Silicon Valley, Meet Ethanol

As billionaire Vinod Khosla announced the formation of Cilion, a new company which plans to build eight ethanol plants—three in California—within the next two years, it becomes apparent that the cutting-edge technologies involved in ethanol production have attracted the interest and the deep pockets of the Silicon Valley.
By Nicholas Zeman | October 02, 2006
Vinod Khosla is making serious moves in the California renewable energy sector. He was recently involved in one of the biggest venture capital investments ever in the clean technologies industry, and he is also a founding partner in Cilion Inc., a company that plans to build eight ethanol plants in the United States by 2008. Perhaps more importantly, he was a financial force in Proposition 87, "The California Clean Energy Initiative," which will appear on the California ballot in October and would direct $4 billion in funding to renewable energy projects, if passed. Ideally, the funding would reduce the state's dependence on gasoline and diesel by 25 percent over the next 10 years.

From Khosla's perspective, legislation that specifically supports renewable fuels would be an important step in meeting his future goals. If Proposition 87 is passed, oil drilling fees will essentially be used to fund, subsidize and encourage renewable fuels production and research. The coalition of businesses, environmental groups and scientists backing the bill have officially announced that, "Proposition 87 will set California's oil drilling fees at levels similar to those in Oklahoma, Alaska and Texas at no cost to consumers and at no increase at the pump."

The revenue generated by these fees will then be used to fund consumer rebates for the purchase of alternative fuel vehicles, assist local governments in upgrading local vehicle fleets, support university research and build an alternative fuels infrastructure. Even more unique, this legislation calls for the oil and gas industries to fund the growth of renewable fuels production—and an infrastructure to support it.

Strategic Partnerships
Cilion was formed through a strategic alliance between Khosla Ventures, Western Milling and Praj Industries of India. "To provide Cilion with plants that will be less expensive and greener than standard corn-to-ethanol plants, Western Milling's expertise with ethanol production, grain handling, logistics and feed will combine with the company building and financial expertise of Khosla Ventures, reducing the plant's need for fossil fuels in ethanol production," according to a company statement. From this, it sounds like Cilion plants could possibly favor cellulosic feedstock over traditional corn, but that's not its only progressive claim. "When fully operational, ethanol produced by Cilion is expected to be price competitive per mile driven with gasoline even if oil prices drop to $40 a barrel," said Kevin Kruse, president of Western Milling, in a prepared statement.

Khosla is renowned in business circles for his meticulous research and his ability to spot the kind of innovative technology that can revolutionize an industry. He turned his attention to alternative fuels largely through connections with Praj Industries, which has become a valuable ally. Khosla helped fund Praj Industries, a publicly traded Indian company that is currently building ethanol plants in 30 countries, and Praj has been contracted to supply technology and machinery for two plants being set up for Cilion in California. Recently, Praj announced that it had completed an allotment of shares to Khosla (1.62 million equity shares and 6.49 million warrants).

In addition to its eight ethanol plants on the drawing board, Cilion has tentative plans to order machinery from Praj for two additional plants, which haven't been announced yet. The first two plants, with a capacity of 55 MMgy are scheduled to begin corn-based production by the middle of next year. Cilion plans for its total capacity to reach 440 MMgy by 2008.

Jeremy Wilhelm, CEO of Cilion, told EPM the site locations for the first six plants, all of which will use corn as a feedstock, are nearly finalized. The first project, a 60 MMgy facility in Keyes, Calif., already broke ground in mid-August; it is expected to begin production in August 2007. A second plant, a 60 MMgy facility in Famoso, Calif., is expected break ground in November. The third project, a 120 MMgy plant in Imperial Valley, Calif., is scheduled to break ground in February. A proposed plant in Gila, Ariz., is a 60 MMgy facility that is scheduled to break ground in May 2008. On the East Coast, a 60 MMgy Caledonia, N.Y., facility is scheduled to start construction in July 2007. The sixth project, a 60 MMgy Ritzville, Wash., plant, is still in the preliminary stages of development. Wilhem says he isn't ready to announce the locations for the last two sites.

