June 23, 2016

Tesla Considering Shanghai For New China Plant

Doug Young 

Bottom line: Tesla will announce a joint venture production facility in Shanghai within the next 1-2 months, and could see its China sales pick up sharply after its more affordable Model 3 reaches the market next year.

Just a week after Disney (NYSE: DIS) launched its newest theme park in Shanghai, media are saying that new energy car superstar Tesla (Nasdaq: TSLA) is also eyeing China’s commercial capital as the location for a new production base costing up to $9 billion. We should note from the start that the potential partner mentioned in the reports, the Shanghai government-owned Jinqiao Group, has denied the signing of a memorandum of understanding (MOU) for such a deal. But in this case I trust the source of the story, Bloomberg, more than the Chinese officials who have a track record of denying reports that later turn out to be true.

This particular investment plan has been in the headlines for much of this year, though Tesla has been quick to always say that it will only make such an investment if it can find the right partner and market conditions justify such a move. A major breakthrough appeared to be near last month, when a senior Tesla executive met with a high government official in charge of the new energy car sector and the pair later released photos of their meeting. (previous post)

All that said, let’s review the latest developments that include both details of the potential plan and also Jinqiao Group’s denial. According to the Bloomberg report, Tesla has signed an MOU to build a manufacturing plant in Shanghai’s Pudong New District, making the city the front-runner to host the long-discussed production base. (English article; Chinese article)

Under the plan, Tesla would provide half of the investment for the plant, or up to 30 billion yuan ($4.5 billion) of the total cost of around $9 billion. Jinqiao Group would provide the other half. Other places that are still vying for the plant include the interior city of Hefei in Anhui province, and the city of Suzhou about an hour’s drive from Shanghai.

The Bloomberg report cites a representative of one of Jinqiao’s listed units saying that the parent company hasn’t signed any MOU or other documents about a Tesla joint venture factory. (English article; Chinese article) The fact that Bloomberg decided to run its article despite the denial leads me to believe that a deal is really happening in Shanghai, though perhaps there’s no actual signed MOU just yet.

Aggressive Suitor

The fact of the matter is that Shanghai is quite aggressive when it comes to courting cutting-edge famous brands like Tesla. The city just opened its state-of-the-art Disneyland last week, and the latest reports are pointing out that the reported new Tesla factory would be worth nearly twice as much as the $5.5 billion price tag for the Disney resort.

Shanghai has also been working aggressively to build up a charging infrastructure for electric vehicles (EVs), in a bid to jump-start Beijing’s stalled program to promote the industry. That program includes not only building charging stations throughout the city, but also working aggressively to get residential property management companies to permit apartment dwellers to install such stations in their parking spaces at home.

Tesla zoomed into China 2 years ago on a flood of positive publicity, fueled by Beijing’s emphasis on the technology and also the celebrity power of company founder Elon Musk. But it stumbled badly after that due to lack of infrastructure, poor marketing and also problems with China’s broader incentive program to promote the sector.

This latest move to localize production, combined with Tesla’s recent introduction of a more affordable model priced at $35,000, seem to indicate the company may be regaining some of the momentum it lost after its fast start 2 years ago. Accordingly, I expect we could see a formal announcement of the new joint venture in the next month or two, and the company’s China sales could pick up sharply when the new more affordable Model 3 becomes available here next year.

Doug Young has lived and worked in China for 20 years, much of that as a journalist, writing about publicly listed Chinese companies. He currently lives in Shanghai where, in addition to his role as editor of Young’s China Business Blog, he teaches financial journalism at Fudan University, one of China’s top journalism programs.. He writes daily on his blog, Young´s China Business Blog, commenting on the latest developments at Chinese companies listed in the US, China and Hong Kong. He is also author of a new book about the media in China, The Party Line: How The Media Dictates Public Opinion in Modern China.

June 22, 2016

Capstone Turbine: Not a Pretty Picture

by Debra Fiakas CFA

Last week microturbine manufacturer Capstone Turbine (CPST:  Nasdaq) reported financial results for the final quarter of its fiscal year ending March 2016.  Sales were $18.9 million in the quarter, bringing total sales for the year to $85.2 million.  FY2016 sales shrank 26.2% from the prior fiscal year for the second year in a row.  Some shareholders may be taking solace in the FY2016 net loss of $25.2 million or $1.39 per share in that it is an improvement over the even deeper loss in the year before.  That does not necessarily mean that operating performance has improved for Capstone.  The year-over-year comparison is muddied by a special charge in FY2015 for bad debt expense totaling $10.1 million.  Then in the more recently reported FY2016, $1.5 million in bad debt recovery worked in the company’s favor.

No one should be surprised at recent deep losses.  Capstone Turbine has been reporting operating and net losses since  -  well, since the beginning.  The continued deep losses beg the question:  will Capstone Turbine every turn a profit?

The company staged an initial public offering sixteen years ago this month in June 2000, disclosing losses as far back as 1998.  In that long-ago year, Capstone achieved the first commercial sale of its versatile Model C30 turbine.  This was followed close on in 2000 by the introduction of the Model C60 using natural gas as fuel.  Shareholders must have had high hopes for that second model, and sales initially popped to $36 million in FY2001 only to drop back to $19.5 million in 2002, well below sales achieved even by the first Model C30 turbine product.  In both years, cost of goods far exceeded sales.

This last metric provides a clue to what might be Capstone’s bottom line struggle.  Even as the product line expanded and unit production increased, cost of goods exceeded sales up through 2011.  In FY2012, the Company finally reported a positive gross margin of $5.4 million on $109.4 million in total sales.  Unfortunately, it was still far too small to cover $37.1 million in operation costs, leaving an astounding operating margin of negative 28.9%.

Fast forward to the most recently reported fiscal year, the gross profit margin has improved to 15%, allowing the company to pull out $12.8 million of sales to cover operating expenses.  Except that gross profits are not sufficient cover operating expenses.  Spending on research, development, selling general and administrative activities totaled $37.3 million.

Of course, this is a look at reported net losses, which presents only part of the picture of operating results.  Cash flow from operations brings the rest of the image into focus.  It is not any prettier.

Capstone Turbine has never reported positive operating cash flow, relying year after year on cash resources to support operations.  In FY2016, the Company used $22.5 million in cash resources for operations.  There was $11.7 million in cash on the balance at the end of March 2016.  At the recent spending rate the cash balance could last another six months.

Thus capital resources are an issue for Capstone Turbine.  Management has avoided debt, and at the end of March 2016, there were $435,000 in notes payable and lease obligations on the balance sheet.  The bias against debt has forced the company to go back to the equity capital markets every year for additional equity capital.  In May 2014, the company staged a negotiated offering of 900,000 shares of common stock at $34.00 per share to a single investor, bringing in $29.8 million in new capital.   Capstone has raised a total of $853.3 million in equity capital since inception, nearly all of which has been burned up by operations with losses totaling $827 million.

In August 2015, a little more than a year after the follow-on offering, the Company entered into an at-the-market equity offering program to sell shares of its common stock.  By the end of March 2016, the Company had sold 6.9 million shares under this $30 million facility and took in another $12.7 million in new equity capital after expenses and fees.  I estimate the balance of the equity facility could provide support for Capstone’s operations for another eight months

Capstone shares are trading near $1.40 per share, which given the long history of weak results seems a bit dear.  Microturbines offer the promise of energy efficiency and for some investors the whiff of environmental benefit may be enough to put up with dismal operating performance.  I do like all things green, including money.  Unfortunately, Capstone does not appear to be able to deliver any of that kind of green to shareholders.

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

June 20, 2016

Green Plains Primes The Pump

by Debra Fiakas CFA

Ethanol producer Green Plains Renewable Energy, Inc. (GPRE:  Nasdaq) announced today plans to build a fuel terminal point in Beaumont, Texas.  The terminal will be located at a facility owned by Green Plains’ partner in the venture, Jefferson Gulf Coast Energy Partners.    It will be helpful to have a friend in the project that is expected to cost $55 million to complete just ethanol storage and throughput capacity.  Planned storage capacity is equivalent to 500,000 barrels, with the potential to expand to 1.0 million barrels.  Capacity to handle biofuels or other hydrocarbon fuels will be added later.  The terminal should give Green Plains better access to world fuel markets through railroad, barge and ocean tankers connections at the terminal.

This is the second terminal project for Green Plains.  In November 2015, the company announced plans to build an ethanol terminal in Maumelle, Arkansas for access to the Union Pacific rail line.  The terminal will have the capacity to unload trains as long as 110 cars in one day and will be able to store as much as 4.2 million gallons of ethanol.  The price tag is projected to be $12 million, which will be split equally between Green Plains and a partner, Delek US Holdings.  A downstream refining and distribution company, Delek is experienced in fuel logistics and has connections to convenience stores.

The two projects should smooth the way for Green Plains to economically reach customers both in the U.S. and around the world.  Lower cost distribution can also give Green Plains a competitive edge in striking deals.  Now the company needs to ‘fill the pipe,’ so to speak.  The altered strategic plans of some competing ethanol producers may be giving Green Plains an opportunity to do just that.

Abengoa SA (ABG:  Madrid or ABGB:  Nasdaq) has debt issues back home and is putting its U.S. operation into bankruptcy.  Green Plains has offered $200 million in cash for Abengoa’s ethanol plants in Illinois and Indiana.  The deal will give Green Plains another 180 million gallons in production capacity and elevate it from fourth to third largest ethanol producer in the U.S., passing up Valero Energy (VLO:  NYSE).

Even top-dog Archer Daniels Midland (ADM:  NYSE), with its 1.7 billion gallon ethanol production capacity, is rethinking its ethanol priorities.  In February 2016, ADM announced its two dry mill ethanol plants that grind and crush corn feedstock were under scrutiny.  At that time ethanol prices had slumped to the $1.34 to $1.40 range and renewable fuels policy seemed unclear.  Since then the profit potential in ethanol has improved as prices have come back to the $1.65 to $1.70 price range.  ADM may ‘think’ its strategy right back to the starting point.  In the meantime, Green Plains management can still speculate about grabbing up even more capacity.

Acquiring production capacity during a market downturn, is a tactic well known by number two ethanol supplier Poet, LLC (private).  Based in Sioux Falls, SD, Poet has a long history of buying up bankrupt and otherwise beleaguered ethanol producers and then installing its own proprietary technologies to improve efficiency.  Poet itself might have an interest in ADM’s dry mill plants if either or both of them get put up on the auction block.  Poet has patented its proprietary dry mill process and is the largest ethanol producer in the country in terms of dry mill plant capacity.

Green Plains ambitions may be tempered by the condition of its balance sheet.  The company has not shied away from debt to finance its expansion in the ethanol sector.  At the end of March 2016, long-term debt and notes totaled $765.9 million, representing an 82.4% debt-to-equity ratio.  A look at assets helps put leverage into clear focus.  Book value of property, plant and equipment assets net of accumulated depreciation was $920.5 million in March 2016, representing a multiple of 1.2 times debt obligations.  A current ratio of 2.10 should also provide some comfort to shareholders and creditors.

The company had $383.4 million in cash on the balance sheet at the end of the last quarter, suggesting nice little treasure trove.  Unfortunately, during the period of weakened ethanol prices in late 2015 and early 2016, Green Plains was using cash to support operations  -  $259 million in the twelve months ending March 2016.  In my view, a company generating nearly $3.0 billion in annual sales needs as much as $450 million to $600 million in cash just for working capital purposes.  This is especially important when at the trough of the business cycle and profits have been reduced.  Against this ruler the treasure trove is more like a bare bones reserve.

