Kermit the Frog was right: It's not easy being green.
It was originally envisioned that a product created from renewable chemicals or resources would be entitled to higher selling prices. Same or similar product, same market, but worth a little more because of the environmental stewardship contained within. This extra markup is called the Green Premium -- and, in most cases, it's a total myth. In order to fully compete with market incumbents, in this case, petrochemicals produced from non-renewable resources, renewable chemicals must match or best performance, functionality, and price.
Many companies that produce the renewable chemicals that become the "green products" you know and love have discovered that the hard way. While some have accepted the challenge head on, other companies have led investors down dangerous, money-losing paths. Therefore, investors need to consider the competitiveness of a technology platform, not just it's sustainability. Let's take a look at the competitiveness of three renewable products -- all at different stages of development and commercialization -- from DuPont (NYSE:DD), Braskem (NYSE:BAK), and Solazyme (NASDAQ:TVIA).
- Company: DuPont, "the veteran"
- Renewable product: Bio-PDO
- Production since: 2006
- Applications: Polymer fibers, anti-freeze, liquid detergents
DuPont is associated with petrochemicals and genetically enhanced agricultural seeds, but it's also a quiet leader in industrial biotech. The company's industrial biosciences division generated $1.26 billion in sales in 2014 at a gross profit margin of about 16% by using fermentation to manufacture enzymes, cellulosic ethanol, and a handful of other green chemicals. That includes the flagship industrial chemical: renewable 1,3-propanediol, or bio-PDO, which is converted into polymers that find use in everyday applications ranging from carpet fibers to clothing.
Bio-PDO boasts several environmental advantages over the petrochemicals it supplants in the marketplace. For instance, production of DuPont's bio-PDO consumes 40% less energy and emits 40% fewer greenhouse gases than the production of petroleum-based PDO. But the advantages don't stop there. After production, bio-PDO can be converted into renewable polymers such as the company's Sorona brand while reducing greenhouse gas emissions 63% compared to the production of petroleum-based polymers such as nylon.
Sounds pretty great, right? While it is a remarkable product manufactured to the tune of 45,000 metric tons annually, DuPont's bio-PDO doesn't come with a Green Premium. Instead, the chemical is cost competitive with petroleum-based PDO and other polymers, although specific applications of Sorona are accompanied by increased functionality. For instance, Mohawk SmartStrand carpets produced using Sorona are naturally stain-resistant, whereas nylon carpet fibers must be treated chemically to offer homeowners the same benefit.
- Company: Braskem, "the rising star"
- Renewable product: Renewable ethylene
- Production since: 2010
- Applications: Plastic bottles, polymer fibers, liquid detergents
Chemical manufacturers could spend nearly $124 billion expanding existing or building new petrochemical facilities within the next decade or so, according to The American Chemistry Council. The capital expenditure binge is fueled by the race to build infrastructure capable of converting ethane, a component of natural gas, into the building block chemical ethylene, which is the starting point for various everyday plastics, adhesives, fibers, and more. A lack of infrastructure has resulted in nearly 300,000 barrels per day of excess ethane production in the United States, which has pushed its price to near-zero levels.
Despite favorable economics for the future of ethylene production, South American chemical leader Braskem has pioneered a process for converting ethanol into ethylene. Since the ethanol is ultimately created from renewable sources such as sugarcane the company is able to market the resulting product as renewable ethylene, which is chemically identical to petroleum-based ethylene in every way.
While nearly 80% of the production from Braskem's 200,000 MT-per-year facility was sold before construction even began, renewable ethylene is sold on a cost-competitive basis with its petroleum counterpart. However, it seems unlikely that production costs will compete with ethane-to-ethylene manufacturing in the United States anytime soon. That could handicap the product to a small niche market globally and hinder expansion, although cost advantages over another petrochemical process for manufacturing ethylene could make it the preferred production route for certain regions, including Europe.
- Company: Solazyne, "the new guy"
- Renewable product: Biodegradable drilling lubricants
- Production since: 2014
- Applications: Oil and gas well drilling and completion
When an oil or gas well is drilled thousands of feet below the ground, well operators must carefully select lubricants based on the subterranean geology, depth of the borehole, and type of equipment used. The first goal may be to protect expensive drilling equipment from mechanical failures, but the second goal is to complete the first goal for the lowest cost possible. That can be more difficult than it sounds, especially since drilling speed, operational downtime, and additive costs must be factored into the equation.
Renewable oils manufacturer Solazyme markets Encapso drilling lubricants that can be used to protect expensive drilling bits from wear and tear by reducing friction, which increases drilling speed and reduces the time needed to complete an oil or gas well.
In contrast to other drilling lubricants produced from petrochemicals, Encapso drilling lubricants are manufactured using renewable resources and are fully biodegradable. In fact, the lubricating oils are encapsulated in inert algal cells ("algae" cells), which offers precision lubrication where it's needed most.
Unfortunately, Solazyme hasn't had much success selling large quantities of Encapso. While many of the commercialization hurdles could be derived from the company's inexperience in the oilfield services industry and more established competition, the company needs to achieve substantially lower production costs in order to compete with less sustainable alternatives readily available in the market. Investors may not receive the Green Premium they expected from Encapso, but a distribution partnership with Italian oil and gas company Eni could provide a little relief in the year ahead.
What does it mean for investors?
Renewable chemicals are a nice-to-have, but many commercial customers don't make it a priority when making supply chain decisions unless the green product competes with market incumbents on performance, functionality, and price. While some consumer-facing companies and brands will pay a little more for sustainable chemicals, their purchasing decisions are made selectively and quantities remain limited. As a result of the market's hesitance to pay a Green Premium, successful chemical manufacturers have adapted by lowering production costs or enhancing performance to draw even or close the competitive gap.
What's the lesson for investors? Simply put, there is no Green Premium. It isn't wrong to factor a product's manufacturing process into your investment decisions (I'd encourage it), just don't expect renewable products being sold into massive markets to be successful solely for being green. It's not that easy.