Perspectives on Clean Technology (Follow-on)

In 2009 I shared some thoughts here on clean technology development. After some positive feedback I thought it would be appropriate share additional perspectives to do a follow-on piece for 2012.

Clean technology is not a phenomenon that is going away, and that is becoming clearer with each passing year. A few pervasive fundamental drivers exist:

• The same motivating factors that were driving clean tech five years ago still exist, and some (emerging market demand and environmental stress) are even getting stronger
• Clean tech is an incredibly diverse industry and the term reaches into a broad array of business segments
• There is systemic inertia which continues to push toward greater efficiency and reduced environmental impact – not just in energy, but across the spectrum
• Need for sustained innovation and the effect of cost arbitrage
  

While folks are concerns about sovereign debt, regulatory changes, and increased competition, 2011 was a record year for clean technology deployments and I believe 2012 will be even a better year as capital flow increases and emerging dynamics continue to make the case for clean technology as a worthwhile industry. From energy, to materials, to natural resources, and even governmental and regulatory action, developing clean technology is a mindset that a host of players are caught up in. And one issue that is frequently misunderstood is the utter scale and pervasiveness of what this area encompasses. To put it simply, clean tech is in play virtually everywhere that matters (e.g. water, smart or renewable materials, clean transportation, electric vehicles, energy storage, etc.)

Energy issues do not seem to ever go away. Today, there is a lot of regulatory action which is setting out with the goal of correct arbitrage and imbalances between technological development and commodity pricing (think of the corn ethanol subsidy/drawdown). It serves as an impetus for new tech growth, and that is what is important here. Appropriate regulatory action is certainly not slowing down development, as clean tech is also a politically popular and viable economic movement.

As I have said before, this is a different animal that what we saw in the 90s with the dot-com era (high initial capital infusion followed by a network of low cost start-ups to develop value). Rather, the clean tech industry is one that driven by “tech innovation AND implementation.” That is to say – the dissemination of innovative technology on a broad scale and the ability to ramp up production and utilization sooner rather than later. It is important to balance that point by saying that technology is the driving concern here, and a capital-intensive asset-driven business is not. Technology developers should be implementing strategies which allow them to advance their developments with lighter asset burdens. Partnerships with manufacturers and high-infrastructure companies while focusing on research and development is a smart play – one which will see faster commercial realization. Once again, a savvy industry focused investor (e.g. specialty venture capital or private equity investment firms) should understand the difference of “asset plays vs. new technology play” and consider review both the immediate capital cost of deployment of a new technology as well as the long-term cash flows and liabilities that can be inherent in such investment consideration.

Nowhere is the implementation need more conspicuous than in sustainable and renewable energy. Traditional energy sources, especially fossil fuels, are creating incentives for their own replacement – both economic and environmental. To scale this sector to the point of wholly replacing traditional energy is far from a realistic proposition in the foreseeable future. What is important at the present moment is to scale deployment of new energy technology while reducing associated costs. The goal is to grow an important supplement to traditional energy, which will mitigate its costs. We are seeing this more every year (think of growth in wind and solar, as examples). Efficiency is another key theme in energy – one that can be addressed by clean tech advancement (but which necessitates the incentives to do so). Regulators can play an important role here.
Certainly one of the biggest areas for clean tech development moving forward is powered transportation. Here we see some of the greatest energy consumption (again, particularly fossil fuels) coupled with high environmental impact. This is particularly true for emerging markets, where we see exploding industrialization and associated demand. The impact of these areas cannot be ignored. Much can be done to improve the industry on a technological basis. Fuels, materials, drivetrains, and motors are all components that are ready for innovation. Again, incentives must be in place.

The central theme of my view on clean technology is that it’s an expansive industry, which will provide consistent economic development opportunities moving ahead and chemical and specialty materials industry players are at the forefront of this movement. An innovation in “business of chemistry” could translate into an innovation for “clean technology industry”, and vice versa. What are you views?