Green Plains will need to come up with $33.5 million to support commitments to the two terminal joint ventures.  Then there is the $200 million bid for the Abengoa assets.  The company has some alternatives.  Green Plains Partners, LP (GPP:  NYSE), the holder of the company’s downstream assets, could use some of the $49 million in remaining credit on a revolving line of credit facility opened in 2015.  The parent company has a revolving line of credit as well.  However,  to be meaningful in the current investment scenario, the company would need to petition the agent to exercise the $75.0 million accordion feature that was built into the facility.   Of course, new common stock could be issued through either the parent (GPRE) or the downstream limited partnership (GPP).   GPRE current commands a multiple of 13.5 times projected earnings, while GPP is trading at 8.3 times expected earnings in 2017.

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

June 16, 2016

Fossil Fuel Companies Should Be Issuing Green Bonds

by the Climate Bonds Team

     ‘Fossil fuel companies should not be issuing green bonds because they are not green businesses.’

Varying versions of this statement crops up often at green bond conferences and in articles. We disagree, and here is why:

It’s use of proceeds that matter

Green bonds are about use of proceeds. What matters is the green characteristics and features of the projects that are being invested in, the ‘use of proceeds’, not the balance sheet backing the bond. This is an accepted concept in the green bond market globally (and the first pillar of the Green Bond Principles).

The use of proceeds concept means a fossil fuel company could issue a green bond with proceeds allocated to qualifying green projects – offshore wind farms, for example – and that bond will be just as green as a green bond issued by a pure-play offshore wind company allocating proceeds to the very same type of projects.

It’s already happening

Engie, a largely gas energy company, has already done this with their green bond.

The oil-filled balance sheet backing the bond does not impact the green credentials of the bond - provided sufficiently strong management practices are in place to ensure proceeds are properly earmarked for green projects alone. We need trust in the process.

Now, to clarify, Climate Bonds does not support fossil fuel companies (or any other issuer) issuing green bonds for fossil fuel projects, such as "clean" coal (what a brilliant piece of disinformation that term has been).

To meet internationally accepted emission reduction targets, we need to shift away from fossil fuels, and ramp up the speed of that transition to clean energy sources dramatically.

Urgency of the climate challenge means we need the big players to change

The urgency of climate mitigation means we encourage fossil fuel companies that wish to issue green bonds for ambitious green projects and should welcome them with open arms to the green bond market. Those fossil fuel companies that embrace a transition from their high carbon business model, should garner institutional investor support.

We need the big companies with massive investment and capex budgets to put less into exploration and development and more and more into money into green projects. The urgency of the climate challenge requires a faster re-allocation of capital.

We simply don’t have the luxury of leaving all green investments to smaller, pure green companies, and wait for them to slowly displace fossil fuel companies in the energy supply mix.

We were reminded of the great urgency of climate action this week when reviewing reports of masses of methane – a greenhouse gas 20 times more potent than CO2 - being released from the arctic seabed. The quantities will only increase with a warming ocean.

Fossil fuel companies offer scale and existing internal capabilities to green projects

The green business units or divisions may still account for a relatively small share of any fossil fuel company’s balance sheet, but because of the vast scale of many fossil fuel giants, the green divisions are surprisingly large when pitted against other players in the renewable energy industry.

If the solar division of French oil company Total SA solar division were separated from its parent company, it would be one of the world’s largest solar businesses. Similarly, if Norwegian oil giant Statoil were to spin out its offshore wind business into a separate company, it would be one of the 15 largest companies listed on Oslo Stock Exchange – across all sectors.

Turning an oil tanker may be a slow process, but when it comes to shifting a fossil fuel company into renewable energy, it can be a surprisingly simple shift, since many of the technical and management skills needed are the same. Everyone in Statoil's wind energy department was recruited internally, as "not much is required to retrain an oil engineer to be an offshore wind engineer".

Dirty balance sheets backing clean energy – exactly what we need

The beauty of green bonds issued by the fossil fuel companies to finance these divisions is that they would be backed by the full balance sheets of these giants. Hence investors don’t need to take any renewable energy risk, but proceeds would be earmarked for the green business units alone. I.e. using brown balance sheets to build green.

No different from banks and energy giants issuing green bonds

Still not convinced fossil fuel companies have anything to do in the green bond market?

What about green bonds issued by banks and large energy companies? Both banks and large energy companies also have fossil fuel filled balance sheets, due to their lending and investments in the area. As BankWatch pointed out this week, the banks that created the Green Bond Principles still have quite large fossil fuel loan portfolios. So welcoming oil companies to issue green bonds is really no different from accepting banks with fossil fuel exposure issuing green bonds.

Simultaneously we can and should continue the push to have banks and institutional investors get out of fossil fuels.

Like encouraging good behaviour among children while chastising bad behaviour.

The Last Word

“What exactly is wrong if Total issues a corporate green bond to finance their solar division-one of the world's largest solar companies. That's using oil industry balance sheets and creditworthiness to finance (and reduce the cost of capital for) solar - exactly what we need, is it not?” – Sean Kidney, CEO Climate Bonds Initiative

——— The Climate Bonds Team includes Sean Kidney, Tess Olsen-Rong, Beate Sonerud, and Justine Leigh-Bell. 

 The Climate Bonds Initiative is an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

June 13, 2016

DAR the Rins Blow!

by Debra Fiakas CFA

Last week the management of  Darling Ingredients (DAR:  NYSE) staged a webinar on its opportunities in biofuels.  Darling produces biodiesel in Kentucky and Canada and is in a renewable diesel joint venture with Valero Energy (VLO:  NYSE) in Louisiana.  As a recycler of wastes and excess from the food production processes, the production of energy with organic feedstock is a logical extension of Darling’s collection and aggregation infrastructure.

The event did not do much for Darling’s share price, but the presentation triggered a few questions about RINs  -  shorthand for Renewable Identification Numbers.  These are a creation of the U.S. Environmental Protection Agency (EPA) to track renewable transportation fuels.  They come in handy for the EPA to monitor how well oil refiners and blenders are doing in meeting the Renewable Fuel Standard (RFS).  Those standards were set up by Congress through the Energy Policy Act of 2005, to promote the use of renewable transportation fuels.  On the simplest level, the standards require the use of a minimum amount of renewable fuel usage based on the amount of petroleum product sales.
Here is where the RINs really become important.  Of course, refiners and blenders can meet the RFS standards by buying ‘wet gallons’ of actual renewable fuels.  They can also buy RINs from other parties who have exceeded the requirements.  There is a market for RINs.  As with any other asset, the value of a RIN is dependent upon the number of RINs sloshing around and whether refiners and blenders can get enough ‘wet gallons’ to meet the standards.

Progressive Fuels Ltd. publishes weekly RINs trading data. For example, in the week ending June 2, 2015, D3 RINs for cellulosic biofuel produced in 2016 ranged from $1.77 to $1.79.   Generally, RINs prices for cellulosic biofuel produced in both 2015 and 2016 have traded down from prices in late 2015.    Corn ethanol (D6), biomass-based diesel (D4), cellulosic diesel (D7) and advanced biofuels (D5) each have their own RIN code.

It is a well-intentioned arrangement  -  support development of renewable fuels with a clever economic support system.  Indeed, the D6 RIN for corn ethanol increased in value during times of higher RFS target announcements or near the compliance deadlines.  However, more recently the D6 RIN price has been influenced by the decline in gasoline prices.

What might be as important for renewable fuel producers like Darling is the amount of gasoline demand in the country.  With prices at the pump at record lows (at least since 2009), gasoline consumption is expected to rise.  The U.S. Energy Information Administration (EIA) estimates that gasoline consumption could reach 9,530 million barrels per day in 2016.  This is 1.5% higher than consumption in 2015.  However, ethanol blended into gasoline is expected to reach 950 million barrels per day, an increase of 1.1% compared to last year.

Darling is looking at RINs also, but in terms of market opportunity.  Looking at the EPA’s new 2016 advanced biofuels mandate in terms of RINs, the company sees an opportunity to sell fuel worth 440 million RINs.  Put into ‘wet gallons’ it would be 288 million in 2016.  With a capacity to produce 18 million gallons of biodiesel and 160 million of renewable diesel per year, that is an attractive prospect.  

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. Darling Ingredients is included in the Biofuel Group of the Beach Boys Index of alternative energy developers and producers.

June 08, 2016

High Income Green Investing For Small Investors

Tom Konrad Ph.D., CFA

Until recently, green income investing was an oxymoron.

Most companies people think of as green (think Tesla Motors (TSLA) or First Solar (FSLR)) are relatively new companies that are investing all of their profits (such as they are) back into the business.  Meanwhile traditional income sectors like utilities, oil and gas, and coal mining are deeply tied into fossil fuels.  Real Estate Income Trusts (REITs) are the sole exception.  A REIT is as green as the property it owns, and a few such companies are real leaders in sustainable buildings... but not nearly enough to build a diversified portfolio.

The Birth of the Global Green Equity Income Portfolio

In 2013, with the IPOs of Hannon Armstrong (HASI), NRG Yield (NYLD and NYLD/A), and Pattern Energy Group (PEGI), there were finally enough high-income green stocks (if you include international stocks) to build a diversified portfolio.  In December of 2013, I teamed up with Green Alpha Advisors to manage a green, fossil fuel free portfolio designed produce a high level of dividend income which we hoped to persuade Shelton Capital Management to use as the basis of a mutual fund, joining the growth-oriented Shelton Green Alpha Fund (NEXTX) as a natural complement.

Fossil Fuel Free, or Green?

We chose to make the portfolio fossil fuel free (FFF) because that is part of the Green Alpha brand.  They have one of the strictest definitions of FFF in the industry, and it is an important part of their identity.  My own definition of green is considerably broader.  For me, a company is 'green' because of its effect on the environment. If our economy would be doing more damage to the environment if the company did not exist, or if the environment benefits as the company grows, then the company is green. 

In 2014, I started to become frustrated with the difference between our definitions of green.  The pure fossil fuel free approach eliminated several of the most attractive green income stocks from the portfolio.  These included Brookfield Renewable Partners (BEP), TransAlta Renewables (TSX:RNW or OTC:TRSWF), Primary Energy Recycling, and Capstone Infrastructure.  The last two don't have stock tickers because they have been (profitably for investors) bought out since then.

In order to hedge my bets in case Shelton decided to pass on the mutual fund, and because of this frustration, I started a second seed fund in May 2015.  This second fund used the same approach, but my own, broader, green criterion.  I call this second fund the Green Global Equity Income Fund GGEIP, and the fossil free version FFFGGEIP.


Both portfolios have built up strong track records, as you can see from the following (after fees) performance chart and table below.  In 2014, there was no index of high income green stocks, so I have used the SDY, SPDR S&P Dividend ETF of general high income stocks as a benchmark.  In May 2015, YLCO, the Global X YieldCo ETF, which does focus on high income green (but not fossil free) stocks as a benchmark from that point on.

GGEIP performance

2014 Total Return
2015 Total Return
1/1/2016 to 5/31/2016 Tot.Return
Annualized since inception


Seeking Mutual Fund Companies

Despite the strong performance, Shelton decided to take a pass on either version of GGEIP last year, and I have been looking for a different mutual fund company to launch the fund since.  I'm currently speaking with two. 

