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.
nstead 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 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
