Runte rew presentation 2 15 12 b

WORTHINGTON SAWTELLE LLC

WORTHINGTON SAWTELLE LLCNavigators of the New Energy Economy

Biofuels Retrospective:What Lessons Apply to Future Due Diligence?

REWNA 2012February 15, 2012


Consider the following…by mid 2006:n 87 Biodiesel plants were operating (33 new since beginning of the year) and

77 were under construction

n Backlog with plant process providers and E&C companies was over a yearn E85 selling at 40 cents/gal less than regular gasolinen B20 selling at par with diesel


The 2006 Boom: Here’s why

n “Like Printing Money”

Est Net Margin Biodiesel4Q05 – 2Q06

4Q05 1Q06 2Q06

40 c/gal

15 c/gal


Next Year, 2007:

n 1Q07 – Backlog of 36,000 rail cars for ethanoln By 4Q07 more ethanol being produced than distribution system could handle

Ethanol ROI Drops Precipitously


Also in 2007:

n Soybean prices increased to the point that biodiesel….

n Became uneconomic by early 2007 (with subsidy)

Soybean Oil, CBOT 11/0711/07

11/06

Biodiesel Net Margin

Breakeven

1/07

1/06


n 47 Biodiesel plants and 37 ethanol plants were idledn Subsidies expiredn Soy based biodiesel, except in states with additional subsides or for export

(“splash and dash” phenomenon) never returned to profitability since 2007n Plants were being sold for cents on the dollar

By the end of 2009:

Ethanol Margin

2009


So what happened?n Boom fueled by subsidiesn Unintended agricultural consequencesn Overly aggressive expectations regarding:

0Oil price0Commodity availability and price0Ability of market to absorb products (both biofuels and

byproducts)0Ability of industry to assure subsidies forever

n Lack of understanding of commodity markets and hedging/inadequate assessment of risk

n Incomplete understanding of the business modeln Greed


Basics first... the business modeln The margin equation:

(Cost of feedstock + cost of processing chemicals (methanol) + O&M + Fixed Costs)must be greater than or equal to:(B100 sales price + blender credit rebate + glycerin sales price)

In February 2012:($4.00/gal soybean oil+ $.31/gal O&M + $.50/gal debt) = $4.81/gal($3.14/gal B100 + 0 rebate + $0.05/gal glycerin) = $3.19/gal

n 83% of COGS and 100% of revenue subject to commodity volatility and government subsidy


The subsidies – federal only n Biodiesel

0 Biodiesel Excise Tax Creditg $ 1/gal per gallon blendedg Began in 2004: lapsed all of 2010, revived in 2011, ended 12/31/11

0 Small Producer Tax Creditg $ 0.10/gal, ended 12/31/11

0 B100 Income Tax Deductiong $ 1/gal to dispenser of pure biodiesel to vehicles

n Ethanol0 Excise Tax credit

g .45/gal per blended gallon, ended 12/31/110 Small Ethanol Producer Tax Credit

g $0.10/gal, ended 12/31/11n Biofuels

0 Improved Energy Technology Loan Guarantee0 Advanced Biofuel Production Grants and Loan Guarantees0 Advanced Biofuel Production Payments.0 Ethanol Infrastructure Grants and Loan Guarantees0 Value Added Producer Grants0 Commodity Credit Corporation Production Incentives


US Biodiesel Production


Ethanol Subsidies Impactsn Construction and Capacity


Agricultural Consequencesn When farmers saw this in the fall of 2006, they adjusted their corn planting

plans for 2007:

Dollars per acre

450

350

250

150

50

0

02/03 03/04 04/05 05/06 06/07 07/08 08/09

Net Returns, Corn Crops

Market Year


n Since the tradeoff is usually between corn and soybeans, less soybeans were planted

n More acres to corn and increased export demand from China, did this to soybean prices:

Agricultural Consequences

WORTHINGTON SAWTELLE LLC14

Soybean Oil (cost) grew atnearly 60 %

1 cent per pound increaseadds 7.5 cents/gal cost

Heating Oil (revenue) grew atabout 25 %

1 cent per gallon increaseadds 1 cent/gal revenue

But Oil didn’t have the same rate of growth


And once the disconnect occurred, it stayed


Where are we today?

Sources: Energy Management Institute and The Energy Information Administration

n Approximate total investment in ethanol plants, $ 9 to $12 billion; biodiesel $2 to $4 billion (since 2005)

n Ethanol projected tobreakeven for foreseeablefuture

n With blender credit nolonger available,biodiesel industry long term healthquestionable

Ethanol Projected Margins

Return Over Operating Costs

Cost of Corn

Other Costs

Capital Costs


So how do we apply this experience to biomass project due diligence?n Risk based due diligence that:

0 Identifies the nature of and quantifies the scale of all risks involvedg Commodity risk – in biofuels, impact is on both expense and

revenueg Government policy risk – assume overnight loss of support!g Technology risk – might your economics be eclipsed?

n Know your competency limitations – do you have the depth to fully appreciate farming, commodity trading, wholesale fuels blending and distribution – and curb your appetite to what you know!

n Never rely on commodity cost projections out beyond a year or the available hedging horizon

n Make certain you really understand the details behind the metrics (e.g., gallons/acre)


So how do we apply this experience to biomass project due diligence? Pt. 2n If buying feedstock or selling product, hire a strong hedging

consultant and amass sufficient working capital to maximize hedging on the expense and sales sides

n Disconnect from commodity feedstock markets via 0New feedstocks: micro & macroalgae, jatropha, carinata,

cellulosic, switchgrass, etc.0Unlock value in wood residues; bagasse, MSW; waste gases0Add value to corn starch; cane syrup

n And finally, from Vinod Khosla: “Subsidies bring cash flow forward but seldom create your market or build your business. In order to succeed, your product must be price competitive without subsidies.”


Thanks!

Gerry Runte

[email protected]

(505) 603-2259