Since this would be a new category of mutual fund, both are uncertain as to total demand.  To me, the need seems obvious.  The need for current income is common for retirees, as well as endowments and foundations.  A report from Bloomberg New Energy Finance identified the difficultly in replacing high income fossil fuel stocks as a sticking point for investors seeking to divest from fossil fuels.  So the demand for a high income green alternative will come from anyone who currently owns REITs and MLPs, but wants to divest from fossil fuels.

Why I Built The Green Equity Income Motif

While I was pondering how to demonstrate the demand for my fund, Jigar Shah, the President of private clean energy infrastructure investment fund Generate Capital suggested that I start a Motif on the Motif Investing platform.  Jigar was also a co-founder of SunEdison (SUNEQ), but he left long before the company got itself into its latest troubles.  He can also be heard weekly on my favorite podcast, The Energy Gang (Soundcloud, iTunes).

The Motif platform allows investors to essentially build baskets of stocks (Motifs) that they can buy and sell like exchange traded funds for a single $9.95 commission on a $3000 , but without the ongoing expenses of an ETF. 

I thought it was an excellent idea, and easy to implement, so I created the Green Equity Income Motif.

I can't replicate the GGEIP strategy on Motif for three reasons:
  1. Motifs only include stocks on US exchanges.
  2. Adjusting or rebalancing the holdings in a Motif requires additional trades.
  3. I use covered calls and cash covered puts in GGEIP to lower volatility and increase income.  Such option strategies are not available on the Motif platform.

Offsetting these disadvantages is the large advantage of cost- you can buy the entire Motif for a single commission.  And these disadvantages are also an advantage in that the people who may be interested in the Green Equity Income Motif are not likely to be the same ones who will want the mutual fund... but they can still help me demonstrate demand.

If there is significant demand for my Motif over time, I'll update it at least every year to add new green income stocks that go public and replace ones which get bought out.  I'll also re-weight the Motif towards the stocks that I think have the best chance of doing well in the coming year.  I called this first version the "Green Equity Income Motif 2016" to distinguish it from future versions, but I intend to update it more than once a year assuming there is demand and market conditions change.

How You Can Help (and get $100 for your efforts)

If you would like to help me start my fund, or just want a cheap, easy way to invest in my green dividend income ideas, here's how:

You can get $100 for opening a new Motif account now (I also get $100 for referring you.)  When someone buys the Green Equity Income Motif or future motifs I create, I'll get $1 as well.

Even if what you really want is the fund, the $100 bonus for signing up for the Motif account is a nice compensation for your trouble... you can always sell the Motif and use the money to buy the fund when it's available.

I know most of my readers are active investors and are more interested in investing their own money, rather than using a mutual fund or even a Motif.  If that is you, please consider this idea for that friend who has been asking you for advice.

Disclosure: Tom Konrad will receive $1 for each purchase of GEIM on the Motif platform, and $100 for each new Motif customer who signs up through the referral link.  Tom Konrad manages and invests in The Green Global equity Income Portfolio, which owns HASI, PEGI, NYLD/A, TRSWF and BEP, as well as most of the stocks in the Green Equity Income Motif.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

June 06, 2016

Ocean Power Nets A Discerning Buyer

by Debra Fiakas CFA

Earlier this week shares of Ocean Power Technologies (OPTT:  Nasdaq) soared as the company announced its first commercial order for its PowerBuoy hydrokinetic devices.  The order represents a modest $975,000 in potential revenue, but the customer, Mitsui Engineering and Shipbuilding Co. Ltd., provides extra value as a discerning buyer.  PowerBuoys are built to capture the energy in ocean waves to drive an electrical generator.  Power output can be delivered to nearby ocean or terrestrial installations.  With worldwide interests in the numerous marine markets, Mitsui could develop into a large and long-standing customer.

OPTT traded as high as $6.79 in the first hours following the earnings announcement, representing a fourfold increase from the closing price the day before.  Since that first frenzied day of trading with unprecedented volume, things have settled down a bit.  However, it is clear the Mitsui opportunity has resent investors’ views on Ocean Power.

Quick to take advantage of the newly kindled fervor, Ocean Power announced the pricing of a registered offering of common stock.  A total of 417,000 shares with a warrant attached to each will be sold at $4.60.  Each warrant buys about a third of a common stock share at $6.04 per share.  A fortuitously planned shelf registration statement facilitated the fast response.

Ocean Power will take in about $1.6 million in net proceeds after the investment bankers get paid.  This is not a large offering, but just enough to top off the bank account without diluting current shareholders more than necessary.  Management appears to have the view that, even after the dramatic price increase, the shares still do not reflect the long-term earnings potential in Ocean Power’s technology.

powerbouyMitsui is leasing the PB3 PowerBuoy which has the capacity to generate 350 watts of continuous power.  The structure floats on the ocean surface from a tethered attached to the ocean floor. As the wave move the direct drive generator, the electrical charge is stored in an on-board battery pack.  Power can be delivered to a nearby marine installation such as an off-shore oil rig or to coastal installations such as a communications network.

Ocean Power expects more to develop in its relationship with Mitsui Engineering & Shipbuilding.  Mitsui is among the largest construction companies in the world, with interests in energy and environmental projects as well as shipbuilding and infrastructure construction.  Mitsui is expected to be a strong advocate for the PowerBuoy if it begins designing the ocean-based power source into its assignments.  Mitsui has recently been trusted to address customer problems in a wide range of projects involving underwater inspection, marine position keeping and deep-sea remote observation.

Indeed, the range of potential applications that Ocean Power sees for the PowerBuoy is as wide as Mitsui’s business interests.  In a recent investor presentation, management outlined multiple addressable markets:  ocean observing, communications, off-shore oil and gas installations, and off-shore wind energy projects.  Likely, the new capital going into Ocean Power’s bank account this week, will be used to reach customers in these markets.

It was impressive that Ocean Power was able to take in capital at a strong price  -  at least from the corporate perspective.  However, one lease to Mitsui  -  and it is a lease, not an outright sale  -  may not be sufficient to support the current price.  Effective execution on market penetration will be the key for OPTT valuation.  It is then important that Mitsui fulfills the promise so many have placed in that relationship  - bringing in a big catch of fish for Ocean Power.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

June 02, 2016

Ten Clean Energy Stocks For 2016: Earnings Season

Tom Konrad CFA

May was a tough month for most clean energy stocks, even though the broad market was up slightly, but my Ten Clean Energy Stocks for 2016 model portfolio continued to out-perform, mostly because of strong earnings for several stocks.  The model portfolio was up 3.1% for the month and 3.8% for the year to date, even though its clean energy benchmark fell 2.0%, for a decline of 2.8% for the year through May 31st.  The broad market of small cap stocks also rose, and was up 2.2% for a total gain of 2.4% for the year to date.

Income and Growth Stocks

Clean energy income stocks continue to outperform growth stocks. with my income benchmark, YLCO down only 0.7% for the month compared to a 5.1% decline for my growth benchmark, PBW.  The seven income stocks in the model portfolio posted modest gains of 1.2%, comfortably ahead of their benchmarks decline, but were put to shame by the stellar performance of the three growth stocks, which advanced 7.6%.  The Green Global Equity Income Portfolio (GGEIP), an income-oriented clean energy strategy which I manage, continued to out-perform as well.  It rose 0.8% for the month, and is up 8.8% for the year to date.

performance chart

The chart above (larger version here) gives detailed performance for the individual stocks.  Significant news driving individual stocks is discussed below.

Income Stocks

Pattern Energy Group (NASD:PEGI)

12/31/15 Price: $20.91.  Dec 31st Annual Dividend: $1.488 (7.1%).  Beta: 1.22.  Low Target: $18.  High Target: $35. 
5/31/16 Price:  $21.78.  YTD Dividend: $0.671. 
Expected 2016 Dividend:$1.56 (7.2%) YTD Total Return: 8.1%

At its first quarter conference call, wind Yieldco Pattern Energy increased its dividend from $0.371 to $0.39.  The 2.4% increase was the ninth consecutive quarterly increase since its IPO.  Wind speeds were lower than average at its farms in the first quarter because of El Nino, but they have a good chance of being higher than average towards the end of 2016.

The company has $100 to $150 million in liquidity to acquire additional projects, and has also put in an "At The Market" (ATM) facility to raise small amounts of additional equity if the stock price continues to recover (which it has since the announcement.)  This is part a growing trend of Yieldcos returning to the capital markets which I believe signals a return to normalcy.  I took an in-depth look at this trend here.

Enviva Partners, LP (NYSE:EVA)

12/31/15 Price: $18.15.  Dec 31st Annual Dividend: $1.76 (9.7%).  Low Target: $13.  High Target: $26. 
5/31/16 Price:  $22.88.  YTD Dividend: $0.97  Expected 2016 Dividend: $2.10 (9.2%) YTD Total Return: 31.9%

Wood pellet focused Master Limited Partnership (MLP) and Yieldco Enviva Partners raised its quarterly dividend from $0.46 to $0.51 per share, keeping it on track to meet its 2016 distribution guidance of $2.10 per unit for 2016.  That guidance would require $1.13 in distributions in the second half of the year, which could be accomplished with smaller increases of only 4 cents in each quarter.  I think it's likely that they will continue with larger increases of 5 or 6 cents and exceed the guidance.  The guidance does not include the effects of further acquisitions, which are looking increasingly likely as the stock price recovers.

The demand for wood pellets remains strong and growing.  Enviva's position as the industry leader allows it to continue to sign take-or-pay contracts with quality utility customers for its entire capacity.  One such potential contract was discussed on the quarterly conference call with the final deal announced on June 2nd.  Enviva will supply 800,000 metric tons of wood pellets per year until 2027 to a power plant in the UK.  The plant formerly generated power from coal, but is being converted to run on wood pellets in order to reduce net carbon emissions.

Green Plains Partners, LP (NYSE:GPP)

12/31/15 Price: $16.25. 
Dec 31st Annual Dividend: $1.60 (9.8%).  Low Target: $12.  High Target: $22. 
5/31/16 Price:  $14.40.  YTD Dividend: $0.8075.  Expected 2016 Dividend: $1.62 (11.3%) YTD Total Return: -6.0%

Ethanol production Yieldco Green Plains Partners continues to recover along with gas prices, but the partnerships earnings are not as closely linked to gas prices as is the price of ethanol.  It's contracts with its parent, Green Plains (GPRE) insulate it from the ethanol market, so a continued recovery does not depend on continued increases in oil. 

While its parent operated at a loss in the first quarter, the partnership was able to increase its quarterly distribution to $0.405 per unit while maintaining a coverage ratio of 102%.

Its parent, Green Plains, rallied strongly in May as projections for ethanol demand and margins have improved.  The improved market conditions are helping GPP's units as well, but I believe the units remain very attractively valued.

NRG Yield, A shares (NYSE:NYLD/A)

12/31/15 Price: $13.91.  Dec 31st Annual Dividend: $0.86 (6.2%). Beta: 1.02.  Low Target: $11.  High Target: $25. 
5/31/16 Price:  $14.50.  YTD Dividend: $0.455.  Expected 2016 Dividend: $0.94 (6.3%) YTD Total Return: -7.8%

Yieldco NRG Yield (NYLD and NYLD/A) also reiterated its dividend growth target of 15% year over year, which I expect will mean total dividends for 2016 of 94 or 95 cents.  Its May dividend of $0.23 was precisely 15% above the dividend of a year earlier.

