Wood Bioenergy: Project Count Up, but Viable Volumes Decline in June

The June issue of Wood Bioenergy US indicates that, as of June 28, 2011:

• The continental US has 457 wood-consuming, announced and operating bioenergy projects (up from 453 in May).
• In total, these projects represent potential, incremental wood use of 130.5 million green tons/year by 2021.
• Based on Forisk analysis, projects representing only 68.7 million tons/year pass basic viability screening.

These results represent a net decline from the estimated, viable wood consumption of 71.1 million tons/year reported in the May issue.  Eight fewer projects passed Forisk’s screening methodology in June than in May.  The biggest factor: we modified the status screen to exclude projects that are on hold or shut down, even if the project uses a proven technology and has made significant progress towards operability. “On hold” indicates that a project is at a standstill for an unspecified amount of time.  Click here to download the complete free summary.

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Again, the project-by-project results confirmed analysis of the US biofuels market published last month by Forisk Consulting and the Schiamberg Group.  KiOR’s lackluster IPO  and falling oil prices harden doubts about the short-term commercial prospects of investments in the wood-based liquid transportation fuel sector in the continental United States. To learn more about the study, click here.

Wood Demand and Baseball Bats

Major League Baseball turned to the US Forest Service to evaluate the “epidemic” of wood baseball bats breaking during baseball games.  The Associated Press recently reported how research engineer Dave Kretschmann at the Forest Products Laboratory in Madison, Wisconsin has been addressing the challenge.  This story generated Talmudic debate and cracking of knuckles at Forisk, where we love all things associated with the demand for wood (and at least three of us and two spouses love baseball).

Here’s what Seth Freeman, the leader of our Wood Demand research and our resident sabermetrician, had to say:

I totally agree with the following that ash is more durable than maple on a wide scale.  But you must consider the reasons why  maple bats became popular.  A “supposed” shortage of quality ash led bat manufacturers to consider other options.  But no ballplayer would swap bats unless they thought the new product was better.  The use of maple bats took off with the first player who really adopted the use of maple bats:    Barry Bonds.  Bonds wouldn’t have used maple if he didn’t think it was the best.  And though his bats resemble “the bats” cited as problems in this article, Bonds didn’t break many bats.  Bonds used maple bats to hit 73 home runs and bat .370.  As to how much of a role the bats played, it hard to say, because the role of performance enhancing drugs may have played a role as well.  (However, I must note that Albert Pujols and Ryan Howard are #1 and #2 in the majors for home runs since 2005, and both use maple bats.)  But if one player is excelling with a new kind of bat, others will try it.

What really causes the bat to break?  Or why are more bats breaking?  This was the real question targeted by the researchers.  Obviously changing the ways bats are designed and shaped contribute, as bats have been manufactured to resemble the aluminum bats players use in high school and college.  I agree that the slope in the grain of the wood would ultimately change the strength of the bat.  But I think it’s a combination of factors that have overall weakened the perception the bats.  These factors also include:

1.  Stronger hitters with increased bat speeds;
2. Stronger pitchers throwing at higher velocities (average pitch speed increased dramatically the last 15 years);
3. Increased use of the “power swing” vs. “contact swing”, which leads to less precise contact with the ball.  (The top 9 single season totals for strikeouts by hitters have occurred since 2004)
4. Also consider strikeouts per 9, and take into diluted talent from league expansion and extra innings games and what-not.  A line chart will easily show the trend through the years.
5. The increased use of harder breaking pitches, most notably cutters and hard sliders, also leads to less precise contact with the ball.  In the past, most breaking pitches were change-ups, overhand curves, sinkers, and split fingered fastballs.  The natural movement of these pitches is for the ball to dive or drop.  Since the movement is vertical, the ball will still strike the ball on the barrel of the bat.  However with cutters and sliders, the movement of the pitch is horizontal, and leads to the ball striking the bat off center.  Also cutters and sliders have more velocity than other breaking pitches.

I think the last two factors are especially telling.  Bats don’t break when the ball is hit on the sweet spot.  Bats break when the pitch is hit off center.  Now, more than ever, hitters are hitting pitches off center (see the MIT Baseball team :)).  As pitchers continue to throw more hard breaking pitches like cutters and sliders, more balls will be hit off-center.  And the more balls are hit off center, the more broken bats.  While difficult to address, accounting for these issues could strengthen the research.

To judge the broken bats, you have to account for the hitting skill of the player swinging it, the speed of the pitch, and where the ball connects with the bats.  While reducing the use of maple bats and putting restrictions on bat shape are wise choices to prevent more frequent “shattering” or “exploding” of bats, other factors will cause increased numbers of bats to break even if the bats are made to the same specifications as bats were made in years gone by.

Frankly, I think the declining use of maple bats in the majors contributes to the lower offensive stats.  Though analysts will cite increased drug testing….

KiOR’s IPO Fizzles; Forisk Analysis “Nailed It!”

Last month, our team published a project-by-project study of the US biofuels sector called “Transportation Fuels from Wood: Investment and Market Implications of Current Projects and Technologies.”  One of the 36 projects evaluated in the study is KiOR, which went public on Friday (June 24, 2011) at $15 per share, nearly 30% below the top of the expected range.  The IPO proved uneventful, with shares closing where they started at $15.

An investor and buyer of our research contacted me over the weekend.  “You guys nailed it!” he said.

So far, that appears to be the case.  Our technology assessment of KiOR indicates a high level of technology risk and that commercialization could be at least eight years into the future. In addition, the firm produces end products that require additional refining; these are not drop-in fuels.

