McKinsey Quarterly Addresses Key Hurdles for Cost Effective U.S. Biofuel Production

This year has seen some interesting progress in the production of second generation biofuels.

But the latest report from McKinsey Quarterly suggests that unless distribution and regulation issues in the United States are dealt with, the likelihood of getting the fuel from the refineries to the pumps in a cost-effective manner, is slight.

Midstream ethanol distribution infrastructure is inadequate today, and next-generation ethanol will face these same challenges unless they are addressed. This year, of course, the industry has fallen under increased stress because of a variety of factors, including lower oil prices, the economic crisis, and delayed government regulations.

According to the report, even though biofuels were cheaper to produce than gasoline, regional consumption of blendstocks were far below the 10% allowance under Federal Law. Why? The majority of the blame seems to fall with current local and state regulations and distribution (transportation).

Local and State Ethanol Blendstock Restrictions

In 2008, total ethanol demand was decreased by roughly 3 billion gallons as a result of state and local regulations.

Due to ethanol's price volatility, restrictions were put in place to reduce its availability for blending. So, even though a 10% blend is permitted federally, local restrictions often lessen this to 5-7%. In a lot of these places, the restrictions have been lifted, but it could take until 2010 for the industry to respond and adapt.

Distribution Bottlenecks

This is by far the most expensive hurdle, bottlenecks in distribution require some costly adjustments. Three broad steps are needed for improvement:

1. Expansion to remote areas of conventional markets.
2. Increased efficiency.
3. Up-scaled infrastructure.

The investment needed is huge, each step needing anywhere from $5-10 billion.

Another problem with distribution is the lack of rail connectivity from suppliers to retailers. Trucking is far too expensive and few biofuel pipelines exist, so rail is generally the answer. But as it stands, rail is nor far-reaching enough to work on its own--which increases costs greatly.

What's interesting about new-tech and fuel development is even if the biofuel industry can get past its own controversial methods and begin creating fuel that is environmentally safe, renewable,  and does not inhibit food production, it still faces the problem of getting its product from point A to point B. In other words, success is at the mercy of older, less-efficient infrastructure unless policy changes and investments are put into place.

The McKinsey Quarterly report (and slide show) can be found here.