The company is also making progress developing internal management, and appointed Chris Sotos as CEO.  Sotos was formerly Head of Strategy and Mergers and Acquisitions at NYLD's parent, NRG Energy (NRG), but will now be employed solely by NRG Yield.

Terraform Global (NASD: GLBL)

12/31/15 Price: $5.59.  Dec 31st Annual Dividend: $1.10 (19.7%). Beta: 1.22.  Low Target: $4.  High Target: $15. 
5/31/16 Price:  $2.78.  YTD Dividend: $0.275.  Expected 2016 Dividend: $0.50 (21%). YTD Total Return: -44.5%

Information on Yieldco Terraform Global remains scarce as the company attempts to file its 2015 annual report and first quarter 2016 reports and its former sponsor, SunEdison (SUNE), stumbles through bankruptcy.

The delay of the reports is due to the fact that Terraform Global relied on its parent for accounting and bookkeeping, and the parent's financial controls were inadequate.  Now the Yieldco needs to rebuild everything from scratch.  The company has delayed its second quarter dividend, which I do not expect to be paid until after its financial reports are filed and it can claim to understand its own financial position.  At that point, I expect the regular dividend to be cut dramatically, with the second quarter dividend paid in arrears. 

Goldman Sachs thinks the dividend will be cut from $1.10 to $0.64 annually, but I'm a little more conservative, and think it will fall somewhere between $0.40 and $0.75.  Other Yieldcos currently trade with yields in the 6% to 10% range, so if we're very conservative and expect a $0.40 annual dividend and a 10% yield, the stock is worth at least $4, or 44% above the current price.  If we use Goldman's dividend estimate of $0.64 and a 10% yield, the stock price would more than double.

For me, the bottom line on Terraform Global is that there is much we don't know, but if we focus on the big picture and the little we do know, we have a stock trading far below its fair value because of all the uncertainty.  Eventually we'll have a better picture of GLBL's financials, and the stock market seems to be valuing it below the worst case scenario.

Hannon Armstrong Sustainable Infrastructure (NYSE:HASI).

12/31/15 Price: $18.92.  Dec 31st Annual Dividend: $1.20 (6.3%).  Beta: 1.22.  Low Target: $17.  High Target: $27. 
5/31/16 Price:  $20.33.  YTD Dividend: $0.30.  Expected 2016 Dividend: $1.25  (6.1%). YTD Total Return: 9.1%

Clean energy financier and REIT Hannon Armstrong had a very strong first quarter, with core earnings of $0.32 per share, a 19% increase on the previous year, and already in excess of the $0.30 quarterly dividend.  My previous estimate for the next dividend increase in December was 4 cents, to $0.34, but after this strong quarter, I expect the new dividend will be $0.35 or $0.36.

Like Pattern discussed above, Hannon Armstrong has put an ATM facility in place, and has said that it may raise something less than $200 million in new equity this way.  The difference between core earnings and the dividend will also flow back into new investments, all of which should contribute to per share earnings growth.

TransAlta Renewables Inc. (TSX:RNW, OTC:TRSWF)
12/31/15 Price: C$10.37.  Dec 31st Annual Dividend: C$0.84 (8.1%).   Low Target: C$10.  High Target: C$15. 
5/31/16 Price:  C$12.86.  YTD Dividend: C$0.293  Expected 2016 Dividend: C$0.88 (7.1%) YTD Total Return (US$): 33.9%

Canadian listed Yieldco TransAlta Renewables also had a strong first quarter, and continues on-schedule and on budget with its South Hedland Project in Australia.  The company has signaled that it will further increase its dividend when the project is complete in mid-2017.

The company also secured financing on its 68.7MW New Richmond wind facility which it will use to finance other projects, most likely including South Hedland.

Growth Stocks

Renewable Energy Group (NASD:REGI)

12/31/15 Price: $9.29.  Annual Dividend: $0. Beta: 1.01.  Low Target: $7.  High Target: $25. 
5/31/16 Price:  $9.21.    YTD Total Return: -0.9%

Advanced biofuel producer Renewable Energy Group also reported a strong quarter.  The company sold 64% more gallons of biomass based diesel than during the same period a year ago, although spreads were thin due to high commodity prices. They have also been making significant progress expanding their business through both internal growth ans acquisitions.  I expect these investments to show large benefits as the advanced biofuel and biodiesel markets recover due to the new climate of regulatory certainty.

At the end of the month, REGI sold $125 million of convertible notes due in 2036, with the proceeds to be used to redeem similar notes which would have matured in 2019, as well as for stock buybacks.  This caused the market to irrationally sell off for about a week or so, but it should have a positive effect on the share price in the long term.  I took the opportunity of the selloff to add to my position.

MiX Telematics Limited (NASD:MIXT; JSE:MIX).
12/31/15 Price: $4.22 / R2.80. Dec 31st Annual Dividend: R0.08 (2.9%).  Beta:  -0.13.  Low Target: $4.  High Target: $15.
5/31/16 Price:  $5.03 / R3.10.  YTD Dividend: R0.02/$0.12  Expected 2016 Dividend: R0.08 (3.6%)  YTD Total Return: 20.3%

Software as a service fleet management provider MiX Telematics shot up on the news that the company would be buying back about 25% of its shares at R2.36 per share using cash on hand.  This should result directly in increased earning per share (EPS) of approximately 30%.  After the sale is finalized and the effect starts boosting EPS, I expect the stock to continue its upward trajectory.

Operationally, the first quarter was also solid and exceeded market expectations, with year over year subscription growth of 11% despite many of the company's customers in the oil and gas industry reducing the size of their fleets.  I remain extremely bullish about the company's long term prospects.

Ameresco, Inc. (NASD:AMRC).
Current Price: $6.25
Annual Dividend: $0.  Beta: 1.1.  Low Target: $5.  High Target: $15. 
5/31/16 Price:  $4.68.  YTD Total Return: -21.7%

Energy service contractor Ameresco reported a strong first quarter, with revenue up 16% and rising margins.  The improvement was driven mostly by Federal government projects, while sales of integrated PV solar systems continued to lag.  The latter was due to the weakness in oil and gas, since many of these customers are in that sector.

Last month, I wrote that I was beginning to question my faith in company management.  This quarter has helped, but I'd like to see a few more quarters of strong execution before I put my doubts completely to rest.

Final Thoughts

The first quarter was almost uniformly good for my stock picks.  I continue to think Green Plains Partners and Terraform Global are two of the best values, but recent news has me adding Renewable Energy Group and MiX Telematics to the mix. 

Although MIXT stock was up 23% for the month, it remains greatly undervalued, especially in light of the expected 30% per share EPS increase due to the stock buyback.  As for REGI, I've been growing more confident that this stock is set for explosive earnings growth this year and next.


DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

May 26, 2016

Yieldcos: Boom, Bust, and (Now) Beyond

The Yieldco model is not broken. But investor expectations have changed.

by Tom Konrad Ph.D., CFA

The Yieldco bubble popped almost exactly a year ago after a virtuous cycle turned vicious.

Last May, I explained how these public companies (which own solar farms, wind farms and similar assets) could grow their dividends at double-digit rates despite no internal growth or retained earnings. This “weird trick” can work so long as the Yieldco’s stock price is rising, allowing it to sell stock at higher valuations and increase the amount of money invested per share.

As long as investors expected dividends to continue to rise rapidly, they fed this virtuous cycle by bidding the stock price up, which in turn increased the expected dividend growth. Many Yieldcos increased their dividend increase projections in 2014 and early 2015, when the bubble was at its height.

Yieldco boom and bust

Then the Yieldcos got greedy. 

In the spring of 2015, new Yieldco IPOs and secondary offerings reached a crescendo, with every Yieldco raising new money over a three-month period. There were two IPOS: 8point3 Energy Partners’ (CAFD) for $420 million in June and TerraForm Global (GLBL) for $675 million in July. 

In addition, TransAlta Renewables (TSX:RNW) raised $226 million in April; Abengoa (now Atlantica) Yield (ABY) raised $670 million in May; NextEra Energy Partners (NEP) raised $109 million in May; NRG Yield (NYLD) raised $540 million in June; Hannon Armstrong (HASI) raised $18 million in June; TerraForm Power (TERP) raised $689 million in June; and Pattern Energy Group (PEGI) raised $225 million in July. 

Before that flurry of new offerings, the existing seven Yieldcos had raised only $12.5 billion in total capital. The additional $3.5 billion flooded the market and halted the rise of most stocks. Investors began to scale back their estimates of future dividend increases accordingly. Lower dividend estimates led to lower demand for the stocks, even lower stock prices, and the cycle began to feed on itself in reverse. 

Over the next few months, the departing tide of Yieldco shares deprived sponsors of an important source of cheap finance for over-leveraged business models. It soon became clear which sponsors had been swimming naked: SunEdison (SUNEQ) and Abengoa (ABGB).

Mostly unbroken

SunEdison’s downfall in particular led many to ask if the Yieldco model is broken. Reporters (not to mention investors) have asked me this question on multiple occasions. My answer has always been "No -- except..."

The exception is the double-digit dividend per share growth that Yieldcos led investors to expect during the bubble. With the Yieldco bust in the rearview mirror, I don’t think that investors are likely to bid up stock prices to the point where Yieldcos can restart the virtuous cycle of secondary offerings at higher and higher prices feeding back to rapid dividend increases.

What isn’t broken is the idea of funding clean energy projects with (relatively) cheap stock market capital. When Yieldco stocks were near their bottom, solar and wind developers were openly talking about private equity being a more cost-effective form of capital than the public markets and Yieldcos. 

That situation is inherently unsustainable. The liquidity, better information, and broader spectrum of participants in the public markets ensure that private capital will not remain cheaper than public equity permanently. Private\-market participants have the ability to operate in public markets as well. When the prices are better in the public markets, that is where they will go. 

The opposite is not true for most public market investors: Regulations, lack of knowledge, and the need for liquidity keep them in publicly traded stocks and bonds, even when the returns are better elsewhere. It was only investor hesitancy in the wake of a crash that kept Yieldco stock prices so low for as long as it did. Now Yieldco prices are rising, and these entities can once again think about raising new equity on reasonable terms.

Pulling out the ATM cards

While clouds of uncertainty remain over the TerraForms because of SunEdison’s bankruptcy, other Yieldco stocks have begun to recover, and many are returning to the capital markets to issue new equity.

The strongest (and lowest yielding) Yieldco, NextEra Energy Partners, announced an “At The Market” -- or ATM program -- to sell small amounts of equity during its third-quarter 2015 conference call. Subsequently, NEP raised $26 million in the fourth quarter and approximately $40 million in the first quarter by issuing equity via the ATM. It also closed a $252 million secondary offering in the first quarter.

Toronto-listed Yieldco TransAlta Renewables has also returned to the capital markets by selling CAN $172 million of new equity in December. Unlike American Yieldcos, it never promised double-digit dividend growth, did not see its stock price spike during the bubble, and did not suffer a severe decline when the bubble burst. What decline it did see has now been completely erased by its recent stock rally. 

In their first-quarter conference calls, both Pattern Energy Group and Hannon Armstrong put ATM sales agreements in place to enable more flexibility depending on market conditions.