"These locations allow us not to have to install dryers because of the livestock presence in the areas," Wilhelm says. "So we will use only a portion of the natural gas that is used in ethanol plants." The vegetable production located in the areas where Cilion has chosen to build also presents opportunities for the marketing of carbon dioxide. "Strawberries and grapes, for instance, both use carbon dioxide for enhancement," Wilhelm says. Cilion has chosen not to market its own ethanol; Wilhelm says negotiations for a partner haven't been finalized.

Cilion hasn't had much trouble in raising money for all of these projects. Capital was supplied in the second round by new investors, although Khosla and Western Milling both participated. The company officially announced other backers, including Virgin Fuels, a newly formed part of Virgin Group Ltd.; Yucaipa Cos.; and Advanced Equities.

Political Battle
The San Francisco Chronicle has reported that the opposition to Proposition 87 is being funded by San Ramon, Calif.-based Chevron Corp., which has contributed $13.1 million; Aera Energy LLP's $12.6 million; and Occidental Oil and Gas Corp.'s $4.75 million. The major contributions supporting the legislation include a total of $21.8 million from Hollywood mogul Stephen Bing ($16.5 million), Google cofounder Larry Page ($1 million), and venture capitalists John Doerr ($950,000) and Khosla ($1.1 million).

Opponents of this legislation say that a $4 billion oil tax increase will raise gas prices, create a huge bureaucracy that lacks accountability and is under no pressure to produce results. They say they are not against the development of alternative energy, but Proposition 87 is not the way to get there. Among the supporters of the "No on Prop 87" initiative are the California Taxpayers' Association, small businesses, labor organizations, schools, police, firefighters, farmers and the auto club.

"We agree that you need to develop alternative fuel technologies," says Al Lundeen of the "No on Prop 87" initiative. "We don't dispute that at all. The proponents [of this bill] have neglected to look at the fact that if you place additional taxes on oil production here in California, you make oil production look better elsewhere." This increases the dependence on foreign oil and adds to the price at the pump for consumers, Lundeen says.

This bill also creates a bureaucracy that Lundeen believes lacks checks and balances. The marriage of political and industrial interests makes many people uneasy, and draws hostile and widespread protest. For instance, the Bush family's association with the oil industry has been a favorite target for the president's critics, most notably in Michael Moore's documentary, "Fahrenheit 911." Also, as EPM reported in its September issue, David Morris of the Institute for Local Self-Reliance says that a continued tax incentive for ethanol could generate a backlash—even among ethanol advocates—against the renewable fuel as the industry grows in power and wealth. Khosla himself has said, "I am not a fan of ethanol subsidies or import tariffs." The public has indeed lashed out under various circumstances when it feels it is being exploited by political-industrial cronyism. "[Proposition 87] would prevent a CEO of an alternative energy company from serving on the board, but it would not prevent an employee or relative from sitting on the board that could then direct funds to [alternative energy] companies it was connected to," Lundeen says.

Yusef Robb, the communications director for the "Yes on Prop 87" initiative says the sentiments expressed by Lundeen are simply fictions generated by the oil companies. "Californians Against Higher Taxes is only a sham front for the oil campanies," Robb says. "Do you really think they are mounting a statewide campaign because they care about good government in Sacramento?"
Specifically, in regard to Khosla's contributions to the campaign as they are related to his investments in the ethanol industry, Robb says that the group that would administer the funds—The California Energy Alternatives Program Authority—could have no members that commission the funds for personal interests. Also, meetings where funds would be appropriated will be open to the public.

"If you want money from [the program authority], don't volunteer to sit on the board," Robb says. "When Mr. Khosla is listed as a top contributor in every one of our ads and on every one of our pieces of paper, do you really think that he is going to walk into an open meeting with his hat in his hand and ask for money?" EP

Q&A with Vinod Khosla
Questions by Nicholas Zeman, EPM Staff Writer

EPM: The following excerpt was taken from statements made in the Des Moines Register by Jim Egerton of Co-Bank in Denver: "There is no correlation between the price of corn—ethanol's dominant feedstock—and the price of ethanol, which is pegged to gasoline prices. Also, he said, there is no guarantee that oil prices will remain high. Intense construction of ethanol plants in recent years also raises the specter of an overbuilt industry where supplies exceed demand, he said. Government tax breaks for ethanol could end and, with them, some of the financial benefits that ethanol now enjoys." Could you respond to these statements in terms of the risks involved with ethanol investments in the coming years?

