Kick Start

“The last thing Brandon wanted to do …” is how the typical newpaper article begins. I guess you could call that introducing the hero. Or maybe it could be called hero based journalism. If Brandon’s a celebrity all the better. So, here we go …

Vinod Khosla, founder of Sun and a former Kleiner Perkins VC, wants to kick start a change in the planet’s energy economy.

Sorry, I don’t seem to be able to quite pull this off. Well maybe with more practice.

In anycase you can see Vinod’s sales pich in this Google video. In short the arguement he makes is that a) Brazil has demonstrated that ethanol is cheaper than oil, b) it’s trivial for the existing installed base to switch, c) this politically doable, and d) there are is the potential the technology will make the whole thing even more compelling.

I once watched two old brothers who ran a jewlry story argue with other about the price of a engagement ring; so their customer wouldn’t have to. Such service! He’s doing a pitch; and he’s very practiced at it. It’s alwasy fun to watch a master at work as his craft. The video is fun to watch as theater.

A sophisticated entrepeur knows that the only problem worthy of his attention is how to coordinate the parts to create the change he’s hoping to achieve. For a platform vendor the hardest part to move is his installed base. Changing the energy economy is hard because the entire system is so deeply woven into the fabric of society. It’s clear that a portion of what attracts Vinod to ethanol is that moving the installed base appears plausible.

Installed bases are hard to move because they are interlocked in complex patterns of complementary bits and peices. They are like a house of cards; you can’t move one card; you need to move them all. So the entrepeur looks for places where he can slip a new card into the structure. The installed base sees these moves as risky and it’s natural response is to reject them. You need to have a significant dose of benefit to overcome the resistance; the switching costs.

The installed base is a network with the usual collective costs and benefits (network effects); a house of cards in a kind of pseudo equalibrium. Society and it’s entrepeurs have lots of tools for trying to reshape these systems and it’s interesting to see which ones Vinod is advocating we should pull on.

The dominate A-frame in the structure of the petroleum market is, to here Vinod tell it, the two sided network effect who’s touch point is the gasoline distribution system. Petrol production on one side, it’s consumption on the other. Vinod, the entrepeur, sees that system as caught in an unfortunate equilibrium that is no longer optimal. The capitalist entrepeur looks at that situation and sees a fortune to be made.

Just as the way Windows is a virus platform and phisher’s delight, the transportation fuel platform is in desperate need of a major upgrade. Unlike Windows this fuel platform lacks a single vendor to coordinate finding a solution. I guess that’s good or bad depending on your mood. Lack of a central coordinating entity can be good for innovation; the example of Brazil’s success (note that I’m taking Vinod the pitchman’s word for it) is an example of that.

In the absense of a central coordinating force it can be very hard to move a two sided network. My standard model for this a bridge over a river. If you build a second bridge far from the first one nobody will go over it because you don’t have the infrastructure to support the bridge on either side. The puzzle is how to get the bridge bootstrapped. You need to create a situation where their is supply, demand, and a bridge all at one. I.e. you need to lean the two cards against each other just right so they stand up.

Vinod’s pitch for high ethanol petrol substitutes is that we are almost there. There are lot of cars on the road today that can use both fuels. Who knew! And, it’s not terribly costly for auto makers to make more. We know how to make ethanol at very reaasonable prices. But, we don’t have hardly any gas stations that carry the stuff.

So Vinod wants the central goverment to mandate some things to “kick start” the transition. He wants 10% of the petrol stations forced to sell high ethanol gasoline substitutes (the so called E85). He argues that this is necessary to give “wall street” the confidence it needs to build the ethanol production facilities. It’s not hard to object to that. Presumably if you create a fuel that’s significantly cheaper the gasoline you wouldn’t have much difficulty finding buyers. In turn it’s not hard to counter that objection buy pointing out that the situation is more than urgent, it’s desperate. But that arguement isn’t really what facinated me.

What facinated me in Vinod’s pitch was pondering about motivations. This is a huge transformation and different actors in the game have very different motivations. For example Bill Gates would probably be motivated by the idea of owning the transportation fuel platform. There was one slide the Vinod pop’d up at one point showing that the poorest regions of the planet are probably the best venue for the crops that become ethanol feed stocks.

Possibly because his audience was a bunch of Silicon Valley geeks at Google Vinod spent some time talking up the latent possiblities of biotechnology for making ethanol even cheaper. I swallow that hook line and sinker. It appears to me that there is a lovely confluence of opportunity there.

But, I can’t help wondering. What patent rights Vinod is working to capture and where on the planet he would build his first half dozen ethanol plants. Assuming, of course, he can get the kick start problem resolved. On the otherhand nothing is a distructive to fixing a tough problem like this as getting fixated on the other actors’ motives.

Meanwhile the hacker/DYI/small-is-beautiful crowd will enjoy this page on making your own ethanol still

One thought on “Kick Start

  1. James

    In Australia, ethanol is a political issue. It’s widely assumed that the subsidies for ethanol-fuel production exist as a vote-buying method in the sugar-growing electorates and possibly also an insider deal as the head of the major ethanol producer is a friend of the PM and met with him (although possibly only about protection from Brazilian ethanol imports) before the most recent subsidy was announced.

    So, currently up to 10% ethanol is allowed in fuel sold, and there was significant pushback from car manufacturers and automobile associations for that level, let alone any higher. There was also a study done in 2001 that looked at the production cost of ethanol vs petrol and concluded it was not economic. Of course, since then the Austrlian dollar has strengthened but the cost of oil has also tripled, so by my rough estimates it’s about cost-neutral at the moment, if as according to this backgrounding document ethanol costs AU70c/L to produce, and has a 65% efficiency per litre vs petrol. The study above did look at Brazil, and says (summarized, stupid copy-controlled pdfs):

    – 56% use of sugar cane for ethanol production, 93% of which goes to fuel
    – requires market intervention, including
    – the state oil company purchasing guaranteed amounts of ethanol at a price cross-subsidised from taxes on conventional fuel
    – economic incentives to sugar cane ethanol producers, inc. low interest loans
    – ethanol subsidised to be priced 60-85% of gasoline which is double the US price due to tariffs
    – was initiated in response to the oil shocks of the 1970s, on the basis high oil prices would continue or increase further
    – but (in 2001, when the report was written) had not happened.

    It also mentions a world bank report on Brazil’s sugarcane sector from 1994 and quotes (although I can’t find it in the world bank report)
    “because of the ‘lock in’ effect of the range of Brazilian market intervention policies to encourage sugar cane based fuel ethanol production and use over this period since the oil price hike, Brazil has been unable to gain the benefit of the real reduction in the world crude prices”

    Sorry to not have anything to say about the topic you’re actually interested in, but it does seem as if there was a central coordinating force in Brazil’s move to ethanol. Also the US would probably want to stop the sugarcane subsidies that make corn sugar cheaper, but that’s a whole ‘nother argument.

    Some more urls:
    http://www.smh.com.au/news/national/ethanol-will-cut-petrol-cost-pm/2005/09/23/1126982233640.html
    http://www.onlineopinion.com.au/view.asp?article=803
    http://www.affa.gov.au/content/output.cfm?ObjectID=C966A946-0DB8-4BD3-9EE73220FF10D630
    http://au.finance.yahoo.com/q/bc?s=AUDUSD=X&t=5y
    http://futures.tradingcharts.com/chart/CO/M
    http://www.google.com/search?q=site%3Aau+ethanol

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