"We view this ATM as one tool in a broader toolkit, and we intend to use it judiciously for future project-related investments that are accretive and other corporate purposes. Again, to be clear, we do not plan on issuing under the ATM at this time, and at the current stock price. The ATM is only an option for the future," said Pattern CEO Mike Garland.

Hannon Armstrong seems a little closer to using its ATM than Pattern. Hannon CFO Brendan Herron described it as a “filler to help us increase leverage as the larger equity raises result in a lower leverage until we can reinvest and de-lever. We believe...the ATM will benefit shareholders and do not expect it to be a primary source of equity.”

Clearly, neither Hannon nor Pattern is planning on issuing large amounts of equity with this mechanism. But it's a positive signal that they are getting ready to tap the public equity markets.

Most Yieldcos have rallied significantly from their post-bubble lows, but are still far below their highs a year ago. This recovery has allowed several to once again begin to tap the markets for new equity, an early sign of the return to normalcy.

Because of the Yieldcos’ lower share prices and the relatively small size of these new equity offerings, they will not increase the investable funds per share nearly as much as previous offerings. Hence, despite better prices available for the clean energy assets Yieldcos buy, the investments made with the funds will have more modest effects on the Yieldcos’ dividends per share.

Yieldcos are returning to normalcy. We are no longer in the bubble.


Disclosure: Tom Konrad manages and has a stake in the Green Global Equity Income Portfolio (GGEIP), a private fund which invests in Yieldcos and other high-income green stocks. GGEIP holdings currently include CAFD, GLBL,TSX:RNW, ABY,  NYLD/A, HASI, TERP and PEGI.

May 20, 2016

FutureFuel: Still Future, Less Fuel

by Debra Fiakas CFA

The last post “From Fuel to Fudge” discussed how the old Solazyme developer of algal-based renewable fuel has been transformed into a new company called TerraVia, (TVIA) which is pursing algal-based food and personal care products.  Solazyme is not the only renewable fuel company to make an about face.  Granted FutureFuel Corporation (FF:  NYSE) has not changed its name or stock symbol like Solazyme.  However, its ability to produce specialty chemicals has given FutureFuel an alternative to biofuels and its early plans to build a plant that could eventually produce 160 million gallons of biodiesel each year.

It took very little time from the company’s inception for FutureFuel strategists to pull back the biodiesel plant to a 40 million gallon name plate capacity.  Even as the company was getting started in the 2006 and 2007 time frame, margins on biodiesel began to shrink.  Management was worried.  The plant finally ended up with a capacity to produce 58 million gallons of biofuels per year.

FutureFuel was already keeping the lights on by selling performance chemicals.  As much as two-thirds of revenue in the early years was generated by the sale of specialty chemicals, including a bleach activator that was sold to a detergent manufacturer and a proprietary herbicide for a life sciences company.  Biofuels accounted for only about a quarter of revenue.  Fast forward to the year 2015, biofuels are providing the majority of sales and specialty chemicals have taken a back seat.  

Fact of the matter is sales of BOTH specialty chemicals and biofuels have declined.  Biofuel sales peaked in the year 2013, but have since declined on lower selling prices and volumes.  Specialty chemicals sales peaked that year as well.  The herbicide producer has stopped buying the herbicide additive and FutureFuel has had to accept a lower selling price for its bleach activator in order to keep its detergent manufacturer customer through the year 2018.

Rebuilding the specialty chemicals segment is a largely a matter of finding new customers.  It is a situation over which the company has some control.  It is a matter of marketing, branding and messaging.  Then again it could be just a matter of salesmanship and good old fashion shoe leather.  

Unfortunately, in its biofuel segment FutureFuel is experiencing plenty of difficulties  -  none of which are so easily resolved.  Protecting profit margins from costly feedstock is just one of them.  FutureFuel appears to have little latitude on feedstock even as other biodiesel and renewable diesel products have found success. 

There are numerous biodiesel producers, some also using the transesterification process that FutureFuel uses.  An increasing number are using less expensive feedstock, such as waste oils.  For example, Diamond Green Diesel, the joint venture of Darling Ingredients (DAR:  NYSE) and Valero Energy (VLO:  NYSE) uses the waste oils that Darling collects from meat processing plants and restaurants around the country.  Diamond Green just announced plans to expand production capacity.  Another 125 million gallon capacity will be added by the end of 2017, bringing to total capacity to 275 million gallons per year.

Renewable Energy Group (REGI:  Nasdaq) is also expanding storage capacity for both its waste oil feedstocks as well as finished biodiesel at its Danville, Illinois facility.  The storage capacity is pivotal in allowing REG the flexibility of timing its sales at peak or at least better pricing.  The ability to delay sales to wait for better prices is one of the keys to building profits in the fuel production industry.  REG now has 45 million in annual biodiesel production and 12 million gallons in biodiesel storage capacity in Danville.  This facility is only one of a dozen active biorefineries REG has in operation around the country.

In the most recently reported twelve months FutureFuel delivered $48.6 million in net income or $1.11 in earnings per share on $292.2 million in total sales.  The company remains profitable, but comparisons to the previous twelve months are not favorable. Even in the most recently reported quarter ending March 2016, the company reported sales 10% lower than the previous year period.  Earnings we well above expectations, but only because the company benefited from reinstatement of the blenders tax credit.

FutureFuel has tried to break free from its biofuel origins, finding new products and new customers.  It seems investors might be doing the same.  After a brief recovery, the stock has sold off, leaving FF priced at ten times expected earnings for the year 2016.  We note that the stock was nearly at the same value about two years ago.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.  Crystal Equity Research has a buy rating on Darling Ingredients and a Hold rating on FutureFuel.

May 19, 2016

KiOR: The Inside Story Of A Company Gone Wrong, Part 2

by Jim Lane

Note. This is Part 2 of our series on the inside true story of KiOR.

In part 1 of our series, here, we explored: the formation of BIOeCON and KiOR, the problem of too much oxygen and coke, the entry of Khosla Ventures, and the loss of a CEO. Also, “a recipe for technical failure”, disastrous pilot scale results, culture clashes, catalyst development, reactor design trouble and the departure of a key scientist.

Two KiOR scientific wings emerge

No one was more emphatic about the pilot plant results than scientist Robert Bartek, who sent an email ‘More Math on BCC’ on December 7th, stating:

“We are in a period of denial. We must forget that our original conceptions of BCC are not right and must do something radically different to save the Project”.

By the end of 2008, it is clear from discussions with multiple KiOR sources that the KiOR scientific staff had divided into two groups. One group believed that the BCC Technology had been sufficiently tested, was not working, had no value to KiOR’s business and should be immediately stopped.

The other group, which was headed by O’Connor, focused on improving the BCC Technology, and on support of the three European Labs doing so. The controversy over the R&D Plan for 2009/2010 — to the extent that it exacerbated a growing rift between O’Connor and Ditsch — would have far-reaching consequences as 2009 unfolded.

Paul O’Connor confirmed that cultural problems were rife at KiOR at this point.

“Part of this was my problem because I wasn’t there full time in Houston,” O’Connor told The Digest. “Basically I was the CTO, and André [Ditsch] had no experience in FCC biomass or hydrotreating, but he had it in his head that he was second in command to Fred. When I was away he would push it in another direction. Because people considered him Samir’s boy [Samir Kaul, a partner in Khosla Ventures], and no one dared to criticize him much. I did, and that became a problems.

“Partly, that was the Houston culture. In The Netherlands as in places like San Francisco and New York, everyone tells you exactly what they think of you even in the management meeting, we fight like crazy but we resolve issues and make up. In Houston, people don’t often want to talk about the problem. It’s a case of everything is fine, everything is great, and Fred was very good at that.

“But there were problems to be solved, and there would be all these in-fights between myself and Ditsch, and with so many new people. Everyone wants to invent their own process and thinks they have the right ideas. Fred never really took a stand, he always stayed out of it.”

No team, no stable technology

“One problem that hurt KiOR,” O’Connor recalls, “was we just had too many people from Albemarle. Catalysis is important, but what we needed also were process engineers, and people with experience in hydrotreating and operations. The balance went wrong.

“And then there was this entirely different idea, coming I suppose from the Khosla approach to business, and André himself in some ways represented this approach, which was to go out and hire a whole bunch of MIT PhDs. But you need time to train them and they are not the ones who are going to scale up a process.

“And so it became a struggle to unite all these people into one team, and in that struggle I began to struggle with Fred, and it became a case of Fred and André on one side, and although I stayed around until the end of 2009 my influence was minimized.”

By all accounts, at the beginning of 2009, as one source familiar with the state of technology development described it, “KiOR had no Technology that was sustainable, competitive, cost-effective, and economically/technologically feasible, and the operating funds were practically depleted.”

By all accounts, at the beginning of 2009, as one source familiar with the state of technology development described it, “KiOR had no Technology that was sustainable, competitive, cost-effective, and economically/technologically feasible, and the operating funds were practically depleted.”

The fateful Columbus first commercial-scale plant

The fateful Columbus first commercial-scale plant

A Stealth Team forms

Amongst the loosely-associated group of staff that felt the BCC technology as designed was hopeless, a “save the company” effort launched on a stealth basis.

Their goal? Reliable, data showing increased bio-oil yields of reasonable quality using less costly catalysts and processes. The new data, demonstrating a feasible technology, could be used by KIOR in business development, and to convince new investors in funding efforts.

The timing? Those who were aware or active in this effort took the view that time was critical, not only because KiOR, as a company in development, was shortly going to be starved for funds if results were not forthcoming; they were also concerned that the plans and design of the demonstration-scale Unit (a 10 ton/day biomass processing capacity) needed to be formulated, firmed and contracted out for fabrication. And any new technology would need to be developed before that.

Out of a wider group, catalyst expert Mike Brady, FCC unit expert Robert Bartek, solid state chemistry expert Dennis Stamires, and Drs. Vasalos and Lappas of CPERI in Greece would be the most visible. Their concern was not only the development of a technology that could save KiOR from disaster, but doing so in a way and in a time frame that would not cost them their own jobs.

In February 2009, Stamires wrote to a scientific team composed of Bartek, Yanik, Loezos, Cordle, and Brady, proposing that, at the KiOR Pilot Plant, test runs to duplicate published test data obtained from other similar Pilots using the same biomass feed and sand as a heat transferring medium. This was the baselining project which had been specifically ruled out for the KBR pilot.

Paramount the need to ascertain why the CPERI FCC Pilot Plant produced higher bio-oil yields than the KiOR pilot. The Stealth Team decided to conduct a “Round-Robin” testing program where both Pilot Plants would use the same biomass feed, sand/catalyst and process conditions.

The idea?

Stamires reasoned that, if Prof. Vasalos and Dr. Lappas at CPERI , who had a similar FCC Pilot plant in operation, could pyrolyze the same kind of biomass with sand, under the same process conditions, the team could confirm that new KiOR pilot was working correctly. If the CPERI FCC Reactor design was responsible for the higher Bio-oil yields, then the design could be introduced into the KiOR Pilot.

On the same day, Bartek replied: “I agree! I am hoping we can do significant alterations to the process to assure some chance at victory in the next two months, so we do not purchase the wrong DEMO“.

After baselining the pilot plant, the expectation was that new catalysts could be tested aimed at improving bio-oil yields. Specifically, Bartek speculated that it was “Time for some Z?”