Khosla: Certainly, there is no guarantee oil prices will stay high, stay the same or go lower. The only guarantee is that no one can accurately predict the price of oil. Right now, demand exceeds supply, and we think this will reverse to some extent in the next 18 months, where ethanol prices will come down. The market for ethanol is growing, and it is our hope that with the further increase in flexible fuel vehicles (FFVs) and E85 pumps, demand will continue to grow but at a much more predictable pace. We also believe that at above-$45 oil, ethanol can compete without subsidies.

EPM: Political support is crucial for ethanol. Will energy security be a major issue in political races over the next few years? Do you have a presidential candidate that you are supporting or endorsing?

Khosla: Energy security is and should be a major issue for all of us, and will certainly be an issue in the political elections. I don't have any one candidate I am endorsing.

EPM: Why do you believe that a significant increase in the use of E85 would stabilize what could be a volatile ethanol market?

Khosla: The ethanol market is volatile because the phasing out of MTBE was supposed to lead to a 7.5 billion-gallon-per-year market by 2012. However, as we all know, MTBE contains many harmful chemicals, and the refiners are replacing it much quicker. This unexpected spike in demand has led to the volatility. With E85, you need FFVs, which will enter the market over the course of the next decade and increase demand for E85. We will build up our FFV fleet over time, but it would help energy security tremendously if we require automakers to make at least 70 percent of our cars be FFVs.

EPM: What are your feelings about how Proposition 87 will fare on the California ballot in November?

Khosla: I am very hopeful that the people of California will support this bill. We have a lot of support, but the oil companies have a lot of money and are spending it aggressively to protect the gravy train they have in California.

EPM: You have supported ending the tariff on ethanol imported into the United States. What do you think the benefits of this would be?

Khosla: I have supported ending the import tariffs on ethanol for the E85 market not for the blending market. In fact, I have proposed that we increase the renewable fuels standard (RFS) for blending to 15 billion gallons by 2015. I support the removal of tariffs for the E85 market. Lower E85 prices will dramatically increase the sales of FFVs, creating a long-term market for ethanol in this country that is 10 times larger than the blending market. I am a proponent of free markets, and I strongly believe that market forces will support the widespread adoption of ethanol and kick-start the E85 market. It makes no sense that we tax the cheapest ethanol in the world while we have no such thing for expensive oil from the Mideast. Alternatively, we could tax oil imports, but that does not seem politically feasible.

EPM: The previous question concerning the handling of tariffs seems to have some strategic implications in terms of the development of a global biofuels market, and supporting political initiatives has strategic implications as well. Could you explain some of your philosophies or strategies for the incorporation of the biofuels industry into the mainstream?

Khosla: I think we need to do three things: mandate that 70 percent of all new cars be FFVs by 2014, mandate that 10 percent of gas stations (not mom and pop shops, but chains with multiple locations) offer E85 pumps, and signal to Wall Street that renewables are here to stay and will not fall prey to oil company manipulation. To do that, I propose we change the volumetric ethanol excise tax credit to a flexible credit, ranging from 75 cents a gallon when oil prices are at $25 per barrel and 25 cents a gallon when oil is at $75 per barrel.

EPM: Your appearances advocating ethanol (for example, at the American Coalition for Ethanol conference in August in Kansas City) have drawn a considerable amount of press in recent weeks. Do you think educating the public and disseminating information are as important an aspect as any in the near-future success of biofuels?

Khosla: Absolutely. There are a lot of vested interests against biofuels and renewables. They have a lot of money and a powerful lobby, and we need to make sure that the American consumer is provided with the facts, not myths. I have a paper on my Web site that addresses many of the myths propagated against ethanol and other biofuels.

EPM: Could you tell us a little about your involvement with Celunol, that company's partnership with SunOpta, and your investments in the future of this industry via cellulosic ethanol? How do you feel the race for the lead in cellulosic ethanol production is shaping up?

Khosla: I am an investor in Celunol and a few other cellulosic companies. Some, like Celunol, use a biochemical approach to converting cellulose to ethanol. Others, like Kergy, use a thermochemical approach. It is too early to say which technology will win or how many will win. This is a large market, so I suspect a few different approaches will find success.

Nicholas Zeman is an Ethanol Producer Magazine staff writer. Reach him at nzeman@bbibiofuels.com or (701) 746-8385.