Leap year?

REDFIELD, S.D. -- Redfield Energy LLC is making a leap this year, using its own ethanol plant as a springboard and with money from a big new partner for the muscle.

This fall, the seven-year-old, 55 million-gallon ethanol operation will start a retrofit to isobutanol funded by Gevo Inc., an Englewood, Colo., biofuel technology company. It's the second move of its type in the region.

In August 2010, Gevo purchased Agri-Energy LLC, an ethanol plant in Luverne, Minn. It now has 220 workers in Rock County in the process of converting that plant to an 18-million-gallon isobutanol plant, a retrofit expected to be completed by June. When the Minnesota conversion is done, Gevo officials will turn their attention to the Redfield conversion, in a joint venture, for production in the fall of 2013.

"The basic change is that they have a new fermentation process which is a kind of a continuous flow of the liquid," says Redfield Energy CEO Thomas P. Hitchcock, sitting in the board room, two miles north of Redfield, in the bustling agricultural hub of Spink County.

Redfield Energy was part of the ethanol revolution in South Dakota.

It has 850 members in three unit classes -- A, B and C -- with some redundancy. Redfield Energy organized in July 2005 and raised equity in September 2005, gathering $37 million in a breath-taking three days. It took about $75 million to build the plant, and have adequate capital for corn storage and receivables.

"That's when ethanol was gangbusters," Hitchcock says. The company's 42 full-time employees processed 19.8 million bushels of corn, produced 161,600 tons of distiller's grains feed and 55.3 million gallons of ethanol in 2011.

Enter Gevo. Established in 2005, the Denver-area company started as a venture capital-funded company to make methanol from methane, but shifted toward butanol. It licensed some university research work from California and made refinements in 2006 and 2007. It has a "landmark patent" on a system called the GIFT, which stands for Gevo Integrated Fermentation Technology. Gevo genetically changes the yeast that produces ethanol so that it produces a four-carbon isobutanol molecule instead of the ethanol. In the GIFT system, the isobutanol molecule is separated through condensation, whatever is left goes back through the fermentation tank

Gevo's 100 percent investment

Gevo is putting up 100 percent of the capital investment for the project.

"They don't have any equity interest in the joint venture so far," Hitchcock says. "If it's successful and they hit certain production targets, they'll back into an equity interest. They could spend $30 million to $40 million retrofitting our facility and if, all of a sudden, they start producing isobutanol and it doesn't produce at the levels they thought it would, their equity interest is going to be very small relative to the existing Redfield Energy investors.

"They're kind of at risk for that, but if they hit certain targets, then they can earn up to a certain equity that's set forth in the joint venture agreement." That amount was determined by analyzing the returns if the company remained in the ethanol business, versus its returns in the isobutanol industry.

Redfield Energy took other measures to protect its investment, Hitchcock says.

"As they put this extension on to our plant, we'll continue to make ethanol until they get to the point where they're ready to tie in the GIFT system," Hitchcock says. "It's expected the changeover will take three weeks. The facility will be designed so that Redfield Energy could convert back to producing ethanol, if necessary, in about two weeks. That was paramount."

The new product is expected to take some of the volatility out of the plant ownership, because there are more markets for isobutanol than for ethanol, Hitchcock says.

Eighty percent of the cost of producing ethanol is the cost of corn, Hitchcock says. If corn were at $6 per bushel, Redfield Energy would probably need roughly $2.25 per gallon for ethanol to break even. If corn is $3 per bushel, the company needs about half of that to break even, or about $1.25 per gallon. "In the five years we've been in business here, I think the lowest price was about $1.25 per gallon but that was okay because our cash price for corn was about $2.30 per bushel at the time. We've made money when we've paid $7 per bushel for corn because ethanol prices were high."

Redfield Energy officials were intrigued with the idea of isobutanol from the start and were quick to act on the opportunity.

The co-op officials were among representatives from four different farmer-owned ethanol plants -- about 40 or 50 people -- who met with Gevo officials in October 2010 at South Dakota State University in Brookings. Gevo said it was looking for a joint venture partner to go with its Gevo-owned venture in Luverne, Minn. Gevo explained that isobutanol is four-carbon alcohol, compared to the two-carbon alcohol that is ethanol -- the form of fuel conventionally produced from corn.

Redfield Energy was the first to put up its hand. In November 2010, the co-op signed a letter of intent to share financial information. By June 2011, the board went to the membership with a joint venture proposal, which was accepted by a majority of all outstanding shares of each class, voting separately.

