Betting on Biofuels

Billions of dollars, euros, pounds, and reais are pouring into biofuels. High fuel prices and generous regulatory support have given the industry healthy margins and relatively short investment payback times. Meanwhile, the triumphs of the first movers and dreams of future growth are enticing companies in industries from petroleum and agribusiness to biotechnology, chemicals, engineering, and financial services. And of course, the allure of a greener future has raised the expectations of investors and bystanders who hope that biofuels will help meet the world’s energy needs while lowering greenhouse gas emissions.

Can biofuels deliver? The answer appears contingent on fuel prices as well as three other variables that directly influence the profitability and environmental impact of biofuels: the cost and availability of feedstock, government regulation, and conversion technologies. All are in flux, so an investment today is a bet on how these interrelated factors will evolve. Feedstock costs vary tremendously by region and could change significantly in the years ahead. Governments may alter the industry’s ground rules to match changing priorities in climate change, energy security, and economic development. The energy, cost, and carbon efficiency of various biofuels are already quite different,1 and new conversion technologies could make them even more so—at different rates in different regions. Decisions about where to produce and distribute biofuels could have dramatic implications for the feasibility of the business.

Amid all this uncertainty, why enter now? In many commodity industries, the winners are the latest entrants, at the bottom of the cost curve—wielding the newest, most efficient technologies. But waiting may be a costly strategy in the nascent biofuel industry because land and other essential resources are at a premium.

Biofuel players should consider different ways to mitigate the risks, but every strategy will require trade-offs. Betting on a number of geographies and technologies will make things more complex, for example, but helps balance risk. Vertical integration, though both complex and costly, may be essential in helping to establish this young industry. Companies that want to play should try to get a head start on the difficult task of reducing the seemingly infinite number of options to a feasible set of solutions.

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