Meaning “ZSM-5 catalyst”. A commercial grade, high-priced catalyst, well established in the market place, being used by most oil refineries worldwide, containing the ZSM type of Zeolite. Papers had been published by Dr. Paul Williams at Leeds University in 1995 indicating that zeolite catalysts would not produce a high bio oil yield, but could produce, as one observer put it, “a reasonable amount with a substantially improved quality containing a lesser amount of oxygen, easier and less costly to be upgraded to gasoline and diesel fuels.”

Whose technology is this, anyways?

The other team? In a March 5th memo to the KiOR community, a R&D review of the BCC Technology, specified the continuation of the R&D work on BCC Technology in all four Labs.

As O’Connor confirmed to The Digest, “one of my biggest frustrations was that the technology that was moving forward was never actually the BIOeCON technology. What we were doing in Valencia was not what we did later in Houston. If you look at the first patents and so on, you see that the basic trick was to have an interaction between the biomass and the catalyst before it enters into the reactor. We called it mechano-chemistry. When I compared the data between Houston and Greece, Greece was better, and that was because in Houston, they never pre-treated the biomass.

“That created more conflict with Ditsch. He had a ‘make it simpler, don’t do that’ attitude towards it. And you could sort of get away with it in the pilot plant because you could mill the biomass very fine. But when you get to demo scale, much less commercial, you can’t mill the biomass like that. For one, it can get sticky. It can even catch fire in the plant, which happened.

“But if you are feeding [larger] wood particles of 1-3 MM instead of this finer sort, it takes quite a long time before the particles heat up, and the outside can get charred while nothing happens to the inside.”

So you coke up and lose yield.

Cannon sidelined by heart problems, and “who’s in charge?” chaos ensues

But the week of March 8th would prove even more fateful for KiOR, as CEO Fred Cannon was hospitalized with a heart problem and was sidelined for some weeks, in hospital or at home, while recuperating.

And so, a leadership crisis erupted.

By March 19th, O’Connor emailed the staff, “In the absence of Fred, I have assumed his responsibilities to assure a smooth continuation of our business.” Most staff at the time took that to mean that, as soon as Cannon returned to the office, O’Connor would assume his former duties.

But more than that was going on.

Cannon had received a memo from O’Connor, expressing concern about the leadership of KiOR, the direction KiOR was taking, and a lack of team effort and communications between groups. O’Connor expressed the view that, if matters continued as they were, key personnel would leave the company.

Some discussions took place over a potential revision of management duties and structure, which failed, not the least because as Cannon explained, even if he really wanted to re-divide CEO responsibilities and authority, he could not do that without a resolution and approval by the KiOR Board.

A degree of chaos ensued, and morale dropped. In Cannon’s absence, VP for Strategy Andre Ditsch also stepped forward to assume more commercial responsibility, and it became at times unclear to staff who was in charge.

One observer recalls, “[Ditsch and O’Connor] were calling their own regular staff meetings at the same time, and starting to re-organize and re-assigning responsibilities and projects to the staff.”

The controversy over the research program boiled over. Those familiar with this period at KIOR said that Ditsch “accused O’Connor of grabbing for Cannon’s job”, and having failed to develop a feasible technology, despite two years of investment in R&D.

The battle reached the KiOR board in March 2009. The board confirmed Cannon as President and CEO of KiOR, Ditsch remained VP for Strategy; in May 2009 O’Connor was re-assigned from the CTO role, although he continued to work for KiOR until November 2009 when his contract expired.

Observers of KiOR during this period stress that, although Cannon returned to the office by the end of March, Andre Ditsch assumed some extra managerial functions and, according to one observer, “was communicating frequently directly with Samir Kaul (a KiOR Board member, representing Khosla).”

Dead Man Walking

While the management crisis was unfolding, the Stealth Team had outlined new catalysts and had made the request to test these, and to calibrate the KiOR pilot plant with sand. The request ultimately would have to be made to Ron Cordle, the Pilot Plant supervisor, as a confidential, weekend test. The backup plan was to have CPERI run the tests in their pilot in Greece.

“It was like the blind leading the blind,” Stamires recalled. “The KiOR pilot plant reactor was deficient and underperforming and not capable of producing optimum bio-oil yields. Adding to this structural Reactor problem, and [later] the additional problem of the data manipulation of John Hacskaylo. The combination of these problems resulted in a general situation where nobody knew what we were actually doing, what oil yield numbers to believe.”

As Robert Bartek would express in a March 28th memo:

“You had already been hounding me to get sand in the Unit. At that time the three of us started on this, I had already accepted the fact that I was a “Dead Man Walking” in Fred’s organization and my time at KiOR would be short. So why not one final act of defiance? If you are going to be let go, let’s do it for a noble project reason rather than politics. May be we could rescue this thing and snatch victory out of defeat we [are] heading into.”

Ultimately, the sand test was carried out, using sand obtained from CPERI, and confirmed that higher oil yield was produced at the Pilot Plant at CPERI in Greece. That finding prompted Bartek and Stamires with further discussions with Lappas and Vasalos, to arrange a meeting with Cannon and Vasalos in Houston. And an agreement was made with Cannon that CPERI would license the design of their Reactor to KIOR

With this, the Reactor at KiOR’s Pilot was replaced with a new Reactor constructed according to the design of the CPERI Pilot Plant. With some process variables optimizations, the KiOR Pilot Plant was able to produce higher Bio Oil yields.

Work on catalysts also continued. The Stealth Team was convinced by that time that the BCC Catalyst (the synthetic clay) was a very poor heat conductor, and incapable of transferring a sufficient amount of heat to the Biomass fast enough. They thought that a new material with high bulk density, low porosity microspheres, with a low catalytic activity, would be much more suitable.

By March 9th, the Stealth Team had obtained, via “a friend at BASF”, 5 gallons of high temperature calcined clay microspheres, which were tested secretly at the KiOR Pilot Plant. In a memo on March 27th, Bartek reported to O’Connor, Yanik and Stamires an overall substantially improved performance over the BCC Technology and its Catalyst. Oil yields were higher, there was less coke, and a reasonably low oxygen content in the oil. The Stealth Team began to make arrangements to purchase a Spray Drier and a Calciner to be able to make calcined clay microspheres.

Meanwhile, a March 13th 2009 report from Peter Loezos entitled Mass Balance Data “validated again that BCC technology was not working for KiOR,” an observer reported. Dennis Stamires added, “It was mainly due to the very low bio-oil yields.”

Stamires also pointed The Digest to an independent validation of the performance of the HTC catalyst (i.e. the Hydrotalcite, HTC), published in 2013 in the Defect and Diffusion Forum by F. L. Mendes, A.R. Pinho, and M.A.G Figueiredo. That report concluded:

“The use of either the FCC catalyst or hydrotalcite are not suitable for intermediate pyrolysis reactors, generating a product with high water content and low content of organic compounds in bio-oil and produce more coke. None of the materials tested produced bio-oils with considerable hydrocarbons yields and presented high amounts of phenolic compounds. In general, silica had the best results in terms of yield and quality of bio-oil.”

Both Mendes and Pinho were working for Petrobras in Brazil, and during this period it has been asserted to The Digest that KiOR was involved in negotiations with Petrobras, regarding forming a joint venture, or licensing KiOR’s BCC Technology. Suggesting though not proving that the journal results reported were related to KiOR story.

The Tipping Point

By April 2009, Cannon had returned to his desk at KiOR, but according to an observer, for some time after Cannon returned, “In reality, it was Ditsch and [Kaul] who were managing KiOR, and Cannon seemed to be a bystander, and sometimes their spokesman.”

One notable change in the company’s management style? “Most of the important and crucial issues were only discussed in the new mini-Management Team of Ditsch and Cannon, in communication with Samir,” one team member recalled. “Not in the weekly general management team meetings as was done before.”

The problems facing KiOR at the time were substantial, but not unheard of for a young company in the advanced bioeconomy. They were summed up internally at this time as:

*Finding new investors to provide further funding as KiOR was soon running out of monies.

*Having not yet developed and demonstrated a feasible, sustainable and profitable technology, it was difficult to convince new investors to provide funds for KiOR’ operation.

*Soon running out of monies, will be difficult to keep the R&D function going on, which was needed to develop new sustainable technology.”

*The large processing capacity Demonstration Pilot Plant Unit (DEMO Unit ) was being designed and will require several millions of dollars to be constructed and installed at the Houston KiOR site.

*Negotiations were going on with Chevron / Weyerhaeuser/Catchlight Energy, involving the formation of a joint venture, in which KiOR will provide the technology to convert waste wood to liquid fuels. However at that time, KiOR did not have technology that was sustainable and commercially feasible and profitable.

*KiOR was in a great need to have a feasible demonstrated technology which can be commercialized and be economically sustainable and profitable, for use in the discussions and application to the DOE for getting a loan guarantee of a $1 billion, for use in building commercial Plants.

*KiOR was in need to have, at pilot plant / DEMO Unit scale, its Technology demonstrated and validated that was feasible, economically sustainable and profitable, while discussing with the Mississippi Development Authority a $75 million loan.

*Morale of KiOR’s employees was very poor with a fragmented Management leading in different directions, while key technical personnel, either had left or were looking for new jobs outside KiOR.”

*KiOR’s competitors Ensyn and Dynamotive were fast developing and improving their technologies, and preparing for commercialization.”

65 gallons per ton, but not really

It was this latter point — the progress of Dynamotive, that perhaps formed a tipping point in the story of KiOR.

For, coincidentally or otherwise, we see the first appearance of 60+ gallons per ton yields, a level of yield that would eventually feature prominently in KiOR’s 2011 IPO, in an analysis written by Andre Ditch — not of KiOR’s results, but of Dynamotive’s.

Ditsch was juggling — at haste — data from Dynamotive and results from a UOP/PNNL project as reported in the September 2008 issue of Hydrocarbon Processing, written by a team led by Jennifer Holmgren (nowadays, CEO of LanzaTech), then GM of UOP’s Renewables unit, entitled “Consider Upgrading Pyrolysis Oils into Renewable Fuels”. He notes that he is “running out of daylight for report, but a few comments”.

Later, he comments “IF (big if) we assume the UBA oil and our Kaolin oil are similar (without more data, a stretch)…”. Later still, he added that “all this is written in great haste, so feel free to add and pressure test numbers.” All indicative of a memo written in back-of-envelope calculations.

Overall, Ditsch projected a break-even for KiOR at a yield of 65 gallons per ton of biomass, or a 22.5% yield of bio-oil from the biomass.

From this point forward until the end of 2013, it will be impossible to find a commercial projection or communication based on less than 60 gallon per ton yields, or a scientific set of data from any KiOR pilot, demonstration or commercial unit that has a yield of 50 gallons per ton or higher (even at an oxygen content of 17% that would be very difficult to upgrade).

Exotic yields get mentioned like "business as
usual" scenario baselines in this KiOR slide

Exotic yields get mentioned like “business as usual” scenario baselines in this KiOR slide presentation.

“We need 2X”

By June 2009, the Stealth Team, working with zeolite catalysts in the Pilot Plant, were showing enhanced yields and bio-oil quality. At the same time, literature searches turned up projects from the 1980s and 1990s demonstrating that the same type of Zeolite (ZSM) had been used before in Catalytic Pyrolysis.

