Portrait of a Transformative Technology: Qteros and its Q Microbe

In Massachusetts, Qteros has been gaining heavy support in the Transformative Technologies poll – far more than you get from marshaling all the friends, Romans and countrymen associated with  a 50-person, early-stage company in the business of consolidated bioprocessing.

In fact, I remarked to Qteros CEO John McCarthy that, had the company been renamed QAlgae, it might well be #1 in the polls.

Qteros – the backstory

For those less familiar with the Qteros story, the company is developing its “Q Microbe” as a licensable key technology for consolidated bioprocessing. This organism, discovered several years ago in Massachusetts, is a natural consolidated bioprocessor, expresses requisite enzymes for the extraction of fermentable sugars from biomass, and co-ferments all the C5 and C6 sugars into ethanol.

It’s a remarkable bug that has been substantially optimized by Qteros’ biology program, which recently received its foundational patent for the optimized micro-organism, now tuned for the right quantity of enzymes to maximize yield, and for tolerance of ethanol on the back end.

“The patent was very broad – issued including all the key claims, focusing around the unique organism from 4 years ago,” McCarthy noted, while pointing to a raft of patents that can be expected in the future.  “We’ll have an extensive portfolio around this foundational patent.”

McCarthy arrived less than a year ago from a long stretch at Verenium, where he was the key executive in the strategic partnership and investment from BP. Before Verenium, he was at Microbia.

“The company needed rework and organization,” he recalled. “It needed a grounded strategy, and to early get into licensing mode – asking ourselves what kind of partners we really needed, and looking for large scale strategic partners to fill those roles, with a 5-20 year perspective. We needed to be generating larger scale data from participating in pilots already underway in the industry. Above all, we needed to focus our strategy around the key question:  what is the lowest cost?”

Cost, cost, cost. There have been innumerable announcements by innumerable bioenergy companies of “$1 per gallon” or “competitive with $40 oil.” But as Advanced Biofuels Association president Mike McAdams challenged listeners at FEW earlier this week, “Show me the gallons.”

Gallons — that’s what policymakers, investors, and the public want. With so many announcements of big partners like Shell, BP, Exxon, and so many companies  talking about the low cost of their fuels, where is the gallonage in cellulosic ethanol?

“I know, in excruciating detail from the Verenium years, that its the lowest cost that will succeed, and that it’s at the scaled design level that it happens. I well remember BP’s view of the designs to date, and knowing Abengoa and others, there’s no mystery about the difficulties of commercialization and optimization in a low cost manner,” McCarthy said. “The industry needs to reach $1 per gallon to be competitive at large commercial scale, and we are not there yet. And we have about 12-24 months or we will not continue to have political support.”

The Qteros edge

Here’s where Qteros has staked its all, on a licensing strategy for its consolidated bioprocessing technology. The company believes it will reduce, by $50 to $100 million, the capital expense for cellulosic ethanol at scale, and dramatically lower the operating costs.

That’s the essential promise of CBP – by having a magic bug that will extract sugars from biomass, and at the same time ferment those sugars into ethanol, you have a smaller, more consolidated design — compared to systems that have hydrolysis, and then move the sugary broth to a fermenter system to convert into ethanol. Savings on steel, savings on enzymes, savings on people.

“These are not aspirational, but actual savings,” McCarthy contends, “and our advantage is that we are focusing not on the creation of an organism that will perform consolidated bioprocessing, but on optimizing the one we already have.”

The players, the feedstocks and the geographies

Qteros is keeping mum about its partners and its work with various cellulosic pilots, except for a publicly announced participation with an NREL project. McCarthy is not keeping mum about the feedstocks, which in the end drive the location of the pilots and the companies that have strategies to use those feedstocks.

He says it plainly: “We are focused on canes and grasses, as opposed to woods. Energy crops are the way we see that scale plays out. In the US, there’s the corn belt, and we like corn stover although its hard to see much of a scaled market there. We see opportunities with wet distillers grains, which is not novel, but we think we have a way to make it interesting. In the US, there isn’t much right now in the way of canes and grasses, other than small things in the Southeast. We see a lot of potential in Brazil, India and even China, and especially with bagasse.”

