The biofuels market is in a funk. Corn-based ethanol has become an environmental pariah to activists and an economic lodestone to people in favor of energy independence. Plant-based biofuel companies seeking to harvest oils from green matter have struggled to reach economies of scale and have faced political headwinds in Europe. And biofuels based on rendering animal and food waste have run into rough waters.
Alone among the biofuels remains algae, a prolific reproducer that is the current great hope among venture capitalists and other investors.
At the AlwaysOn Going Green Conference in San Francisco, I got a chance to sit down with Jim Long, the chairman of the board of Aurora Biofuels, one of the leading players in setting up systems to entice algae to produce high concentrations of biodiesel. A general partner at venture capitalist fund Gabriel Ventures, Jim was among the first VCs to jump the fence from technology into green investing and also is one of the most knowledgeable investors in the biofuel space.
We talked about why algae is the best biofuel play, how far away these types of companies are from being profitable, and why he believes Aurora is already worth $100 million. Here are edited excerpts of our conversation:
DailyFinance: How did you decide on investments in algae biofuels?
Jim Long: We decided to look at clean-tech and the biofuels area was very attractive. We felt that biodiesel was going to be a straight-forward thing as opposed to ethanol. If you could produce diesel, then it would just work. You could put it in the same trucks, the same tankers, and the same pipelines. When you produce ethanol, it's a whole new beast. You have to think about mixtures and other stuff. We felt that was too complicated.
Even though we generally invest in companies that need smaller amounts of capital, we thought that being on the ground floor of algae was a good bet. If algae works, it will work big. You will end up creating an algae ecosystem that can create another five or 10 investments down the road.
DailyFinance: Why do you think algae biofuels are so hot?
Jim Long: When we did the investment, algae was the like Rodney Dangerfield of biofuels feed-stocks. Now its sexy but it still needs a lot of improvement. Part of the reason it's sexy is because everything else is petering out. But we have to be careful because interest in algae could peter out as well if there are real setbacks.
But there are very basic reasons why algae makes sense. Algae is an omega-three oil. The fish eat algae. The dinosaurs that made the oil we pump now, they ate the algae and much of that oil is actually made from decomposed algae. It's one of the leading sources of oil on the planet -- period. So it's logical that algae would be a great source of biofuels.
DailyFinance: What roles has genetics played in Aurora's attempts to create organisms that produce a lot of biodiesel?
Jim Long: We were not comfortable doing genetic modifications. Modifying e-coli to spew out biodiesel is not our game. But we knew right out of the shot that in order for us to be successful at Aurora, we would need genetic breakthroughs. So what we did was genetic manipulation to help us do better hybridization and figure out the best way to create algae that will produce a lot of oils. Think of it as taking dice that have 100,000 possible combinations and reducing that number of combinations we have to look at to find the right genes for high oil production to only 100 or so.
The good news is that Aurora is already at the point that we have taken a couple of natural strains and turbocharged them without using any genetic manipulation or gene insertion techniques. Our research strains that use genetics are not mixed at all with strains we intend to use for production. We have some wickedly cool IP in the area around the genetics of algae. I can't say what it is, but it is big time stuff.
We also feel that GMOs in algae land are very benign. Generation two or three you will see GMOs and no one will care. Algae is everywhere. Stuff from Norway gets to Africa. It's on oil tankers, cruise ships, and it moves all over the world. But we understand that GMOs are a political hot-potato and we are glad we don't have to use GMOs.
DailyFinance: How big will you need to build in order to make an algae factory, or farm, profitable?
Jim Long: There are three ways to make algae: in open ponds, in closed systems, or through fermentation. We had no interest in putting seawater in bags in rows or closed tanks with tubes snaking everywhere. That seemed too complicated. Fermentation also seemed really hard to us. That left open-air algae ponds and those, those are hard enough. You have to worry about external contamination -- both chemical and biological -- wind, weather, etc. One could argue that closed reactors are better but we could never pencil out the economics.
To be frank, even open ponds, no one on the planet has ever done it to scale. In China they have built 2,000 acres of cement ponds for their nutraceuticals industry, but that would not work for what we need. We need bigger scale than that and locations that are close to a source of CO2 and seawater. That means roughly around the Equator. To make that work, you have to go from pilot project to massive installation. There is no economics in between. And its very, very complicated to make something like this work, let alone at scale.
Our spreadsheet for economic forecasting for Aurora has 200 variables. For each variable, we have to decide whether we want to build it or own the key parts of that variable ourselves, license it from someone else, or buy it on the open market. But we are really about perfecting a process.
Essentially, down the road we want to help people build algae farms. We don't want to own them. We want to be a combination of Monsanto (MON) and an engineering services firm and get royalties and joint ventures. We're still years away from a big plant. Even perfecting our pilot site will take time. Ideally, farms will be 15,000 acres or so. That's the sort of scale we think works best.
DailyFinance: This seems like a very long horizon investment for a venture capitalist. The exit might be 15 years out.
Jim Long: Not really. I mean, to get to a point of significant discounted cash flows it's maybe a decade. But there are plenty of chances to go public before that. The first farm that works and then it will be off to the races. This is not a two-year internet flip play but I think right now, based just on the algae technology and IP position, the company could be sold for $100 million. Considering that investors have put in $20 million, that's not a bad return, in the neighborhood of three-to-four times initial investment.
DailyFinance: You had mentioned how a successful initial algae farm play would open up an algae ecosystem. What other areas would start to look attractive in that case?
Jim Long: You might look at co-location opportunities. An algae farm could be specialized to work around cement plants, which put out a lot of CO2. In that case, an algae farm might work at 500 acres because its right next to a cement plant. Then you get the potential to sell either capital equipment or operating stuff to the algae farmers. There should be growth businesses for specialty fertilizers or contamination control systems. Those are all opportunities for smart entrepreneurs once the sector takes off.