Perspective: The Marcellus Shale Boom as an Impetus for Technology Development

Strengthening domestic energy production has been a very hot topic for some time now, and for good reasons, such as drilling affect in the communities and environment, opportunities and consequences of developing an economy. American dependence on crude oil reserves from traditional foreign sources has become a more precarious situation with diminishing supply, skyrocketing demand, and geopolitical instability. To meet the energy needs of coming generations the charge is being led to bolster U.S. production, particularly with alternate and
non-traditional energy sources. The natural gas extraction in the Marcellus Shale is an extremely valuable asset to petrochemical, which can convert ethane into a feedstock for their manufacturing processes in the downstream of the value-chain. Many chemical related business could indeed achieve lowest cost position in the world; thus strengthening our economic engine. Remarkably, many of the concerns and challenges associated with “Marcellus Shale” could be solved thorough chemistry related innovations and technology development.

One of the biggest windfalls for American energy in recent years has been the discovery of expansive natural gas reserves in the Marcellus Shale region of the Northeastern United States. Many of the most recent estimates peg recoverable gas supplies in the Marcellus at over 150 trillion cubic feet, with some experts suggesting a far more extensive untapped supply.

Of course, ongoing technological improvements in extraction methods continue to grow this figure. Much of the gas is found in shale deposits at depths of 7,000 to 10,000 feet which, in the past, made for a prohibitively high cost exploration and removal process. Areas which were not commercially viable for gas wells fifteen years ago are now able to be exploited thanks to advances like directional drilling, where bore holes can penetrate laterally at the target depth to magnify accessibility to local gas. As the promise of unlocking a torrential supply of domestic energy in close proximity to the demand-intensive regions in the Eastern U.S. has become a reality, both public and private sector investment has surged.

And with more R&D going into extraction methods, we have seen improvements in environmental impact as well as increased supply. The primary and most efficient means of natural gas extraction in the Marcellus region is hydraulic fracturing (“fracking”). Hydraulic fracturing is actually a well-established technology, coming into broader commercial use in the mid-20th century. Recent years, however, have seen an explosion in new fracturing technology. According to IP Spotlight, the U.S. Patent and Trademark Office between January 2008 and August 2011 received more than 1,100 U.S. based patent applications which mention fracturing. This is an 80% increase over the previous 3-1/2 year period. This jump is a product of the shale gas boom – one that produced 140,000 jobs and more than $11 billion in value added in Pennsylvania alone in 2010.

On a basic level, fracking involves boring deep into shale formations and using very high pressure fluids to create fractures (or expand existing fractures) in the rock. This releases the trapped hydrocarbons for extraction. There has been no shortage of speculation as to the impact of the traditional fracturing process on local communities and water supplies, and the environment as a whole. These effects must necessarily be left to the experts to determine. What is certain now is that shale gas is a mainstream concept and a booming business, and the U.S. stands to benefit from better access to cleaner fossil fuels. What matters now to business is how they can find the safest way to exploit this resource without missing the boat. The most effective way to reach that goal is through innovation and investment in new technology.

And the more recent proliferation of the extraction process, investment, research, and regulatory pressure seems to be generating plenty of tech growth and secondary industry. Shale gas is a rapidly changing landscape. Areas like western Pennsylvania and Ohio are seeing new construction for wastewater treatment plants which process used fracturing fluids from gas wells. The plants typically operate under permits from state environmental agencies, which impose standards for use of new filtration and treatment technology. A competitive field of energy producers is striving to be the leader in the region by stepping up innovation. Chesapeake Energy, one of the largest gas producers, recently announced a new process which will allow used fracturing fluids to be recycled for new drilling at up to 100% efficiency, reducing both the burden on local water supplies and the need for wastewater processing installations. A new type of fracking method is also emerging, development from oilfield and shale gas giants like Halliburton and Schlumberger. “Super fracking” is based on several improvements to the existing process. New materials are being used to hold open shale cracks at the site of the fracture which allows a greater flow of hydrocarbons for a longer period of time. New types of pipe fittings for wells are making extraction much less time intensive and sparing about half of the surface water needed in the traditional process. And traditional plastic “valve” materials
which, in the past, have had to be recovered in an expensive process after drilling are being replaced with new disintegrating materials. A Texas company called Jadela Oil is even experimenting with a waterless fracking process.