So, despite their avowed interest in the US corn belt — for Qteros, think offshore. That magic bug from Massachusetts will need to have its passport ready. And it wouldn’t take a rocket scientist to speculate that Qteros is deep in discussions with Tropical Bioenergia, a joint venture between BP, Santelisa Vale and Maeda Group, which is developing 264 Mgy in sugarcane ethanol capacity. The project is scheduled to open this year in Goias state, northwest of Sao Paulo in the heart of sugar country. BP is an investor in Qteros.

The Tropical Bioenergia venture will not only refine fuels, but will farm the cane, and will have a lot of bagasse. In the near-term, bagasse is burned to generate renewable power for ethanol processing, and often creates a side business distributing power up to the Brazilian grid.

But burning bagasse is a low-value play – better to extract the sugars from the hemicellulose and then, conceptually, burn the residual lignin pellets.

Readers of Biomass Digest will know, from our report this week on lignin, that there are even higher value opportunities than simply burning lignin. But even if one is only combusting the lignin,  it has similar BTUs properties to coal and a lot less ash, not to mention the clean energy benefit in CO2 emissions.

If BP is not your preferred flavor this month, think Soros, another investor in Qteros. Soros Capital Management has announced a plan, through its Adecoagro unit, to increase its cane-crushing capacity from 4.8 million tones to 11 million tones by 2016, and is in the process of building its own 6-million tonne cane processing unit in Mato Grosso do Sul. They are even, reportedly, looking at an IPO to raise funds for Brazilian expansion. Soros is also an investor in Qteros.

Soros, BP — those are our guesses for Qteros, which has its corporate lips tightly sealed. The other massive source of bagasse is in India — but sugar and ethanol are, to put it mildly, in some degree of chaos after the failure of the sugar crop last year. Our guess is that conversations there may well have started, but it would take a real visionary to project out India’s ethanol strategy over the long term, right now.

McCarthy is bullish about the pace of international development. “Here in the US we’re in 1st gear, vs 6th gear elsewhere. The pace is a lot more aggressive overseas.”

The Pilots

But back to the question of pilots. How many, where and when? “By end of 2011, our goal is broad, commercially reliable data from pilots at multiple facilities. I know that may sound aggressive.”

Got that right, John.

But as he notes, development in cellulosic ethanol is gaining traction on an international basis, and there are more pilots to work with across the US and overseas.

The Markets

OK, back to markets. I did agree with John that energy canes and grasses are a viable strategy — if less suitable to the US, where Qteros has hitherto been better known. I did wonder, given that the Q Microbe can fully ferment C5 sugars (a tough scientific challenge), why the company is not looking at partnerships with pulp and paper mills, with their rich supply of C5 sugars in the black liquor waste streams.

“We’ve had some conversations with the usual suspects,” McCarthy responds, “but not a compelling enough opportunity. There are time interesting C5 opportunities — pulp and paper is a sector where our organisms could be uniquely applicable. But my experience is that pulp & paper industry —well, they’ve got significant issues themselves, and  a C5 project is interesting but not strategically critical to them.”

Got it. So what about renewable chemicals – hot markets generating real sizzle throughout the investment community?

“We’ve very interested in chemicals,” said McCarthy. “For sure, a cheap sugar platform that utilizes the organism will have opportunities with high value organic acids and chemicals, and a higher price point. But I would argue at same time – there are tougher competitors in the chemicals space. BASF, DSM, Dupont, Dow, I have a lot of respect for the large scale chemical companies, I would caution that that industry is a lot harder to break into than it may seem. It’s all about the lowest cost of sugar, really. That’s the reason our West Coast brethren are all looking at Brazil and other places for cheap sugar – they have long chain molecules that require a lot of carbon.”

So, Qteros, how cheap is your sugar?

