Sweetwater Energy, Ace Ethanol sign landmark cellulosic ethanol deal

$4/gallon capex, low opex, $15 million upfront. Existing offtakers. Cellulosic RINs. Expandable. Product diversification. Operating next year.

What’s not to like?

So, you’re an ethanol producer, and you’d like to improve returns, create more certainty for your investors this year, or access higher-price markets.

In so many ways, cellulosic ethanol sure looks like a good idea, or maybe biobutanol (where you can access a higher price for the fuel product).

But then capex reality sinks in. Even a 25 million gallon cellulosic add-on at POET’s Emmetsburg, IA plant is costing $250 million and the DuPont plant adjacent to Lincolnway Energy in Nevada, Iowa is costing $200 million. The biobutanol conversion costs are not as public, but you know you are expected to be the deep pockets there, too.

Hmmm.

OK, we have good news today. There’s a side door opening into cellulosic ethanol. Costs you very little up front, payback is quick, and the risk is going to be generally borne by the cellulosic feedstock supplier. Who also assumes the responsibility for building, owning and operating the facility supplying feedstock to you. All you do is ferment cellulosic sugars mixed in with the corn mash, in blends (eventually) of up to 50 percent.

That’s the shape of the deal that emerged overnight between Wisconsin’s Ace Ethanol and New York’s Sweetwater Energy.

Deal timeline and expansion opportunity

Sweetwater, for its part, will build, own and operate a cellulosic sugars facility dedicated to supplying cellulosic feedstock to Ace Ethanol. Ace will mix the sugars in with its corn mash, and produce ethanol. Pre-permitting work has already started up, and construction of a first cellulosic sugars facility is expected to be completed by mid-2014. Permitting is no walk in the park — there’s going to have to be a resubmission on the air permit. But its in a state with a lot of experience with ethanol.

“Ace Ethanol has been bench testing Sweetwater’s cellulosic material for some time and we’re confident that this project will be commercially profitable,” says Neal Kemmet, President of Ace Ethanol. “With Sweetwater, we’ll move from 100% corn to a combination of corn starch and 7% cellulosic sugar as our feedstocks.”

It’s the first in a hub-and-spoke model that could result in up to six such facilities supporting the Ace Ethanol plant. But that’s down the line.

The Economic impact

The initial project delivers enough refined monomeric sugar for Ace to produce up to 3.6 million gallons of cellulosic ethanol per year. It’s a 16-year deal for this phase of the relationship, with a total deal value of up to $100 million – or around $1.73 per gallon of ethanol.

Now, according to work that the Center for Agriculture and Rural Development (CARD) has been doing for some time in measuring returns on ethanol production — corn ethanol is a break-even proposition based on corn at around $6.50 per bushel. At the $7 prices today, there are challenges.

Now, in the case of Ace, like other producers, they are buying at contract prices from a group of 300 growers in the natural “draw area” as well as supplying themselves from a half-interest in a nearby grain elevator. But they are also supplementing with buys from outside of the draw area from other elevators — that’s where the bite is, that’s where corn prices spike into those $7 price ranges seen on CBOT screens.

That’s where this deal proves helpful – not only in addressing price volatility and risk, but in addressing the costs associated with spot buys.

But let’s look at price, too.

The RIN impact

Keep in mind, cellulosic ethanol sells at a premium to corn ethanol – it’s a mechanism built into the Renewable Fuel Standard to encourage the migration to cellulosic ethanol. last year, the cellulosic biofuel waiver credit ran $0.78 per gallon, a sharp increase over $0.05 corn ethanol RINs.

Also, there’s the $1.01 per gallon cellulosic biofuels tax credit, just extended for 2013 – and may be available in 2014 and beyond.

Now, today is not 2014, and woe betide the producer banking his plan around the value of RINs and tax credits. We asked Ace CEO Neal Kemmet about that.

“Clearly, we feel this is beneficial and profitable for our shareholders,” he reflected. “Based on the business model, it’s a good project for us. You have to have that high level of trust in the business case, and your business partners, to have the willingness to be the first. As far as RINs, we won;t go live until 2014, and there’s no guarantee, ever, that RINs will be in place at a given price, but if they are available and trading, we very much appreciate the support that Congress has created via the RFS.”