Natural gas itself is cleaner than other hydrocarbon fuels, which makes growing supply even more attractive and conducive to new tech. Burning natural gas for heat energy emits 30% less carbon dioxide than petroleum and 45% less than coal. Nitrogen oxides are reduced by two-thirds and sulfur oxides by nearly 99% compared to coal combustion. A rapidly growing supply of a cleaner hydrocarbon fuel is spurring new technology. Research is progressing in fuel cell technology which could expand on already robust electricity generation applications. Transportation is another promising sector. The U.S. is seeing growing fleets of government, public transit, and shipping vehicles powered by compressed natural gas. The Department of Energy speculates that a switch to natural gas in the U.S. transportation segment would reduce carbon-monoxide emissions by at least 90%, carbon-dioxide emissions by 25% and nitrogen-oxide emissions by up to 60%. There are even expectations to use natural gas in aviation, with estimates of 60% improvement in efficiency while decreasing harmful emissions.

Technology and innovation is developing very rapidly and is touted to present serious cost savings, as well as a reduced environmental impact. Developments like these are interesting, but also raise some important questions. In such a rapidly evolving business, what will gas producers have to do to stay relevant? The next few years should prove to be very exciting, as new technology and investment fleshes out alongside a developing regulatory scheme and a better understanding of the industry. Chemistry is necessarily at the forefront of tech expansion stemming from the Marcellus boom because the natural gas industry is chemical intensive. As natural gas becomes more prevalent, the broader chemical industry is presented with a great deal of opportunity. It will continue to benefit from access to clean, domestic energy, as well as the demand for innovative technology. Recycling and wastewater treatment is highly dependent on chemistry, as are the new technologies in extraction. The high ethane content in Marcellus Shale gas has led to plans for ethane crackers in the region. Renewable Manufacturing Gateway and Aither Chemicals recently reached a deal for a $750 million petrochemical facility which will use shale gas as its feedstock. Clearly, energy development is a sector where chemistry continues to be relevant and our success in energy independence or economic prosperity is still INNOVATION!

Perspectives: What impact higher commodity price has on a chemical company?

Whenever we discuss potential chemical investment, we frequently ask about the possible impacts that may result from higher prices for commodities such as oil, gas and other raw materials. As I am writing this blog, oil prices are around $98/bbl; a decade ago, oil prices were merely in the teens. Not surprisingly, some companies’ financial performances are impacted by their exposure to oil, gas and petrochemical-derivatives, yet many others have relatively limited and/or low exposure and are therefore better able to weather the storm - the trick is the ability to know the difference!

Few inputs impact the world economy to the same extent that the price of oil does. Oil powers cars, trucks, boats, airplanes, and even power plants, which make up the backbone of the global economy. Needless to say, higher energy prices will have an impact on consumers, as well as a company’s ability to invest in capital equipment and grow the business. Increased commodity chemical prices will place downward pressure on a company’s finance/debt as well as negatively effects consumers’ credit. From the feedstock to the commodity producer to the ultimate consumer, everyone suffers.

However, the magnitude of the impact depends on the company’s pricing power, business model, location in the value-chain, and uniqueness of their products and services. During an economy where commodity prices are rising, chemical companies’ financial performances may depend on their ability to pass along the increasing costs to customers (e.g. price escalators) and ultimately to the end-users. Hence, the management team’s ability to execute the company’s risk management strategy plays a crucial role!

The above chart provides a useful reference guide, illustrating the potential impact that certain commodity prices have on various products. Commodity chemical producers (e.g., SABIC, LyondellBasell), diversified chemical producers (e.g., Dow, Dupont, 3M), specialty chemical producers (e.g., Lubrizol, Milliken, Ferro, Solutia), agricultural/fertilizer producers (e.g., Monsanto, Potash), chemical formulators and service providers (e.g., Ecolab, Nalco), and chemical distributors (e.g., Univar, Brenntag) are influenced differently and to varying degrees of their margin. Some could even benefit from rising commodity prices. To say the least, the chemical industry is complex. Companies typically have a very long value chain, and very rarely can a company be found containing only one product line with just one end market. A savvy investor needs to possess a deep domain expertise in order to gain visibility into the value chain, take a broader view and appreciate the supply/demand dynamics.

