This week The Economist asked the question “What happened to biofuels?” The biofuels in question are so-called second generation fuels that are produced from trees, grasses and algae — in general feedstocks that don’t also have a use as food. The appeal is obvious to anyone concerned about the world’s dependence on petroleum, and further worried that a major shift to ethanol will cause food prices to rise.  

About a decade ago, a number of entrepreneurs like Vinod Khosla, one of the co-founders and the first CEO of Sun Microsystems, began to use their political influence to convince the US government that the only thing keeping the US from running its cars on advanced biofuels was interference from oil companies and the lack of government support.

These advocates eventually won over enough political support that state and federal governments began to funnel large amounts of taxpayer dollars into advanced biofuel ventures. President Bush spoke of running cars on switchgrass in his 2006 State of the Union address. The federal government sought to deal with supposed oil company intransigence with a mandate requiring gasoline blends to contain growing volumes of corn ethanol initially, but starting in 2010 advanced biofuels as well. The federal government mandated that 36 billion gallons of biofuels had to be used in the fuel supply by 2022, with 21 billion gallons coming from advanced biofuels.

But the history of cellulosic fuels goes back much further than many of those entrepreneurs realized, and many set out to reinvent the wheel with tax dollars. It was nearly 200 years ago, in 1819, that French chemist Henri Braconnot discovered how to break cellulose down into component sugars, which can then be fermented into ethanol. The Germans first commercialized cellulosic ethanol production from wood in 1898, and the first commercial cellulosic ethanol plant in the US was built in 1910 to convert lumber mill waste into ethanol. Nevertheless, many budding biofuel entrepreneurs insisted that this was a field in its infancy, and therefore required generous government support.

Some attempted to produce fuel from wood via a different route. Wood (or natural gas or coal) can be partially burned to produce synthesis gas (syngas), which consists of hydrogen and carbon monoxide. That syngas can be converted into diesel (among other fuels) using the same process that Germany used to produce fuel in World War II. The problem is that this is a terribly expensive process, and so there are only a handful of commercial plants around the world that use either natural gas or coal (in South Africa, which has its roots in the old regime’s inability to secure petroleum because of sanctions opposing its apartheid policies.)

The high costs were no deterrent for Silicon Valley entrepreneurs who wielded Moore’s Law as the solution to every problem. In their minds, the advanced biofuel industry would mimic the process by which computer chips continually became faster and cheaper over time. But advanced biofuels were governed by a fundamentally different industrial process that was already more than 100 years old.

In an interview with Wired Magazine in 2006 headlined “My Big Bet on Biofuels,” Khosla described his investment in Kergy (which later became Range Fuels). He wrote that to his knowledge, they had invented “the first anaerobic thermal conversion machine.” In fact at that time there were hundreds if not thousands of these gasifiers around the world, mostly used to produce power (a much lower cost proposition than biofuel production).

My professional experience touches on all of these areas: biomass conversion, gasification, and production of liquid fuels — and I wrote a number of articles critical of the claims coming from the Range Fuels/Khosla camp. Some referred to me as “Range Fuels’ Number 1 Critic.” But the mainstream press couldn’t say enough great things about the company, right up until it declared bankruptcy in 2011. Hundreds of millions of dollars of taxpayer and investor dollars had been wasted, and the company never produced a drop of qualifying renewable fuel.

Now some might say that failure is just a part of doing business and trying new things. That’s true, and I would never have criticized Khosla and others, except for the fact that they were influencing energy policy on the basis of inflated claims and collecting tax dollars as a result. If entrepreneurs try and fail on their own dime, that’s their business. If they take tax dollars, it’s my business as a taxpayer. And if they take investment dollars, it may become my business if I am advising investors.  

I gave a fair bit of investment advice as some of the advanced biofuel firms began to take their companies public. Amyris (Nasdaq: AMRS), Gevo (Nasdaq:: GEVO), and KiOR (Nasdaq: KIOR) were three Vinod Khosla-backed companies that went public, and the value of his stakes has reportedly declined more than a billion dollars since. I have been asked by investors about the prospects for each of these three companies (among others) since their IPOs, and every time I warned people away. That has proven to be good advice, because since their respective IPOs Amyris is down 85 percent, Gevo has fallen 89 percent, and KiOR is down 88 percent.

To date, I have not found a single company in this space that I would recommend to investors. The reasons boil down to fundamental challenges of growing, transporting, and converting low energy density biomass to fuels, versus the challenge of drilling for, transporting, and refining energy-dense crude oil. At some point in the future the former may be competitive with the latter, but in 2013 we are nowhere near that point.

Yet one analyst after another recommended these firms to clients. Take KiOR, for example. KiOR uses a process in which wood chips are heated rapidly to form a bio-oil, which can then be upgraded with hydrogen in pretty standard refining equipment to produce diesel and gasoline. KiOR has its own spin on the process, but the basic outline has been around for a long time. The problem has always been cost.

After the IPO, the market promptly bid KiOR’s value up to $2 billion. In response, I wrote an article arguing that KiOR was grossly overvalued. Some investors contacted me to tell me they shorted the company on the basis of my recommendations. Shares have been in a steady decline over the past two years, and the decline has accelerated in recent weeks.

Running on Fumes

But analysts remained undeterred. After KiOR announced a net loss of $31.3 million for the first quarter of this year, several analysts reiterated ratings of “Overweight” or “Outperform” on the company. For instance, Pavel Molchanov from Raymond James reiterated the “Outperform” rating that he first made on Aug. 15, 2011 when shares were at $11. When second quarter results came in far below projections, Molchanov reiterated the Outperform rating and a $9 price target. Shares are now down under $2, a drop of more than 50 percent just since the Q2 results were released.

The point here is that this was totally predictable from the chemistry and low-energy density of biomass, and from the science involved in trying to economically turn that into a low-margin commodity like fuel. There is no magic catalyst or magic process that can overcome that. No matter how I sliced the numbers, I couldn’t see how any of the wood-to-fuel companies were going to make any money other than through government largesse. So I advised investors to stay away, even as the analysts continued to spread the hype that many of these companies put out.

I don’t feel the same way about the entire renewable energy space. Solar photovoltaic (PV) panels, for instance, benefit from Moore’s Law effects, but their manufacture is very different than the production of biofuels from biomass. And in fact, we are seeing not only exponential growth in the installation of solar PV panels, we see costs dropping exponentially. The mistake of biofuel entrepreneurs, politicians, and investors in that space was believing that this is how things would play out for biofuels.

KiOR isn’t dead yet though. In fact, I talked to a reporter from Fortune Monday, and I said they would probably bounce soon. There is probably one or two bits of positive news ahead, and the company may very well get an additional injection of capital from Mr. Khosla. As if on queue, shares were up 25 percent in Tuesday’s trading. But the road ahead will be challenging and the odds of bankruptcy are very high. So I would continue to avoid KiOR and the other companies in this space, unless you simply want to put some money down in lieu of a trip to Vegas.