The Ace Ethanol – Sweetwater partnership

“Over the last year we’ve had some incredible conversations with everyone at Ace Ethanol, and the more we talked about the benefits we could provide for one another, the more we realized that a partnership between our two companies made for a fantastic fit,” says Arunas Chesonis, Chairman and CEO of Sweetwater. “We’ve now signed a definitive agreement for a long-term commercial relationship for cellulosic sugar, effectively moving an existing dry-mill corn ethanol facility to cellulosic ethanol without interrupting their operations. And best of all, since the process is scalable, Ace can increase the amount of cellulosic sugar they’re adding to their process in the coming years.”

The technology

Sweetwater Energy uses a unique, patented technology to produce low-cost sugar solution from non-food biomass. This sugar solution is sold to biorefineries, which use it to produce biofuels, biochemicals, and bioplastics. Unlike petroleum-based technologies, Sweetwater Energy’s process uses carbon from renewable biomass that is grown or procured domestically, and significantly reduces greenhouse gases.

The company received an unusually broad patent in cellulosic sugar production last month. Lots of data there on C5 and C6 separation, feedstock flexibility, products produced, production process and more. Take a look here.

Feedstocks

Those in the feedstock supply business, rev up your engines. The technology works with a wide variety of feedstocks — even energy canes. “It’s a matter of timing,” reflected Sweetwater COO Jack Baron, “in terms of cellulosic pathways, but we think that several feedstocks will qualify.”

Product diversification

“Our patented, decentralized sugar-production model is designed to let us work in tandem with a refiner’s existing infrastructure, which fosters strong collaboration on both sides,” said Baron. “Furthermore, our refined sugars can be used for biochemical or bioplastics production, giving Ace diversification options in the future. Ace is a progressive industry leader located near affordable biomass; they are financially successful and constantly incorporating proven new technologies to maintain their leadership position.”

Good project for Ace. For a relatively small (41 mgy) facility, they’ve been remarkably adept over the years in getting new technologies tested and deployed – diversifying their product set and reducing cost – whether it is capturing CO2 or extracting corn oil. One of the reasons the plant has not shut down in all the topsy-turvy of this past year’s ethanol market. It’s like a small POET or Green Plains – fiercely pursuing process improvement and product upside.

Looking at the capex and opex

There are some uncertainties in this deal because the two companies are private and some numbers are not available for discussion.

Let’s look at it this way. Project cost for Sweetwater is expected to be slightly over $15 million for this phase. “It’ll be a combination of debt and equity ,” according to Sweetwater COO Jack Baron.

That works out to just north of $4 per gallon of capacity, and clearly Sweetwater is generating enough cash flow on 3.6 million gallons of $1.73 ethanol to provide payback. If, for the sake of argument, we figure a 15% rate of return in order to cover the cost of equity and debt – it is suggestive that Sweetwater’s operating costs are in the $1.10 per gallon range (excluding any residual value in lignin byproduct)

Now, we look at a lot of data in Digestville, and $4 capex and $1.10 opex is, as they say, a compelling outlier. Doubly so in terms of having the investment absorbed by the feedstock provider – Sweetwater in this case, with limited capex and risk to the thin balance sheets of hard-pressed midstream ethanol producers.

Not to mention, a $15 million entry point into the cellulosic ethanol business, regardless of who is paying. You can hardly get a meaningful Series B venture round done for that mind of money.

The Bottom Line

Low capex. Low opex. Low nut for getting in. And cellulosics can competing today with $7 corn on a dollar for dollar basis, fully loaded.

Where are you going to go with this, we asked Sweetwater CEO Arunas Chesonis. “Our goal is 25 facilities like this in the next 5 years – in some cases, we will have multiple modules in a hub-and-spoke system with a given customer,” Chesonis told the Digest.

“So it may be, for example, 25 projects with 16 customers. The market is there – not only with this corn ethanol sector, but with bioplastics and biochemicals. For us, though, executing 25 projects is a lot, and we are going to walk before we run; we have a long ways to go in building up from where we are today, with 25 employees.”