One silver lining in this high crude price environment is that many commodity chemical producers are benefiting from relatively cheap natural gas, which is a key raw material for many products manufactured in the United States. Higher natural gas prices, in particular, severely diminish the competitiveness of the industry, as it uses natural gas not only as inputs for fuel and power, but also as a raw material and for feedstocks. Feedstocks for most petrochemicals are typically derived from either oil or natural gas (the U.S. chemical industry is the largest industrial user of natural gas, consuming one-eighth of the total natural gas demand). Oil prices, including heavy liquids (e.g., naphtha and gas oil), are determined in the global market. The price of natural gas (as well as liquid gas such as ethane, propane, and butane) is driven by local/regional supply and demand since it has inherent physical limitations moving over long distances. Many large energy companies are heavily investing in order to find ways to help alleviate this issue, for example, building liquefied natural gas (LNG) terminals. Overall, the price of a feedstock is largely determined by the price of oil and/or natural gas.

Another silver lining is that alternative energies like wind, solar, and geothermal, as well as alternative fuels like biofuels, ethanol, cellulosic ethanol and fuel cells, all see increases in demand when the price of oil increases, since oil is their principal competition – also keep in mind that fossil fuels are the main sources of environmental pollutions. Many chemical companies’ products and technologies will, in fact, benefit from an environment with higher oil or energy prices, since chemical companies produce critical materials for solar panels (e.g., PV thin-film, pastes, encapsulants, coatings, metallization, shingle roofing), components for wind energy system (e.g., carbon fiber, infusions, fiber glass, pre-impregnated materials/prepregs), materials for energy storage devices/systems, various solutions for next generation’s electric vehicles, biofuels, etc. High energy prices also spark other innovations, from industrial biotechnology and bio-plastics to fuel cells.

Arguably, chemistry is the essence of modern life, and as a result, the chemical and chemical-related industries will continue to thrive in any commodity-priced environment, so long they remain flexible.

Synergistic acquisition to promote innovation

In January, BASF and LKCA (a subsidiary of Linde Group), announced that they would jointly market licenses and plants for the capture of CO2 from flue gases, and recently, with assistance from RWE Power, they have created (and successfully tested) a major breakthrough in carbon capture technology. The new innovative technology captures CO2 by means of utilizing new chemical solvents that can reduce energy input by about 20 percent. Furthermore, the new solvents feature superior oxygen stability, which reduces solvent consumption significantly, which consequently improves efficiency.

In the future, climate-capture technology will likely play a key role in generating climate-compatible power from coal, and this new technology process, once scaled up to large power plants, will reduce power plant waste gases and facilitate clean energy generation. In addition, as this technology should capture more than 90% of the CO2 contained in waste gases, a vast supply of recycled CO2 can be created and used for inputs in chemical transformations such as production of fertilizers. New plants demonstrating this technology are scheduled to be in operation by 2015, and the technology should be expected to be utilized commercially in coal-fired power stations by 2020. Ultimately, once this technology expands, there will be a significant reduction in the release of climate-damaging CO2 due to its successful capture and transport for recycling or sequestration.

So, why is this development relevant in the chemicals industry? And why is it relevant within the private equity industry? First, this development illustrates the strong motivations within the chemicals industry to become more environmentally sustainable while simultaneously reducing costs and improving efficiency. Furthermore, this new technology derived directly from the pooling of knowledge and resources from various firms with different areas of expertise; individually, the companies would likely have found development of this technology exceedingly difficult, however, when their resources were combined, breakthroughs were managed in rapid fashion. Similarly, in the private equity industry, companies are strategically acquired so as to enable such synergies to promote swift innovation and long-term value creation, and as this particularly example clearly illustrates, the broader chemicals industry provides a viable forum in which to initiate such developments.