
production. Converting a bigger share into fuel would pinch the world's food
supply--a favorite objection of skeptics. Critics also contend that producing
fuel from crops consumes more energy than it yields. On this topic of endless
Internet bickering, the Energy Department recently reported, "In terms of
key energy and environmental benefits, cornstarch ethanol comes out clearly ahead
of petroleum-based fuels, and tomorrow's cellulosic-based
ethanol would do even better."
Because cellulosic
ethanol comes from cornstalks, grasses, tree bark--fibrous stuff that humans
can't digest--it doesn't threaten the food supply at all. Cellulose is the
carbohydrate that makes up the walls of plant cells. Researchers have figured
out how to unlock the energy in such biomass by devising enzymes that convert
cellulose into simpler sugars. Cellulose is abundant; ethanol from it is clean
and can power an engine as effectively as gasoline. Plus, you don't have to
reinvent cars. Ratcheting up production of cellulosic
ethanol, however, is a gnarly engineering problem.
The onus now is on
companies like Genencor, a Palo Alto biotech. Its biological enzymes are
used to break down stains in Tide detergent and achieve just the right
distressed look in blue jeans. But making underpants whiter and denim bluer is
nothing compared with breaking America's
longstanding addiction to gasoline. The best way to do
this would be to bring down the cost of ethanol to the point where consumers
clamor for it. Before flex-fuel engines came along, Brazilians would mix their
own rabo de galo (cocktail)
of ethanol and gasoline when filling up, simply because it was cheaper than
straight gas. Genencor says its enzymes have cut the
cost of making a gallon of cellulosic ethanol from $5
five years ago to 20 cents today. Now refiners have to learn how to scale up
production. Canada's Iogen is the furthest along in commercialization; another hopeful
is BC International, a Dedham, Mass.,
company that's building a cellulosic ethanol plant in
Louisiana.
There's still a role for
government--and we don't mean more handouts for corn growers or distillers. The
recently enacted energy bill takes steps in the right direction, like mandating
the use of 250 million gallons of cellulosic ethanol
a year by 2013, but much more can be done. Easing the tariff of 54 cents per
gallon on imports of ethanol from Brazil and other countries would
certainly help. Because sugar cane generates far more ethanol per acre than
corn, Brazil can produce
ethanol more cheaply than the U.S.
Not only would importing more of it broaden access to ethanol for U.S. buyers,
but it would also make it cheaper for the ultimate consumers--us. That in turn
would spur demand at the pump and encourage service station owners to offer
ethanol more widely. What's also needed is for someone big--like Shell or BP,
which tout themselves as green companies--to commit to cellulosic
ethanol on a commercial scale. Shell's bet on Iogen
is minuscule compared with the $20 billion it plans to spend on producing oil
and gas off Russia's Sakhalin Island.
Of course, the timing of
when ethanol goes from dream to reality isn't just a matter of an investment
here or a subsidy there. It took decades of ferment in Brazil before
serendipity in the form of high gas prices and flex-fuel engines made ethanol
an everyday choice for consumers. But the sooner we start, the greater our
ability to shape a future that's not centered on increasingly expensive oil and
gas. It's not as if gasoline demand is going to go down: As long as the Chinese
and the Indians want our lifestyle--and they do--you can forget about oil at
$10 or even $20 a barrel. Whatever the technological challenges, a world of
abundant, clean ethanol is suddenly looking a lot more realistic than a return
to the days of cheap, inexhaustible oil.
FEEDBACK
alashinsky@fortunemail.com; nschwartz@fortunemail.com;
sbrown@fortunemail.com