One issue effecting the positive vote was the assurance that the company could effectively retain the state's ethanol producer incentive program. Passed in 2002, it gave ethanol plants a production payment. "The way the law was written it would only be on production of denatured ethanol made from a cereal grain," Hitchcock says. "We went to the South Dakota Senate and House, and got full support of the South Dakota Ethanol Producers." Hitchcock testified on Senate Bill 100 which passed 35-0, and 62-3 in the House and was signed by Gov. Dennis Daugaard on March 1.

Look, then leap

Hitchcock says members saw the potential in a historic industry shift, and wanted to be part of it.

"It sounded intriguing -- taking corn and being able to produce a molecule that, on a commercial basis, could be used in the petrochemical industry, used to make rubber tires, plastic bottles and anything that could come out of a byproduct of a barrel of oil," he says.

The isobutanol process produces 20 percent fewer gallons than the standard corn ethanol process produces, but the price is 25 percent higher. Gevo's contracts for the sale of isobutanol are tied to changes in the price of corn, only. "Any change up or down in that price of corn gives you a higher or lower price for your isobutanol," he says. "In a sense you've locked into a margin.

"If we produce 4 million gallons of this stuff a month, we can expect about the same amount of net income consistently each month during the year, and the same cash flow each and every month, rather than ethanol," which can swing from a 40 cent margin one month to a 20 cent negative margin. It's taking the volatility out, while still giving an opportunity to earn a profit that historically is twice or three times what ethanol has been.

"What attracted us is there are multiple markets for isobutanol," Hitchcock says. "Ethanol, all that it can be used for is as a blended product for gasoline." Isobutanol, through further refinement can be made into a blend fuel for gasoline, yes, but some of the molecules can be blended for jet fuel, diesel fuel, plastics, high-profit solvent markets and nail polish, among other things.

Ethanol can only be moved in trucks or in a rail car while isobutanol -- because it's a four-carbon molecule like oil -- can be moved in a pipeline.

An advanced biofuel

Corn-based ethanol can't be called an advanced biofuel, even if corncobs were burned to replace the natural gas energy in the process, or if a windmill produced the electricity. Because of the compaction of the British thermal units in a gallon of isobutanol today it's allowed to blend up to 12.5 (percent) in gasoline, versus 10 percent with ethanol. Isobutanol has 25 percent more Btu in a gallon.

Isobutanol also benefits from the Renewable Identification Numbers (RINs) used by the U.S. Environmental Protection Agency. Gasoline blenders have an obligation to buy so many gallons of biofuels a year -- ethanol, cellulosic, advanced diesel, each with its own RIN value. Isobutanol has an RIN value of 1.3 while ethanol's value is 1, and advanced cellulosic ethanol has a 2.5 RIN value.

"It's more costly to produce a gallon of cellulosic ethanol today, but you have that RIN value, which means that the guy at the end who's buying it, doesn't have to buy as much to meet his obligations," Hitchcock says. "That's good because if you have more markets out there for your product, you have an ability to get a higher return, plain and simple." Even with $100 oil and $6.50 corn, the returns are still about 20 percent better than for replacement chemicals out of petroleum, he says.

Of course, there can be price fluctuations in both products, but the projections look good for both farmers and investors.

The retrofit for isobutanol will be in the $1 per gallon cost range, so a plant like Redfield Energy's will cost about $50 million. Gevo raised $123.3 million in an initial public offering (IPO) that ended in March 2011, so presumably it has resources. When completed, the Redfield plant should produce 40 million gallons of isobutanol a year, Hitchcock says. If they get $3 per gallon, it would gross $120 million.

The worldwide solvent market today is $5 billion and the rubber and lubricants (tires, plastics) market is more than $4 billion. The "biojet fuel" market is more than $160 billion. United Airlines is working with Gevo to produce a biojet fuel because countries in Europe are a few years ahead in requiring fuels come from a biosource. "Is it a better fuel than fuel that comes out of oil?" Hitchcock says. "It's the same thing. It may be a little cleaner. It's certainly a lot greener."

Redfield energy gained some confidence because Gevo had purchased Agri-Energy at Luverne. Agri-Energy was started in 1997 by CORN-er Stone Farmers Co-op of Luverne, which itself was established in August 1996. Gevo reportedly paid $20.7 million for the 22-million-gallon ethanol plant and planned to spend $17 million to retrofit it. About 95 percent of CORN-er Stone members voted for the sale.