(Reuters) - The great promise of a car fuel made from cheap, clean-burning prairie grass or wood chips -- and not from expensive corn that feeds the world -- is more mirage than reality.
Despite years of research, testing and some hype, the next-generation ethanol industry is far from the commercial success envisioned by President George W. Bush in 2006, when he pledged so-called cellulosic biofuels would be "practical and competitive" by 2012.
Instead the only real alternative to traditional gasoline is ethanol made from corn, a fuel environmentalists say is not green at all because of the energy-intensive nature of modern farming.
Critics say it is a failure of government policy, not science, that the U.S. is still so dependent on corn for its biofuels. Washington has backtracked on cellulosic ethanol production targets and failed to provide assurances to investors that the sector would be subsidized over the long term.
While there are dozens of pilot and demonstration cellulosic ethanol projects around the country, the groundwork for the first commercial plants is only now getting underway.
Battered by recession, funding remains scarce for $100-million-plus plants needed for commercial-scale production so cellulosic can compete against cheaper ethanol-based corn.
"The earliest you're going to see efficient cellulosic ethanol is five years," said Richard Brock, president of Brock Associates, an advisory firm in Milwaukee.
For the industry to take off, investors need to be reassured that Congress will extend a cellulosic production tax credit for several years and cellulosic output targets will be big enough to encourage blenders to lock in future capacity.
"It would certainly increase volumes at a faster rate than what we've seen in the last couple of years," said Mac Statton, biofuels analyst with the Energy Department's forecasting arm.
Gasoline in the United States is blended with up to 15 percent ethanol, which helps reduce oil imports.
In the short term, however, the cellulosic industry's slow growth will make little difference to either America's addiction to foreign crude oil or the strains on corn supplies that critics claim have pushed up food prices.
Cellulosic biofuels production was supposed to reach 500 million gallons next year under federal mandates that rise each year until it eventually passes corn-based ethanol output.
But no cellulosic production is expected this year and it may grow to only a few million gallons next year.
Because the cellulosic industry is not able to meet the production goals mandated by Congress, the Environmental Protection Agency has the authority to lower them.
That's what the agency did this month for the third straight year when it proposed lowering the original half billion gallon target for 2012 to between 3.6 million and 15.7 million gallons. EPA issues the final target in November.
The Energy Department doesn't expect cellulosic output to reach its first 1 billion gallons until 2018. Congress, under its mandates, wants 7 billion gallons that year.
The industry has made great progress in bringing down the production costs of cellulosic ethanol from $5 to $6 a gallon a decade ago to as low as $2.50. However, the first cellulosic plants are expensive to build and will add to that $2.50 cost, putting cellulosic slightly above corn ethanol's cost.
GOVT HELP FOR COMMERCIAL-SCALE PLANTS
Coskata Inc. was given a $250 million federal loan guarantee in January to build a 55-million-gallon a year plant in Alabama to process wood biomass into ethanol. POET LLC, the world's biggest ethanol producer, was awarded a $105 million loan guarantee this month for a plant in Iowa to produce 25 million gallons of ethanol from corn cobs starting in 2013.
Other companies aiming to produce big volumes of cellulosic ethanol or provide enzymes that break down cellulose feedstocks are DuPont's Genencor, Abengoa Bioenergy, Qteros and Novozymes A/S.
About $1.5 billion in venture capital poured into the cellulosic industry to help fund initial pilot projects over the last decade, according to the Advanced Ethanol Coalition that lobbies for the industry.
As cellulosic producers move to large-scale operations, venture capital investors are reluctant to bet on the expensive $150 million plants, said Brooke Coleman, who heads the coalition.
"The venture capital guys will spend $20 million or $30 million on you in the start-up phase," he said. "They don't build plants and like to get in and get out in five years."
It is the big banks, oil firms and major energy companies that will help finance the new commercial-scale plants, but many are scared off by the uncertainty over the $1.01 tax credit and changes in production goals.
Analysts argue that with oil prices high, it should be easier for cellulosic biofuels to attract investors, but incentives from Congress are a big question mark.
A draft bill unveiled in the Senate would extend the $1.01 per gallon tax credit for three years and add ethanol made from algae to the list of cellulosic biofuels eligible to get it.
Extending the credit for cellulosic ethanol is part of a compromise for Congress to end a 45-cent-a-gallon tax credit for corn ethanol, which is exceeding its production targets.
But with lawmakers looking to cut government spending, cellulosic producers may be lucky to get a one-year extension.
"How the hell do you extend a tax credit for a multi-year period, when there's no money in the Treasury," said Christine Tezak, energy analyst at Robert W. Baird.
All the uncertainties, however, hurt the industry. Refineries that blend the fuel don't have a reason to sign long-term contracts with biofuels producers, which would encourage investment in new plants and boost output.
"There's no incentive for anybody on the consuming side to ring up a cellulosic guy and say: 'Hey, I'd like to take care of my renewable fuel standard obligations for the next five years, so I need to secure not only present but future production capacity with you,'" said Tezak.
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