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 Sulphco (AMEX:SUF) is developing a technology that improves crude oil by using ultrasound waves to remove sulfur, a process it calls 'sonocracking'. Sonocracking could allow companies to process previously unusable crude oil and improve the quality of the final gasoline product. Generally, "sweet" or low-sulfur content crude sells for higher prices to refineries than "sour" or high-sulfer content crude because the latter requires expensive and elaborate refineries such as those operated by Valero. If it were commercially viable, sonocracking could turn cheaper, high-sulfur crude into more valuable, low-sulphur crude. This can be a major benefit to oil companies, who will be able to refine a wider variety of crude. The process could also help oil drillers process more crude, while oil transporters could normalize their crude quality, making it easier to ship. Overall, third-party estimates say that Sonocracking could add $3.00-$3.50 of value to each treated barrel of gasoline, as the fuel will burn more efficiently.[1] Sonocracking also lowers the sulfur emissions of the the final oil product, which adds value to companies that are struggling to comply with the Clean Air Act's emissions mandates and want to avoid government fines.[2] Despite the potential value of its technology, however, February 2008 was the first time Sulphco had an opportunity to earn revenue. The company signed a deal with Pt. Isis Megah, an oil distributor in India, Malaysia, Singapore, and Indonesia to implement sonocracking technology in their plants. The technology has not yet been installed, so its profitability (and viability) are undetermined. [3] If Sulphco's operations in Pt. Isis Megah fail, it will become increasingly difficult for Sulphco to be recognized as a "going concern" (or a legitimate business).[4] Even if Sulpho's technology works on a commercial scale, it must compete with similar technologies - many of which are in development by the oil majors themselves. Chevron will begin to deploy its technology, Vacuum Resid Slurry Hydrocracking (VRSH), as early as late 2008 [5]. Sulphco lacks the resources of large competitors like Chevron or ConocoPhillips (COP), but hopes that its technology's novel use of ultrasound will prove more effective.[6]
[edit] Business FinancialsAs a company in the development stage, Sulphco's financials are completely driven by expenses incurred while developing Sonocracking technology. Sulphco has never turned a profit, and 2008 will be its first opportunity to do so. Sulphco's future profitability assumes the following:
The following graph describes the makeup of Sulphco's 2008 business expenses. Sulphco's high 'deemed dividend' expense was not a cash expense. Rather, Sulphco had to readjust a large number of its outstanding options to market value. Sulphco's stock price has declined significantly since its $20 per share peak in 2006, which is why the deemed dividend expense this year is so high. This type of dividend expense is unlikely to happen again, but is nonetheless very significant this year.
[edit] Research and DevelopmentSulphco's research and development attempts to make sonocracking into a large scale industrial process through rigorous live testing on hundreds of thousand oil barrels.[9] Most testing occurs in Sulphco's facility in the United Arab Emirates, but some also occurs in Nevada. So far, Sulphco has conducted four separate series of sonocracking trials. While Sulphco has a commercial prototype, the success of sonocracking research and development is yet to be seen. [10] [edit] Selling, General, and AdministrativeSulphco's large number of pending lawsuits surrounding its new technology cost millions of dollars annually. Sulphco's legal fees will stay high due to the proprietary nature of Sulphco's business. As a company that licenses technology, if Sulphco cannot defend its patents in court, it cannot compete. When employees cannot figure out how to adjust their sonocrackers, they must pay for outside help. That is to say, Sulphco has a limited number of scientists testing Sonocracking technology. When they cannot solve a physics problem, or a technical difficulty they must contract to outside scientists and technicians. Because Sulphco has only 15 employees, only a few of whom are trained scientifically, technical consulting fees will continue to burden Sulphco. In total, Sulphco spent $3.2 million dollars on consulting and payroll expenses. Sulphco has very high travel expenses due to the need to send its people around the world. At $900,000 of travel expense, Sulphco is spending $60,000 per year per employee on traveling alone. Travel expenses would decrease if the Sonocracking testing facilities (or future productions sites) became more self-sufficient. International operations are necessary insofar as Sulphco's most extensive testing requires many thousands of barrels of petroleum (oil is far cheaper in the UAE). Oil producers are spread across the world, so it is likely that Sulphco will continue to incur high travel expenses, especially as their technology is becoming commercialized. Sulphco compensates its board of directors extremely well. The top 4 company executives received average total compensation of $348,000 in 2007 even though the company has generated no material revenues. [11] Finally, Sulphco's business is energy, and space intensive, justifying its $1.6 million general expenditure on leases, utilities, marketing, and investor relations. Sulphco's SG&A expenses are summarized in the millions in the below table.
