Silicon Valley investor Vinod Khosla chats about the promise of ethanol

Billionaires are piling onto the biofuels bandwagon. Bill Gates is doing it. Richard Branson is doing it. The Google guys are doing it.

Less well-known is the billionaire who kicked off the whole trend: Vinod Khosla, a cofounder of Sun Microsystems and former partner with Kleiner Perkins, the venture-capital firm that helped give rise to Google, AOL, Amazon, and Compaq. In 2004, he founded his own firm, Khosla Ventures, which has come to be known as a rainmaker in the ethanol world.

To hear Khosla tell it, the burgeoning revolution in oil alternatives will be bigger — way bigger — than the internet revolution of yesteryear. Biofuels won’t just boost the American economy, he says. They’ll help stop global warming, they’ll alleviate global poverty, they’ll solve our geopolitical woes.

“Just starting another Sun doesn’t do it for me anymore,” Khosla told The Economist earlier this year. “I’ve decided that I’d better focus on taking on problems that really matter, so that when I win, it makes a difference to the world.”

From lobbying in Washington to luring more big-money investors, Khosla has become one of the most influential biofuels evangelists in the world. As such, he has a message for greens who are griping about the environmental costs of corn ethanol: Get a grip. Khosla spoke with me from his home office in California about the risks and promise of the biofuels trend.

You made your fortune in bleeding-edge digital-technology investments. Why did you shift your focus to energy technology, especially something as low-tech and primitive as ethanol?

When I was at Kleiner Perkins in 2001, around the time that the internet bubble burst, I was looking at what you might call the “traditional” venture energy sectors — fuel cells, hydrogen, all that. I began to realize that while fuel cells made sense as a stationary electricity source, hydrogen fuel-cells made little sense for cars. Over the five- to seven-year horizon, there was way too much risk, too many unknowns about technology. Then a biofuels plan from a company called Celunol crossed my desk. I turned it down because the business plan had problems, but there were elements I found extremely intriguing. That’s when I started reading everything I could get my hands on about petroleum alternatives. Almost two years later, I invested in Celunol.

What was so intriguing?

Gasoline is about 60 percent of our oil use. Given the rising cost of oil and its environmental consequences, I said, that’s a worthwhile problem to work on. I saw in biofuels a liquid fuel solution that didn’t require the whole world to change. It didn’t require the engines to change dramatically, it didn’t require the pumping stations to change much. And I realized two other critical factors: biofuel markets wouldn’t need subsidies to compete economically with fossil fuels, and two, they could scale to replace all of our gasoline use.

What time frame are you thinking about?

Twenty-five years. I believe we can replace most of our gasoline use in that time frame with fuels from farmed biomass and waste, both municipal and agricultural.

Of course, the time frame is contingent on several things: We must see the fuels and the engines that burn them become steadily more efficient and have ever-better performance; they must become increasingly affordable; and, most important, we must see steady growth in the yield per acre of farmland. All of these are very manageable challenges.

Let’s start with the farmland issue. Right now, America consumes some 140 billion gallons of gasoline a year. Isn’t it going to require a heck of a lot of agricultural production to replace our gasoline needs with biofuels?

I’ve spent a lot of time researching this issue. Being environmentally very concerned, I didn’t want [the biofuels solution] to increase the amount of land we already have in agriculture. I looked at what would happen if we grew biofuels just on the 40 million acres or so of so-called “CRP lands” where we don’t grow food, we just pay the farmers not to grow food, as well as the 80 million acres of export crop lands, where we grow food to export it — something the developing nations really object to, because these subsidized exports jeopardize their own farm industries.

My analysis shows not only that the combined 120 million acreage could comfortably supply our biofuel needs and much more (like diesel fuel and petroleum plastics replacements too), but also other significant benefits: farms would actually make more money per acre of land that they owned. And they would use less nitrogen, less water, less pollution. And the production cost of ethanol would be far cheaper than the production cost of gasoline, so it should be cheaper for consumers.

And then there are the geopolitical advantages.

Exactly. You know, this is a Darwinian IQ test: Do we want to feed farmers or Mid-East terrorists? I mean, give me a break.

I’ve also heard you discuss biofuels in the context of alleviating global poverty.

Right. Producing fuels from biomass is viable in most countries, whether you’re India or China or the U.S. Agrarian cultures in the developing world, especially Africa, could benefit hugely from a growing biofuels market. In fact, the biggest single thing we could do for poverty would be if biomass became the source of our energy.