But with the improvement, KiOR yields approached a maximum of 40 gallons per ton with reasonable quality. “Higher yields would have been simply contained more oxygen, that would have needed to be removed to convert the bio-oil to transportation fuel,” Stamires told The Digest.

A progress update was held on June 3rd with Khosla, Samir, Cannon, Ditsch, O’Connor and others, Bartek reported the figures.

Khosla’s response was to request of the R&D team that they double the yields over the next 6-8 months. The improvements were not from outer space. They were the kind of yields that would have made the overall process economically sustainable and profitable, without government subsidy, in commercial-scale plants. A participant in the meeting reported to The Digest that certain milestones for monthly incremental increases were established to reach the target.

Possible? Yes. With the existing BCC technology. In the view of one wing of KiOR’s staff, no. Given management’s reluctance to change the R&D plan, add a reactor to the process, hire scientists who could accomplish these goals, numerous members of the scientific team were pessimistic both in terms of the target and the timeline.

Concerns were high, as commercial discussions with Chevron and Weyerhaeuser (as the JV Catchlight Energy) were well underway. As one team member put it, “if Chevron finds out, they will run away from KiOR and essentially seal KiOR’s fate from any future partnerships with Big Oil, and Khosla would pull his funding.”

The race for 2X gets underway

The search for catalysts was underway at a rapid pace.

Cannon approved the request of Brady, Bartek and Stamires to start making KiOR’s own calcined clay microspheres using the spray dryer. The main objective of this work was to develop clay-based microspheres which exhibited acted both as efficient heat carriers, and catalysts with controlled selective activity.

Having then optimized the Physical properties of the calcined microspheres with respect to Bio-oil yield and quality, Brady, Bartek and Stamires proceeded to optimize the chemical/catalytic properties of the calcined microspheres. Then Brady proceeded to prepare clay microspheres with different amounts of catalytically active metal salts — magnesium, calcium, potassium, sodium, and aluminum among others.

In addition, Professor Iaocovos Vasalos re-appeared as a consultant by September 2009. Subsequently, Prof. Vasalos confirmed to Cannon that in order to achieve reproducible Bio oil Yields close to Khosla’s 2X target, with a reasonable quality, certain “radical changes must be made in the design of the pilot plant and to the process.”

The urgency was not only the usual pace of s start-up hungry for milestones that would encourage investments, there was Catchlight Energy relationship looming. In an email from Dan Strope, VP Technology, sent Aug. 11 2009 to the staff, it was revealed that Andre Ditsch was officially heading the negotiations with Chevron, and Ditsch was asking for technology data to prepare an economic forecast for a commercial size plant.

Yields improve, but trouble looms

In an email to Fred Cannon and Andre Ditsch on September 23rd, Bartek reported pilot plant data confirming that the ZSM catalysts produced much higher hydrocarbon yields, as the BCC Catalyst (HTC ) was converting them to gas and coke. The oxygen was in the range of 10 to 15%, but the yields were still stuck in the low 40s. With these results, the decision was taken in late 2009 to suspend work on the BCC technology at the three European Labs as well at KiOR’ Lab in Houston.

Paul O’Connor, still on the KiOR board at this time, blasted the decision to use ZSM-5 catalyst.

“It was the worst decision ever made, ZSM-5. We all knew that to make this process economic we needed a cheap catalyst. ZSM-5 is one of the most expensive around. Plus, you are dealing with a biomass with calcium and many other things in it, and with ZSM 5 you kill the catalyst. It’s so strange they went in that direction.”

But yields at least were up. A 20-30% jump in yields, but catalyst performance, the science team concluded, would not improve anywhere as fast as the 2X target required. In a memo dated Sept. 6, 2009, Stamires proposed a radically different Biomass Conversion system, comprising two Reactors in series or in parallel, with a new catalyst.

The approach? The Biomass in the first Reactor would be thermally Liquefied in a fluidized bed using a high-efficiency heat transferring medium which has a high heat capacity (such as sand ). The Bio oil vapors generated in the first Reactor would then be reacted with a medium activity catalyst in the Second Rector. The invention was subsequently patented by KiOR .

Meanwhile, Ditsch was pressing hard. In emails of Sept. 16 and 17, 2009, he was asking for information to be used in his presentation and “KiOR Update” to Khosla on the 17th .

From that update, Khosla agreed to relax the timeline for process improvement, but not sacrifice the yield target, which would have been in the 80s and into the 90 gallons per ton range. The 2X milestone target was set for Q4 2010. But the scientific team — at least one wing — didn’t believe that anything like those yields could be achieved with anything like the technology that KiOR was readying for commercial-scale.

Stuck in the 40s Doldrums

New catalyst materials were tested in KiOR’s Pilot KCR plant in October and November 2009 Bartek and reported by Patrick Steed in a January 7, 2010 email confirmed the improvement in catalytic activity, while retaining their good heat-transferring properties.

But, the good results came with a ceiling. In their own way, they confirmed to members of the science team, as sources told The Digest, that KiOR was likely to become stuck in a range which would never get much out of the 40s, expressed in gallons per ton.

2010 dawns, with a design input issue

In January 2010, though, focus was on a potential 20% bio-oil yield improvement possible by employing CPERI’s reactor design, compared to the yields obtained by the present design of the KCR Pilot plant (a FCC type).

The Pilot Plant was remodeled with the CPERI design, but to the surprise of the team, the Demonstration Unit design was not changed. According to those familiar with the timelines, the Demo Reactor was already fabricated and was soon to be delivered to KiOR for installation, based on the old, obsolete original KiOR Pilot Plant Reactor design.

Eventually, the large Reactor of the Demo Unit, with a 10 ton per day capacity, would have to be dismantled and be replaced by the new Frustum Reactor licensed from CPERI. Resolution of the problem would lead to sensational additional costs and delays in the operation of the Demo Unit.

How could this have happened? As it turns out, Robert Bartek, described by one team member as “the expert who had supervised the Pilot plant testing work at the KBR Pilot Plant after De Deken had left, who had managed the design and operation of KiOR’ KCR Pilot Plant and who had worked closely with Prof. Vasalos and Dr. Lappas in transferring their Reactor design to KiOR,” was left almost completely out of the loop.

According to KiOR team members of the time, Bartek “was intentionally kept in the dark and out of the design work of the Demo Unit until almost to the end of the project.”

Why? Perhaps because Bartek was openly and clearly criticizing the BCC Technology and its Catalyst for being “a failure and useless to KiOR”.

“Suggestions and disagreements were considered to be politically incorrect, and rather blasphemies against the party-line prevailing in 2009, supporting and promoting exclusively the BCC Technology and its Catalyst,” remarked Dennis Stamires, when asked about the crisis. More than one KiOR team member contended that the decision to exclude Bartek from the Demo design process, among other consequences, convinced Bartek to resign.

About NASA syndrome

There are some classic management set-ups that lead to failure, one of which is NASA syndrome. The type of management failures that were prominently on display in the Challenger and Columbia disasters. As the Columbia Accident investigation Board reported:

The organizational causes of this accident are rooted in the space shuttle programs history and culture, including the original compromises that were required to gain approval for the shuttle, subsequent years of resource constraints, fluctuating priorities, schedule pressures, mischaracterization of the shuttle as operational rather than developmental, and lack of an agreed national vision for human space flight. Cultural traits and organizational practices detrimental to safety were allowed to develop, including: reliance on past success as a substitute for sound engineering practices (such as testing to understand why systems were not performing in accordance with requirements); organizational barriers that prevented effective communication of critical safety information and stifled professional differences of opinion; lack of integrated management across program elements; and the evolution of an informal chain of command and decision-making processes that operated outside the organizations rules.

Finally, the Board noted:

The pressure of maintaining the flight schedule created a management atmosphere that increasingly accepted less-than-specification performance of various components and systems, on the grounds that such deviations had not interfered with the success of previous flights.

The NASA cautionary tale is instructive; there are correlations between KiOR and Columbia.

Specifically, reluctance to test to understand why systems were not performing in accordance with requirements, organizational barriers that prevented effective communication of critical information and stifled professional differences of opinion; lack of integrated management across program elements; and the evolution of an informal chain of command and decision-making processes that operated outside the organization’s rules.

KiOR was on a fast-paced commercialization track, as it
highlighted in this company slide presentation.

KiOR was on a fast-paced commercialization track, as it highlighted in this company slide presentation.

Never commercially viable?

The technology’s progress was under close scrutiny by February 2010, when it was decided to form a Diligence Team consisting of Prof. Vasalos and Dr. Stephen McGovern, a hydroprocessing expert. The review included data and related information derived from KiOR’s R&D work, as well from literature including patents, and data from the CPERI Pilot plant.

By this time, concerns about the data stream from the pilot also became an issue within the company. Stamires himself recalls six such meetings with CEO Fred Cannon, on February 10, March 13, March 26, April 28, May 7, and May 12. What was Stamires bothered about? Specifically, “manipulation and inflation of the pilot plant Bio oil yield data.”

The results of this comprehensive and in-depth Technology Assessment Review Study by Vasalos and McGovern were published in April 2010. Flat out, the report contained the most dismal news possible. The assessment concluded that the maximum yield, based on the pilot plant, was in the low 40s with 15% oxygen content, using ZSM catalysts.

Recommendations were made for improvement. According to one familiar with the report, by and large, these recommendations “were ignored by the Management Team, and not implemented.”

The Impending Public Statement on the Technology

Meanwhile, there was pressure on the company to make disclosures regarding the company’s progress towards scale, and the yields it was achieving, Specifically, there was pressure on regarding a statement describing KiOR’s technology that could be placed at the KiOR Website and also to be given to the public and potential investors.

Dennis Stamires confirmed that there was a controversy. He himself sent an April 5th memo to CEO Fred Cannon and VP Technology Dan Strope, calling for only “Credible” information only to be released. "The message in the event of being Legally challenged, it should be defendable.” He did not receive a response, he said.

On April 10th, a draft Technology Statement to be posted on the KiOR Website, prepared by Matt Hargarten of Dig Communications, was circulated by Andre Ditsch. It would not reach some members of the scientific team until as late as May 11th.

An uproar ensued regarding the draft statement. Bottom line, there were heavy complaints about false claims, misleading information and fake terms like “KiOR’s Proprietary Magic Catalyst“. CFO Kevin Denicola indicated to team members that he too had serious concerns about the truthfulness of the proposed Technology Statement.

Inflated Numbers: The July 2010 Report

In May 2010, John Hacskaylo joined KiOR as VP R&D. With Cannon and Ditsch, they formed what was described to The Digest as “The Troika, [which] manages all the important issues and business items of KIOR”.

The issues? These would grow to include:

The negotiations with the Mississippi Authority regarding a loan of $75 million; negotiations with Chevron / Catchlight regarding the formation of a joint venture; the Technology Review/ Assessment by R.W. Beck; the Application to DOE for a $1 billion Loan guarantee; the preparation of the KiOR S-1 Prospectus for a NASDAQ IPO; negotiations with potential investors, and updates on KiOR’ s technological progress.

One team member wrote of this time:

The formation of “The Troika” caused a deep division and disputes among KiOR’s managers, which later on dripped down to lower levels of operations, and prevented normal working business communications among employees. Hacskaylo created and highly promoted this culture. R&D personnel were told to whom they can talk and to whom should not talk about their work. Co-operation, trust and willingness to communicate fast disappeared, and a spirit of fear of being punished and fired prevailed in the organization.”