[edit] Debt and Dividend ExpensesDebt and equity expenses comprised 66% of Sulphco's business in 2007. The company's debt expense surged in 2007 because of refinancing. Sulphco's stock has been plagued by short sellers, and traders often have difficulty borrowing Sulphco stock because it is in such high short-sale demand. [13] Sulphco has not issued a cash dividend as it is not yet an established business. To successfully maintain Sulphco's equity value, the company incurred a total of $24.8 million of non-cash dividend expense. [14] This stock-related expense nearly doubled the net loss attributable to common stockholders in 2007, depicted on the table below in millions.
[edit] Segment Information[edit] Pt. Isis MegahMegah is a refinery equipment intermediary that sells useful equipment to crude oil processors (also known as gathering stations. Megah has bought some of Sulphco's Sonocracking units to sell to crude oil processors. [16] There is as of yet no evidence that Megah has sold any of the Sonocracking units which it bought from Sulphco in February, but when it does, Sonocracking's commercial viability will be revealed. [edit] Other Potential BuyersSulphco has not reported any revenues yet, but it has targeted several segments that could potentially buy Sulphco's technology. Regardless, Sulphco would install its Sonocracking technology at its own expense, and then charge a percentage of the buyer's "uplift", or additional revenues generated because of its more efficient fuel. [17]
One group of potential buyers of Sonocracking technology would be petroleum producers. Producers have to discard crude oil with too much sulfur content. Sonocracking would allow increased production by allowing producers to ship out crude oil that they would have discarded. Also, Sonocracking claims to improve fuel quality (API gravity) and reduce its sulfur content. Thus, Sulphco could help oil producers make more oil, and sell it for more money. [18]
Oil transporters first blend oil together, and then ship it. If they could treat high-sulfur crude oil with Sonocracking, they could blend it with low-Sulfur crude oil and therefore transport the two together, saving on shipping costs. Also, pipelines have sulfur specifications that would be less of an obstacle with sulfur-reducing Sonocracking technology.[19]
By making cleaner, more efficient fuel, Sonocracking would allow refineries to process higher yields of higher value gasoline. Often times, the sulfur content and high density of heavy-crude oil leads to the creation of byproducts which need to be expensively disposed of. Pre-treating crude with sonocracking would lower these costs, as well as increasing the value of the refined oil.[20] [edit] Geographic RegionsSulphco has already contracted its sonocracking Technology to Pt. Isis Megah which operates in India, Malaysia, Singapore and Indonesia. The company also has its eye on opportunities in Austria, South Korea, South America, and Canada. [21] [edit] Trends and Forces[edit] Environmental Regulations Help but Could Hinder SulphcoBecause sulfur emissions, like carbon emissions, are subject to United States Environmental regulations (namely the Clean Air Act), a growing number of companies are looking for ways to reduce their sulfur emissions. This creates significant demand for Sulphco's product because it is environmentally friendly. More efficient use of fuel also appeals to environmentalists and clean energy lobbyists who believe in conservation of the earth's resources. On the other hand, Sulphco worries that environmental laws and regulations could be applied to its sonocracker units and prevent their deployment. [22] So long as sulfur emissions standards remain in place, in the absence of any unforeseen environmental hazard of sonocracking, environmental regulations will drive demand for Sulphco's technology. [edit] The Uncertain Pot at the End of the Rainbow: Cautious Markets Approach SulphcoSulphco has not made any money since its founding in 1999. Even though it has subcontracted its Sonocracking technology to Pt. Isis Megah, it is unclear whether the technology will function well. If Sulphco does not start generating revenue soon, the company could lose its "business" classification for tax purposes. The company recognizes this as a danger in their 2008 annual report, largely because they have repeatedly told investors that Sonocracking is 'almost ready' since 2002. Now that Pt. Isis Megah is trying to sell Sonocracking technology, it will soon be apparent whether or not Sulphco offers real value. Since the Dot Com bubble burst, investors have been wary of companies that promise a pot of gold at the end of the very long rainbow of research and development. Indeed, short sellers decimated Sulphco's stock after a Barron's article in 2006 exposed Sulphco's founder, Dr. Gunnerman, as a man who created several unsuccessful startups that generated armies of disgruntled investors and lenders. [23] Dr. Gunnerman has since been dismissed from the company. Nonetheless, Sulphco has incurred massive costs developing its sonocracking technology, so buying a share of Sulphco relies on three assumptions:
[edit] Oil Prices Increasing Gas Prices and Scarcity of Petroleum ResourcesAs gas becomes more expensive, and oil fields become depleted, companies increasingly want to make their drilling, distribution, and burning power more efficient. Sonocracking might not have been worth it had it been available in the 1950s. There was too much crude to justify spending huge amounts of money to make it more efficient. Things have changed, and as oil becomes more scarce, Sulphco's product will become more desirable. [edit] Enforcement of Intellectual Property LawsSulphco is essentially a company that has rights to an implementable idea, Sonocracking. Their ability to protect this idea determines whether they can build an economic niche. If foreign companies can implement Sonocracking, or foreign governments decide to nationalize Sonocracking technology, Sulphco will lose its main competitive advantage. [24]If companies could sonocrack their oil without Sulphco's services, Sulphco would go out of business. Many of the countries in which Sulphco operates, especially in South America and the Middle East, are not known for their respect for international copyright law. There are also doubts as to whether Sulphco actually has rights to its own sulfur removal technology. Two court cases (Talisman Capital Talon Fund, Ltd. v. Rudolf Gunnerman and Sulphco, Inc. and Clean Fuels Technology v. Rudolf W.Gunnerman, Peter Gunnerman, RWG, Inc.) dispute Sulpcho's rights to Sonocracking. Sulphco is the defendant in both of these cases which should be resolved within the coming year.[25] Betting on Sulphco assumes that it can retain the rights to its technology, and that it will be able to enforce those rights when conducting international business. [edit] Competitor AnalysisBecause Sulphco has not yet sold any technology, it has no direct competitors. Nevertheless, companies like Merichem, ChevronTexaco (CVX) , CONOCOPHILLIPS (COP) and other large oil producers have been actively pursuing their own versions of sonocracking. Most oil companies, refineries, manufacturers, and manufacturers of refinery equipment who choose to develop sulfur removal techniques have significantly more resources to do so than Sulphco. Sulphco hopes to beat its competitors because Sonocracking allows oil to be treated before being fed into the refineries. Even unrefined oil, then, becomes less dense and less sulfurous with Sonocracking. This allows for more effective refinement processes, and less wasted oil as discussed in the Segment Information section of this article. [26] The oil industry is dominated by large companies, and Sulphco is an extremely small player. If a company like Chevron Texaco develops an efficient Sulfur removal technology, it would have a much easier time distributing it on a large scale than Sulphco would. Additionally, if Chevron Texaco's Hydrocracking becomes available before Sulphco's Sonocracking, it will likely gain an extreme first mover's advantage. If you were running an oil refinery and wanted to install risky new equipment, you would probably want to make sure you could get logistic support and also that the technology was tried and true. This favors large companies like Chevron Texaco, especially considering the shady background of Sulphco's founder Dr. Gunnerman (he has lost investors millions of dollars on technologies that sound good, but then never work). On the other hand, if Sonocracking catches on before Hydrocracking, then Sulphco could use its profits to expand its distribution network and become a large corporation. Finally, it is worth considering that gas prices are rising, and the market is demanding new types of non-fossil fuel energy. A large scale acceptance of Electric Cars or Hybrid and Alternative Energy Technology could throw a serious monkey wrench into Sulphco's future business.Companies which provide and develop these technologies could be viewed as Sulphco's indirect competitors.
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