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Is There Hope in Biofuels: KiOR Inc (KIOR), GEVO, Inc. (GEVO)

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There is a rule for investing in renewable energy. We’ll call it Dana’s Rule of Renewable Investing.

Until costs drop below those of alternatives, you want to be on the buy side of the transaction. You want to be creating a market, not producing product. Once costs drop below replacements, you want to pile in on the sell side.

Failure to understand this basic rule has caused a lot of pain for investors. Renewable fuels are based on technologies, and follow the pattern of past technologies. Like computers that only saw margins compress after the creation of the PC in the mid-1970s.

KiorSolar energy is now reaching parity with fossil fuel grid energy in many places, and in others there is no grid to compete with. There are real opportunities here, which will increase as costs continue falling toward 50 cents/watt. Something similar is happening in wind energy. It wins in remote locations off-the-grid, where it’s used by many extraction industries, including oil. It’s approaching parity in high-cost areas like Europe. It will come good in time.

The picture is not so clear in renewables. Many companies in this sector have failed, or been sold off. But there remain two that retain investor interest.

KiOR Inc (NASDAQ:KIOR): It’s the Process, Stupid

KiOR, whose best-known backer is venture capitalist Vinod Khosla (who founded the company in 2007), is closest to commercial reality with a test plant near Columbus, Mississippi using pine as its feedstock.

The company is very secretive about the plant, perhaps needlessly so. But the plant is designed not to compete in the market, but as a test of the concept. The idea is to adapt the Fluid Catalytic Conversion, or FCC process, used to crack oil to biological inputs, thus the name Biomass Fluid Catalytic Conversion or BFCC.

The reaction is deceptively simple. Fuel goes into a chamber, it’s heated, then it’s separated into useful components, with the remainder processed again-and-again to increase yield. The key is the catalyst, the secret sauce, the proprietary piece of the process which either works of doesn’t. Columbus will tell whether it works.

Getting to the present point required a lot of hype and some delicate financial engineering, including the enlistment of government. Former Mississippi Governor Haley Barbour responded with a $75 million loan, interest free, which is why the plant is in Mississippi, using Mississippi pine that is otherwise wasted. Barbour wanted jobs, and he wanted new markets. Whether KiOR becomes his “Solyndra” is what we’re going to find out, and why the company remains secretive about its operation, which is, at least for now, resulting in about 500 jobs.

Assuming things work, KiOR thinks it can build 35 plants, each using 1,500 tons of waste wood each day, creating the equivalent of 59,000 barrels of oil per day, which would then be fed to refineries on the Gulf Coast. KiOR thinks it can continue taking pine for the equivalent of $25 per “barrel,” enabling the process to eventually compete well against $90/barrel feedstocks coming from Texas and the Gulf.

But it’s the BFCC process, and the catalyst used to break down biomass, that remains the question and remains the risk. If all goes well, then in about two years you have a winner, what they call in the oil business a “gusher,” that could be licensed to use other forms of biomass. Otherwise you have a dry hole.

And that’s the way to look at this investment, as an old-fashioned wildcat. Those who jumped in with the first trade, in June, 2011, at $15/share, were only looking at the promise, not the risk. Today’s price of about $6/share is far more reasonable. This is only a place for “mad money,” for money you can risk, that you don’t mind losing. It’s not a place to put your retirement savings.

If you’re ready to swing for the fences, you have a nice entry point. Just remember that when you try to hit a home run, you may well strike out.

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