In a July 2010 Report, entitled “Yield Improvement Efforts”, according to those familiar with the report, Hacskaylo replotted the previous Pilot plant data to show a steady substantial oil yield increase in the period of 2009 – 2010, claiming that the Pilot was 50% ahead of the Vasalos report’s findings, in gallons per dried ton of Biomass feed and projecting an 80% increase in yield from the upcoming Demo Plant, or 72 gallons per ton.

The yields, according to key members of the science team, were simply not true, and incredibly inflated. The results were inflated from the latest pilot data. Further, the Demo plant as designed at this time did not incorporate improvements that KiOR had deployed at the pilot.

As one observer noted, “Hacskaylo’s new, much greater inflated oil yields, generously met and even exceeded the milestones which earlier Ditsch, Kaul, and Khosla had set forth to be accomplished quarterly for the year 2010, by the R&D group. Hacskaylo managed to accomplish (on paper only) the [required] milestones of increased Bio-oil yields”, without the bother of actually improving the process, so went the theory.

It is not known whether financial motives, data confusion, or honest mistakes went into the July report or into the criticism thereof. It can be noted that executives of KiOR were rewarded with stock options for meeting milestones and accomplishing goals, but there’s no direct evidence that data was changed for monetary gain. It is clear however that the new data was not supported by those familiar with the raw data coming from the pilot plant. The Digest has obtained and carefully reviewed original data from the pilot from this period and the July 2010 report, and can confirm that the raw data and the July 2010 report do not agree.

Another report was made to Khosla in November 2010, and again team members say that the data was “corrected” and the yields “improved” from actual KiOR data. We are all left to guess exactly why.

At this stage, Denicola is reported to have attempted “professionally…to correct this problem and give the public and investors a truthful and representative account of the actual status of KiOR’s technology at that time,” according to one team member familiar with his efforts, but he was unsuccessful. Denicola subsequently resigned.

Bleak refinery upgrading report and a “see ya later” from Catchlight

In May 2010, samples that had been provided from the KiOR Pilot were the subject of a report from Catchlight Energy, the Chevron /Weyerhaeuser Joint Venture. Catchlight reported on two samples, one containing 11% oxygen content and one containing 17%. Their conclusion: they couldn’t effectively process either sample. O’Connor told The Digest that Exxon also reported trouble.

They did indicate that they believed that, with time, a process could be found that would tolerate the 11% oxygen content sample, though it would require alternative equipment that Catchlight was not in a position to finance. They further indicated that the 17% oxygen content bio-oil could not be processed by any existing refinery plant hydroprocessing equipment, and that new technology would have to be developed from the ground up, for that.

Either way, the idea of delivering a bio-oil to Catchlight was out. Catchlight indicated that, going forward, they would only be interested in handling a finished fuel blendstock that had been hydroprocessed by KiOR. Whether that meant using standard or modified equipment, or developing a new technology, would be up to KiOR and at KiOR’s expense.

KiOR does not disclose Catchlight Energy's deep
reservations in this slide deck overview given in 2013.

KiOR does not disclose Catchlight Energy’s deep reservations in this slide deck overview given in 2013.

Selling it to Mississippi

“By mid-June 2010,” as the state of Mississippi recounts in its lawsuit, “Khosla Ventures had retained Dennis Cuneo to assist KiOR in obtaining a favorable state economic development package. Cuneo is a former Toyota executive who enjoyed valuable relationships with Governors of southern states. Cuneo quickly arranged meetings for KiOR and Khosla with the governors of Arkansas, Louisiana and Mississippi. The first executive level meeting between the State of Mississippi and KiOR occurred on July 1, 2010 at the office of Governor Haley Barbour. Three entities were present at the meeting: KiOR, Khosla Ventures and the State. KiOR was represented by Fred Cannon, Mike McCollum (KiOR’s Vice President of Supply) and Andre Ditsch. Khosla Ventures was represented by Vinod Khosla, Samir Kaul and David Mann. Also present for Khosla Ventures was Dennis Cuneo. The State was represented by Governor Barbour and two MDA officials, Adam Murray (MDA Project Manager) and Justyn Dixon.”

Among the documents providing support for the meeting’s agenda was “An Overview of KiOR in Mississippi” white paper, provided to the Mississippi Development Authority, which made the following claims:

1. “Existing refining infrastructure can easily upgrade the oil into transportation fuels, making KiOR’s oil a direct substitute for imported crude oil without changing the refining to automobiles supply chain and infrastructure.”

2. “Our product is a high quality crude oil that can be converted into on-spec gasoline, diesel and jet fuel with standard equipment in operation in every US refinery.”

3. “Our process is already competitive with oil at $50/barrel with existing subsidies, and will be competitive with $50/barrel oil without tax credits in 2-3 years with catalyst tuning and process development, allowing economical access to nearly all available feedstock.”

The state of Mississippi alleges that the financial information provided to the state “did not account for the construction and operation of a hydrotreater and hydrogen plant at the Columbus facility.”

At the time, KiOR may have well held out hopes that a hydrogen plant could be built in partnership with a vendor, who would pay for construction and operation and charge a hydrogen delivery fee to the project. However, given the July 2010 date of the initial Mississippi meeting, there is no doubt on the Catchlight score. At best, KiOR may have believed that other refiners would be able to process its bio-oil.

Did KIOR include water in its bio-oil yield claims?

KiOR’s assertion that the technology “is already competitive with oil at $50/barrel with existing subsidies” seems remarkably similar to the speculative analysis completed by Andre Ditsch at the time of the UOP/PNNL paper, based on 65 gallon per ton yields. There is no documentation that The Digest has been able to uncover, nor any scientist we have interviewed familiar with the actual data out of the pilot plant, that supports KIOR yields at breakeven points.

A KiOR staffer relates a tale about André Ditsch. “Suppose you had a restaurant that seated 200 people,” Ditsch is reported to have told a KIOR team member, when questioned about the reporting of the KiOR numbers. “And, you only seated 10 today, but you were going to seat all 200 in the future. If you say that you are at 100% occupancy, that’s not misleading, because you are going to be at 100% eventually.”

The truth may well be that the KiOR yield claims were based around liquids, rather than bio-oil, coming out of the process.

The state of Mississippi alleges just that. Specifically, that:

“Ditsch’s failure to accurately adjust for losses to water and other waste products also rendered the representations to Mississippi officials false. When the BCC reactor was operated at high oxygen levels (greater than 10%), a substantial percentage – more than 30% – of the biocrude produced by the BCC reactor was lost to water.

“Ditsch’s failure to make an appropriate reduction for losses to water served to substantially inflate his yield estimate; and, as a consequence, the Company’s financial projections misleadingly made the Company appear commercially viable. Neither KiOR nor Khosla nor Cuneo notified Mississippi officials that the Company’s financial projections were grossly inflated to overstated yields.”

Paul O’Connor, as a member of the KiOR board, has a similar theory.

“Hacskaylo, what a disaster area. The 67 gallon figure, that is where I became suspicious. The board hardly saw technical information, as you can imagine people like Condoleezza Rice were not going to be very familiar with technical detail. They were showing us graphs with yields of 68-72 gallons per ton out of the pilot, and they aid that the demo plant was even better. Now my initial reaction was — you’ve got 100 people working in R&D, you’ve got all the best equipment in the world, you’ve figured it out, that’s great.

“But one day I noticed the R&D director, John Hacskaylo fiddling around with the axis, and in his comments to us, he was talking about top of the reactor yield.

“Top of the reactor? That’s the yield coming out of the pyrolysis unit, but that is not the yield coming out of the plant. You have to condense, and you have to recover oil from water, and you lose in the hydrotreater, because for one thing you have to take out oxygen. It’s not a real yield coming out of the plant.

Top of the reactor yields, in the context of transportation fuels, is like counting scotch and water as pure scotch whiskey. Or including the weight of the orange peel in a projection of orange juice yields.

“If you’re saying 68 at the top of the reactor, at best you are making 55 in the plant. At best. So that’s when I insisted on a technology audit,” O’Connor told The Digest. “It was definitely not at 68-72. There were some points where you could get above 60 but only momentarily, under ideal conditions, for instance with very fresh catalyst. And only in the pilot.” O’Connor confirmed that the demo plant was generating yields in the 30s or low 40s at most.

“Who did the analysis? Were they just stupid or crooks?” O’Connor asked. “It’s not for me to say.”

A company on the brink

The company was speeding towards a 2011 IPO. But the fuel yields were low; the fuel was not usable by their initial chosen downstream partner; the catalyst they were using to get even down to this unsatisfactory product, ZSM zeolite, was in the $7,000 per ton range. Catalyst stability would be challenged, everyone knew, with the water that is contained in wood chips. Steam can be highly problematic for zeolite.

More than that, the company was facing a potential problem with the metal content in the biomass feed that accelerated the deactivation rate of the catalyst, which resulted in excessive amount of daily catalyst replacement, according to one KiOR scientist.

There were reactor design issues. The pilot reactor that was working wasn’t used for the demo unit.

There was a rush to commercial-scale of the NASA type. Management issues, communications issues can be seen. Disclosure issues, “truth in data” issues. And, a series of statements to the state of Mississippi that would be impossible to live up to without major improvement in yield. Capital needs were going to be tremendous, and beyond an IPO there was a loan guarantee process and the state of Mississippi loan application to be successfully navigated.

Why the rush to scale? All venture-backed companies rush. But was there a special rush on with Khosla-backed companies, and did that rush apply successfully to industrial technology? The State of Mississippi quoted this passage from the Harvard Business School case study, Khosla Ventures: Biofuels Gain Liquidity:

“Khosla played an active role in helping his portfolio companies determine appropriate milestones in the process of moving from a pilot to a commercial operation. He encouraged his companies to focus on 15-month or 15-day or 15-hour innovation cycles, unlike the 15-year cycles of innovation in the nuclear business, in order to “test, modify, allow lots of mistakes and still succeed.”

The goal was to test ideas in 10% of the time that it would take a large company. Once that was achieved he often challenged the team to reach another 10x reduction in cycle time. month or 15-day or 15-hour innovation cycles, unlike the 15-year cycles of innovation in the nuclear business, in order to “test, modify, allow lots of mistakes and still succeed.”

Everyone was counting on everything to improve in the demo unit, and in 2011. As sometimes happens. And, with design corrections, fingers crossed this could be translated to a commercial-scale unit. It’s been known to happen, yields improving as scale increases and design improves. Not always, not often, but sometimes. Could KiOR pull it off?

Maybe, just maybe.

KiOR was hanging by a thread as the summer of 2010 commenced. In a few days, the first recorded visitors to Pasadena demo unit, representatives of the Mississippi Development Authority, were expecting to see the demonstration unit in action.

We’ll see how all those concerns worked out in the next part of our series, as KiOR launched its demonstration unit, geared up for more financing and an IPO, and hurtled towards commercial-scale.

Further reading.

The O’Connor resignation letter
The March 15 2012 O’Connor email memo
The March 22 2012 O’Connor technology assessment
The April 21 2012 O’Connor technology assessment
The April 30 2012 O’Connor memo
The Spring 2013 O’Connor note

Jim Lane is editor and publisher  of Biofuels Digest where this article was originally published. Biofuels Digest is the most widely read  Biofuels daily read by 14,000+ organizations. Subscribe here.

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