Alas, McCarthy ducked the direct question. “It’s really hard to put production data in the marketplace. I saw this in living color at Verenium. Costs aren’t costs – there are apples and oranges, and it totally depends on the design you are working with. When we do put out data, we will put it out in a way that is transparent and comparable. What I have learned is that the best way to measure commercial progress is to measure the commercial and strategic investments and partnerships. Overall, though, as far as production rate and yield, rate is not a problem, yield is always a challenge, but we are optimizing yield and are ahead of commercial metrics now.”

The Political Ask

No discussion of an early-stage venture would be complete without a look at its political strategy, the policy “asks” that are critical to its success, and how those line up with the realities in Washington. As any biodiesel producer can tell you who has suffered through the unrelieved agony of the renewal of the biodiesel tax credit in 2010.

What’s on Qteros’ radar? As a licensor, it may not need, for example, loan guarantees – but they are considered critical to the development of pilots, and the moving of pilots to scale. For Qteros, that’s critical to its testing strategy – critical to the scaling of its customer base.

“There’s so much swirling around loan guarantees,” McCarthy said. “We’ve seen Matt Rogers and all those guys [at DOE] – who have taken us through the complex mechanical, financial challenges. But here’s too much focus on the loan guarantees. The hard work was already done, with the RFS.”

Well, that’s a unique thought. If I had a dollar for every conversation with a biofuels processor that included the phrase “loan guarantee”, I might well be able to finance a project or two myself. “In RFS, there’s a policy that has opportunity to be sustainable and durable. It has a pricing mechanism baked into the RINs. It has demand scaled in. It’s just that the supply’s not there. But if the government would get behind the RFS, stand behind it – loan guarantees become less of an issue.”

OK, we’re officially listening.

“Between the tail end of 2007 and the beginning of 2008, there was a sea change in sentiment – companies came to the table, accelerated the discussion, major oil and ag. It was the RFS that did that. When EPA stepped in and took the RFS from 100 million to 6 million this year — and everyone knew 3 years ago that the production wouldn’t be there – it wasn’t the delta, it was the act.”

That’s a unique perspective. Remember that the EPA waived the cellulosic ethanol mandate from 100 million gallons down to 6 million, because projects like Range Fuels and Cello Energy either didn’t happen or were coming online late.

“If the EPA is going to waive the mandate to match the supply, then do away with the RFS, there’s no need for it. There are teeth behind RFS, get behind that as a 15 year policy. OK, there are mandates this year and next that won’t be met, but if you enforce the RFS, it will be a nominal tax to the oil industry, and it will make them invest and plan capital. It will drive them to do it. The big companies will get the balance sheet out. Right now [you go the DC] and its like, “you have BP, Shell, ExxonMobil as investors, and you guys can’t  raise $300 million without a loan guarantee? – come on.”

So, enforce the RFS regardless of the planned capacity that is (or isn’t) coming online?

“This is all about who’s is going to bear the risk. The mechanism is in place – stand behind that. That depressurizes the discussion about BCAP and loan guarantees.”

The Capital

Speaking of capital, we concluded our look at Qteros with a brief chat about the company’s own capitalization plan. Is another funding round in the offing?

“Our last capital round was at the tail end, the second half of 2008.” McCarthy said. “We’re 50 people, there’s no building of sizable pilots, and we’ll never more than about 70 people. But we will do a round in the next 6-12 months, with an element of creativity. We have all we need in deep pockets, but we’ll look for another strategic or broader partner who brings more than just money. That round will likely take capital requirement off table for a long time, and could be the last round.”

Last thoughts

So there you have it. The Q Microbe looks like it will be a-travelin’.

In a word, think “Q micróbio”.

And think about those comments about RFS. An interesting perspective worth a long, long look by supporters of bioenergy. Will a policy of “no blinking, no winking at EPA” get it done? All roads in policy lead to the White House – the agencies are simply the agents of policy implementation.

So that’s a challenge not only for the Interagency Working Group on Biofuels, but for the current occupant of the Oval Office. “We will make BP pay for the damage their company has caused,” Obama promised the nation this week in a televised address from the White House. In RFS, he not only has a means of restitution, but a means of making the country less dependent on the drilling that he so recently, if cautiously, embraced.