Are you concerned about the environmental impacts of corn ethanol, given the fossil-fuel inputs that are used to grow corn?

I’m not trying to change the world and make it all green in one step. The thing that corn ethanol does is it sets up a starting point. You see these people make protests about corn ethanol. To me, those are people with an agenda, because nobody in their right mind is proposing we get all our ethanol from corn. There’s no question about it that corn will be a small, immaterial part of our needs within a short period of time. But corn ethanol will have played an invaluable role in getting us started.

So it’s merely a transition technology?

You have to think about the way the investment world works: Corn ethanol is establishing that there’s a market for ethanol. So now there are 10 different ways to produce ethanol that are all being investigated and invested in, and that wouldn’t have happened if the corn market didn’t exist. Nobody’s going to take the risk of cellulosic and other investments if the market doesn’t exist.

And this is the key point that people miss, people who don’t understand how change happens: Revolutions in technology really happen through a series of evolutionary steps. To me it is the essence of why certain technologies make sense and why others don’t.

So, practically speaking, we could have a seamless transition from a corn-ethanol system to a cellulosic ethanol system? Would the technology — the infrastructure, fueling pumps, car technology — for corn and cellulosic ethanol be exactly the same?

In cars, absolutely. In infrastructure, absolutely. The production is different but the use is not.

What about the argument that it will be hard to transition away from corn because the corn lobby would get further entrenched? Or the corn-ethanol technologies couldn’t be converted to cellulosic?

Not a concern. There’s no way that corn can scale to meet the needs. There’s no possible way. Even the corn groups only claim they can produce 15 billion gallons by 2015. Our needs are for 200 billion. We can get far greater efficiency, performance, and yield per acre from cellulosic. And corn will find other uses. You can make plastics out of corn, for example, that are made out of petroleum today.

Biodegradable plastics, at that.

Yep. In fact, bio-plastics are a priority market for me. We’ve just hired the chief science officer of Cargill to be the chief science officer of Khosla Ventures.

What are the barriers to mainstreaming cellulosic technology?

Only one: cost. If you said to me, Can you produce cellulosic ethanol at two bucks a gallon? There’s no question we can do it. The real question is, can we produce it at a buck a gallon? Because that’s what corn [ethanol] costs. So it’s really a question of price, not a question of can we do it.

How long do you expect it will take to achieve commercial scale? My understanding is that it’s only been brought to market in Canada.

Today there are companies willing to invest around $60 million to $70 million of their own money [to commercialize cellulosic]. That is serious private money being invested for this purpose. So, my guess is, if we’re lucky, we’ll have commercial-scale plants in three years. If we’re very unlucky, it will be six.

Do you think that the new boom in renewable-fuels investing is going to create another bubble?

I think that there’s a distinct danger of a bubble. One has to differentiate between stock-price bubbles, which occur because suddenly everybody wants to be in it, and a market-demand bubble that results from an unnatural surge in demand. I think there’s a very distinct possibility of a stock-price bubble, and I worry about it a lot. But I don’t think we’re near a market-demand bubble. When I think in terms of the market itself, I think we’re looking at a very large and consistently growing level of demand. It’s a little bit like the internet: The internet market kept going, and has been pretty robust, even through the stock-market bubble phase.

What federal policies should be implemented to help create market certainty?

First and foremost, I’m suggesting we reduce subsidies on ethanol and make them countercyclical. In other words, if ethanol subsidies are $0.51 [per gallon] today, I’m suggesting we reduce it to $0.25 at $75 oil, but make it $0.75 at $25 oil. That way all price manipulation in the oil markets doesn’t hurt ethanol.

We also need to eliminate oil subsidies. I read a report from the [Government Accountability Office] that official direct subsidies to oil are over $140 billion. That’s not a free market. The best thing for ethanol would be to allow it to compete in a real free market. And we have to include in the price of oil the hidden costs — the environmental and military costs. I’m a big believer that carbon emissions, for instance, have to be included in the cost of oil via a carbon tax.

Does the new Democratic majority in the 110th Congress bode well for pro-biofuels legislation?

With the new makeup of the House and the Senate, and the Bush administration’s interest in the topic, we are even more likely to see a reasonable set of compromises that balance all the conflicting interests and move this country toward energy independence.

Are you a Republican?

I’ve been a lifelong registered Republican. I’m a free-market person.

Last thing. What have you done in your personal life to lighten your environmental footprint?

I am carbon-neutral. I offset my own carbon emissions with TerraPass.com and Carbonfund.org. Soon I’ll be carbon-negative.