Building Sustainable Cellulosic Biofuel Portfolios

The amount of risk in supply variation a biorefinery is willing to accept will depend on its fundamental business strategy, and the amount of premium they are willing to pay to reduce risks associated with biomass supply variation
By Rajdeep Golecha | October 24, 2015

Bioenergy has attracted increasing investments and support in recent decades, as a result of a growing emphasis toward energy security and greenhouse gas emission reductions. More than 30 billion gallons of biofuel were produced globally in 2014, of which around 50 percent was corn ethanol produced in the U.S., and 30 percent was sugarcane ethanol produced in Brazil.

The U.S. EPA now places greater emphasis toward advancement of second-generation biofuel produced from cellulosic biomass such as agricultural and forestry residues and perennial grasses. This involves a more complex conversion of biomass (cellulosic and lignocellulosic material) into ethanol. The EPA’s current target is to produce 20 billion gallons of cellulosic biofuel per year by 2022. Studies have shown this will require close to 200 million metric dry tons of biomass.

In the U.S., corn stover is one of the largest sources of agricultural residue for cellulosic biofuel production. Studies have found that cellulosic biomass, such as corn stover, have 20 to 30 percent supply variations, compared to 12 to 15 percent variations for corn grain itself. This is because while corn stover yields are proportional to corn grain yields, a portion of stover has to be left on the ground due to equipment limitations, and maintaining soil organic carbon. The effect is an increased overall variation in corn stover compared with corn grain.

In addition to exposure to higher supply variations, cellulosic biorefineries will be required to source biomass locally, due to long-distance transport limitations. In the absence of a feedstock strategy, these regional imbalances in cellulosic biomass supply and demand will transform into significant variations in biomass price, and ultimately lead to sustainability issues for cellulosic biofuel business. Engineering solutions, such as biomass storage, pretreatment using torrefaction, pelletization, and pyrolysis, can partially mitigate supply variations but entail significant costs.

Winning Strategy
An effective risk mitigation strategy associated with feedstock supply variations is a portfolio strategy. Using the approach of modern portfolio theory (MPT), companies venturing in cellulosic biofuels can develop a diversification framework that optimizes its business portfolio. Simulation shows that up to 70 percent of business risks associated with biomass supply variation can be mitigated by using a portfolio approach. These strategies do not require additional infrastructure, and can be used together with engineering options to aid in designing biomass supply chains to facilitate the development of a sustainable cellulosic biofuel industry.

According to MPT, creation of a portfolio by mixing assets, the effective variance of the portfolio is always less than the individual variance of underlying assets. This is because the variation of one asset could counter the variation of the other asset, and the net effect is a lower overall variation for the portfolio.

In the case of cellulosic biofuel, an optimal portfolio can be created by investing in biorefineries that are based on different feedstocks such as corn stover, wheat straw, switchgrass, energy cane and sugarcane bagasse. Switchgrass has the potential as a dedicated energy crop using marginal cropland, and produces comparable ethanol as corn stover. Wheat straw, another attractive alternative for feedstock diversification, is also abundant in the U.S. Corn Belt. Energy cane, miscanthus, and sugarcane residue are other potential options.

By varying the proportion of investment on each feedstock type, companies can achieve an optimal portfolio that offers the highest expected return for a defined level of risk (known as the efficient frontier). Portfolios that are not on the efficient frontier are considered suboptimal, because they do not provide enough return for the level of risk.

Companies operating in both first- and second-generation ethanol may look for diversification between products to hedge against policy and price variation.  

Impact on Business Risk
Based on simulation, an optimal portfolio using corn stover, wheat straw and switchgrass could achieve 70 percent reduction in risks associated with individual supply variations, while increasing the biomass cost by only marginally (less than 5 percent). The biomass cost hike is because switchgrass is assumed to be more costly than corn stover. Further advancements in switchgrass research and development to reduce its production cost could further enhance the advantage of using switchgrass to mitigate year-to-year supply variations in corn stover. The amount of risk in supply variation a biorefinery is willing to accept will depend on the fundamental business strategy of the biorefinery, and the amount of premium they are willing to pay to reduce risks associated with biomass supply variations.

Author: Rajdeep Golecha
Biofuel business portfolio developer