Cello: A Lesson in Due Diligence
People sometimes ask me how – if they don’t have any particular technical expertise – one determines whether companies are making fraudulent claims. I tell them that the simple test of “If it looks too good to be true…” will work in the vast majority of cases. In the case of Cello Energy, that sniff test could have saved investors some money. Here’s what happened.
I haven’t written publicly about Cello Energy, but I have exchanged several e-mails with people about their claims. I have long been on the record stating that I do not think the prospects for commercialization of conventional cellulosic ethanol are very good. Any time I hear people promising to produce renewable fuel for $1/gallon (or less!), I generally think that those people making those promises are either severely deluded or committing fraud. Cello made these sorts of promises. Cello said they could make $16 a barrel renewable fuel from cellulose – which works out to be 38 cents per gallon.
About six months ago I received an e-mail from someone within the U.S. government asking for comments on the Cello technology (which they described as cellulose to diesel, not ethanol). We ended up exchanging 17 e-mails discussing the technology. I got some general information (publicly available) on what they were doing, and while the person inquiring was skeptical, he took a tour of their plant and told me “it does seem that his plant does do what he says it does, and that he [inventor Jack Boykin] did indeed invent the invention of the century (it is difficult to verify a technology with a simple plant walk through). And there is this nagging thought – could this really be true (it seems too good to be true)?“
In my first response, I noted that it had elements of two technologies I was familiar with, but “seems very similar to CWT’s thermal depolymerization technology.” That technology of course resulted in bankruptcy because it simply could not do what the inventors claimed it could do. I also added “It works, it is just a lot more expensive than advertised.”
In the next exchange, I noted that I would take a very hard look at their energy balance: “Grinding to an extremely fine state can be pretty energy intensive, and then they are adding heat to the process. Have they made it clear how the energy inputs compare to the energy in the final product?“
In additional follow-ups, I noted that they appeared to have a problem with their energy balance. They claimed that they could produce a certain number of gallons of fuel from a ton of biomass, but the feedstock didn’t have as many BTUs as did the final fuel. So I noted that unless there were other energy inputs “that claimed number does not seem possible.“
I was asked if it was reasonable that they would have spent $12 million on a plant that didn’t actually work, and I responded: “I have seen people throw away more than $12 million on an idea that doesn’t work. It just depends on whether it appears to work, and whether the scientist/engineer who is the inventor is a good salesman.”
Now despite all of these e-mails, I couldn’t say with 100% certainty that their technology did not work. I just saw a lot of warning flags, and wanted to point out some things that he should probably look into. I didn’t hear back from him for a long time, but then I saw a story that said that Vinod Khosla had invested in the company. I wrote and asked for an update, and here was part of his reply:
I have assessed a couple different aspects of the technology such as the energy required for grinding. My analyses suggest that they cannot do what they say that they can do because the energy demand is too great. While my analysis shows that grinding down to the fine size that the process requires would require several times more energy than what the entire process consumes, the inventor reassures me that because most of the grinding occurs in the liquid phase using hot product as the liquid, the energy demand from grinding is vastly reduced. While what the inventor says is possible, I cannot verify it.
So he validated my concerns about the energy balance, but the inventor assured him that he had found a way around that sticky problem. (If it were only that easy; to do the grinding in hot liquid!) So far, this one still isn’t passing the sniff test, but once again I don’t have enough information to conclude that fraud is taking place. But I have enough information that I would be hard-pressed to give them any money.
But now a jury has ruled that they have indeed committed fraud. Two really good stories on this from earth2tech:
From the first story:
As far as speed bumps for cellulosic ethanol ventures go, this one’s a doozy: Jurors in a federal court have ordered Cello Energy, a biofuel startup run by Alabama’s former ethics chairman, Jack Boykin, and backed by both Silicon Valley cleantech investors Khosla Ventures and pulp maker Parsons & Whittemore Enterprises, to pay more than $10.4 million in a fraud case.
Cello reportedly accepted a $2.5 million investment from P&W in 2007 to help finance its first plant. Several months later it received a $12.5 million investment and a pledge for up to $25 million for construction and operation of additional plants from Khosla. Cello agreed to use discounted wood waste from the company as feedstock, but “a string of witnesses testified that samples of the fuel allegedly produced at Cello’s facility…were derived entirely from fossil and not renewable sources,” the Alabama Press-Register reports. This week a jury in Mobile, Ala., decided that Boykin’s original claims (made with his partner and son Allen Boykin) were fraudulent.
The second story sees a silver lining here. If the targets fall short of projections, there will be even more money available for cellulosic ethanol (but I still think there is confusion here over whether this is an ethanol or diesel process; I think the claimed process is actually cellulosic diesel):
As the research firm ThinkEquity notes in a new report, if cellulosic ethanol production falls short of the U.S. EPA’s estimate of more than 100 million gallons next year, new incentives are supposed to kick in to support production the fuel as part of the proposed Renewable Fuel Standard update, or RFS2, which is slated to increase the amount of renewable fuels that must be blended into gasoline.
In the event of a shortfall (not enough renewable fuels to meet minimum blend requirements), ThinkEquity wrote in its report late last month that the EPA can sell credits that would increase the value of cellulosic ethanol to a minimum price of about $3 per gallon (up from ethanol futures’ current $1.77 per gallon).
The story notes that the reason for the EPA’s 100 million gallon estimate was that they were counting on 70 million gallons from Cello! I have said it before, and I will say it again loudly: CELLULOSIC ETHANOL IS NEVER GOING TO MEET THE PROPOSED RAMPED UP PRODUCTION LEVELS. Too many uninformed boosters have done too little due diligence, and we get all sorts of ridiculous expectations. Back to the first story above, they noted how careless investors were in throwing down money on the project:
…P&W and Khosla Ventures weren’t exactly diligent. The excuse? P&W CEO George Landegger said he trusted Boykin after he promised to invest his own money in the $25 million project. For Khosla Ventures, whose founder Vinod Khosla has called cellulosic biofuel his “real love” and invested in more than a dozen biofuel companies, due diligence was not necessarily a deal breaker, and according to emails revealed in court between Khosla and partner Saul Kaul, Boykin refused to give the investors enough time for due diligence. That made the deal “nerve-wracking” for Kaul, but Khosla wrote, “Great job on this one. Herculean effort. But my bet is it will pay off.”
My bet is that it won’t. I think Khosla and the others have simply been scammed. While I appreciate Khosla’s desires to “to use his wealth to fight the war on foreign oil and for energy independence”, sometimes it feels like he is just scattering a lot of money around in the hopes that something – anything – will work. In this case, it looks like he was betting on a miracle, another in a long line of companies claiming “game-changing technology.” Maybe things will turn out OK. But this entire story has all the earmarks of so many biofuel pranksters who came, promised, fleeced investors, and failed. I can promise you one thing: Whether they make fuel or not, it won’t be for $16/bbl.
As I noted in my previous entry, one of my jobs going forward with my new company is to make sure we don’t get tangled up in situations like this. But based on the limited information I had, I would have steered us clear of Cello. On the other hand, I will continue to look for companies that can actually deliver on their biofuel promises. So feel free to send me your $25 million. It will be in good hands.