KiOR, which lost $45.9 million in 2010, remains unprofitable and has yet to produce at commercial scale.  While KiOR has the potential to be a successful biofuels company, the IPO simply gets KiOR closer to the capital it must have to give the commercial scale facilities any chance of completion, regardless of whether or not the technology functions and yields materialize as planned.

In addition, the bedrock support for biofuel tax credits has cracked.  On June 16th, the U.S. Senate voted 73 to 27 to repeal the 45 cent per gallon tax credit on biofuel and the 54 cent per gallon tariff on imported ethanol.  While the House is expected to reject the measure, it received broad bipartisan support.  This signals another red flag for investments in wood biofuel projects dependent on government-based subsidies.

For more information about this study, please click here.

How Do Timberland Investment Managers (TIMOs) Make Money?

“How do timberland investment managers make money?”  The question itself, asked by an analyst working for an institutional investor, was straightforward enough.  However, it was the third time in the past week our team had received a call with such a question.  Since “reading tea leaves” in our research business often involves better understanding the questions and concerns on the minds of those in the marketplace, I’m taking this as an opportunity to review the general business model of timberland investment management organizations (TIMOs).

TIMOs are asset managers.  They generate income through transaction fees, management fees (which grow with their assets under management) and performance fees.   That said, fees and fee structures vary widely across TIMOs.  In part, variance in investment strategies and fee structures help match the investment objectives and risk tolerances of different investors with appropriate timberland investment managers. 

Specific fees earned by TIMOs may include:

• Placement fees based on the purchase price of the timberland investment properties: 
• Management fees as a percentage of asset value (after purchases and dispositions); 
• Management fees as a percentage of appraised market values of the timberland assets over time; and 
• Performance fees (overage) that provide profit-sharing above a pre-specified hurdle rate.  Hurdle rates may be stated in real (without inflation) or nominal (with inflation) terms.  

An example of an overage arrangement would be where the TIMO receives a carried interest in the fund if returns exceed a stated hurdle rate.  For example, with a hurdle rate of 6%, the fund might receive 20-25% of the returns above this hurdle, called the overage.  This overage would remain in the fund and grow with the investment, giving the fund managers an “interest” in the fund that can compound over time.

Total annual fees paid to TIMOs are expected to approach, but not exceed, one percent of the assets under management in the timberland portfolio.  In the past, some TIMOs reported publicly their estimated fees.  For example, for the fiscal year ending 2002, The Campbell Group indicated average management fees at the property level of 96 basis points (0.96%). Hancock Timber Resource Group used 95 basis points (0.95%) to approximate management fees in publicly available timberland investment analyses.  Over time, annual fees have consistently ranged between 85 basis points (0.85%) and 100 basis points (1.00%), with other structures based on services provided or weighting more or less to performance.

TIMOs can generate the bulk of their income at liquidation, upon the sale of the timberlands, so the appraised values/appreciation estimates carry great importance to all stakeholders.  As such, the appraisal process and asset valuations remain ongoing concerns with timberland investors because of the potential for conflicts of interest.  Fee structures that pay-off towards the end of the investment period moderate these concerns as TIMO managers collect performance fees following the actual liquidation of the fund.  At that point, the market dictates the total returns associated with the properties.

A useful exercise in our equity research has been comparing the relative per-acre administrative loads of TIMOs and publicly-traded timberland-owning REITs.  At the end of the day, the earnings potential of timberland assets varies more by location than by ownership structure, assuming structures of comparable tax efficiency.

Wood Biofuels: KiOR Doubles Size of IPO; Investors Should Not Expect Speedy Payback (if any)

Last week, Pasadena, Texas-based KiOR filed with US regulators to increase the size of its initial public offering to $200 million, doubling its initial filing of $100 million in April (KiOR doubles size of IPO, Reuters, June 1, 2011).  KiOR plans to produce crude oil using non-food biomass types such as wood chips and switch grass.  In addition, KiOR was included in a study published last month – Transportation Fuels from Wood: Investment and Market Implications of Current Projects and Technologies – that includes the status of 36 cellulosic biofuel projects in the US, commercialization timelines for 12 technology approaches, and implications for bioenergy and timberland investors.   The list shows all projects covered in the study.

For each technology, the study ranks the level of technical risk, provides a commercialization timeline, and estimates the expected yields at commercial scale. The results indicate that major technical hurdles need to be solved and will delay or disrupt commercialization for most of the technologies under development.

What were the implications for firms such as KiOR?  KiOR currently operates a pilot plant in Pasadena. The firm is developing commercial scale biorefineries to make gasoline and diesel blendstocks from wood.  Its initial-scale plant in Columbus, Mississippi is under construction. KiOR has secured three off-take agreements for fuel produced at its Columbus location with Hunt Refining Company, Catchlight Energy, and FedEx Ground Services. The company also plans commercial scale facilities in Mississippi (likely in Newton and Bude), Georgia, and Texas. KiOR received a $75 million interest-free loan from the state of Mississippi to build the Columbus plant. KiOR received a term sheet for a DOE loan guarantee for $1 billion announced in February 2011. As of May, the loan guarantee was in the due diligence process and requires that KiOR begin construction by September 30, 2011.

With both strong public and private sector backing, KiOR has the potential to be a successful biofuels company. However, our technology assessment indicates a high level of technology risk and that commercialization could be at least eight years into the future. In addition, the firm produces end products that require additional refining; these are not drop-in fuels.  Finally, the increased IPO simply gets KiOR closer to the capital it must have to give the commercial scale facilities any chance of completion, regardless of whether or not the technology functions and yields materialize as planned.

Relative to other firms in the study, KiOR has a shorter technology gap as the overall results find an 11 year gap on average between estimated technology viability and firm announcements.

For more information about this study, please click here.