Solid Raw Materials: A Sustainability Bottleneck

Atoms aren’t bits, but fluids get pretty close. The problem is that sustainable raw materials aren’t fluid.

Since the pandemic there has been a lot of talk about reshoring, or, more generally, the shortening of supply chains. This is mostly a story about reliability: the US wants to make sure there isn’t another semiconductor shortage, and that there are enough battery materials to make electric vehicles.

But it got me thinking—if the goal is to shorten the supply chains, how short can they get? How did they end up the way they are? These aren’t particularly important questions to answer for the sake of reliability, but they are important if we want to transition to an economy built upon a more sustainable set of raw materials.

So, what are we working with? You’ve heard this one before: if we want to make stuff, we need to make it out of something else. And when we look around at our environment, we’re limited to the stuff deep underground, near or at the surface, growing on the surface, or in the air.

Industry spawns from where we find that stuff. Then, the extent to which it scales, and the mechanism by which that happens, is primarily a function of three key variables:

1. On a mass basis, how many end applications could this raw material fulfill?

2. To what degree is the raw material found everywhere (decentralized), or in particular locations (centralized)?

3. Is the raw material found as a solid? Or as a fluid (liquid or gas)?

The best place to start is with a raw material that, if nothing else, has proven its ability to scale: crude oil. It’s a fluid raw material with a centralized supply and countless end applications. How did this scale happen, and why did it take the shape that it did?

Skip some history, and imagine that you just struck oil. To make money from that oil you need to sell it as is, or you need to refine it and sell those refined products. Refining it yourself captures the most value, so, assuming you have the capital to make it happen, the next question you should be asking is where you should do the refining.

Should you refine the oil close to where you found it, or should you refine it somewhere further away? Even if you already know what we do, it’s still worth asking because it teaches us a few things about scale.

Here’s the first thing: a key benefit to refining crude oil somewhere else is that a bunch of other oil producers could also send what they found to that same location.

And if all of that oil goes to one place, then you can build super large refineries—which, as you probably already know intuitively, is the most cost-effective thing to do because of “economies of scale”. But super large refineries benefit from more than just your typical centralized benefits, they also benefit because of geometric scaling laws (h/t Brian Potter). The basic idea is that you don’t need twice as much steel to build a tank that holds twice as much volume. It’s a surface area to volume ratio thing. And it applies to more than just tanks. The end result is that you don’t need twice as much capital to build a refinery that’s twice as big.

So, if possible, we’d like to get to a centralized location for refining. Now what stands in the way? Well, if you found that oil in the Permian basin, there are about 500 miles that stand in your way. You need to get it to that centralized location somehow.

This is notoriously not-a-problem for companies that develop software. The raw material of the software industry is knowledge, and from wherever that knowledge aggregates, it can scale because it can be transported in the form of software to customers for zero marginal cost. It’s cheap to flow electrons down wires.

Similarly, it’s cheap to flow fluids down pipelines, and the marginal cost of sending an extra 10,000 barrels per day down a pipeline is roughly zero. That’s the second thing.

And here’s the third thing: it’s not all about transport costs. Imagine that instead of using a pipeline, we chose to transport oil from the Permian to Valero’s 255,000 barrel per day refinery on the Houston Ship Channel with tanker trucks. Assume that we go with the standard 30,000 gallon truck: 30,000 gallons is 714 barrels, which means we’ll need to unload 357 of these trucks at Valero’s refinery everyday, at a rate of about 4 minutes per truck. It’s not gonna happen.

Long story short: if we want to really reap the benefits of geometric scaling laws, we have no choice but to use pipelines, and we’re happy to do that because pipelines let us scale without incurring marginal costs.

Let’s switch gears and look at a new raw material: air. In this case, the raw material is still fluid, and there are still plenty of end applications, but it’s found everywhere. And because that supply is decentralized, we don’t build giant cryogenic distillation units and pipe nitrogen across the country. Instead, we usually build small versions of those units everywhere they’re needed, and convert air into its valuable constituents (nitrogen and oxygen) on-site.

Let’s try another: how about a solid raw material with just a few end applications, and a centralized supply? We only make about 3,000 tons of gold per year, so even though there are just a few places that we find it, the demand is too low for us to justify shipping it to some centralized processing location. Plus, even if there was sufficient demand, nobody is going to build pipelines to pneumatically convey gold ore. Solids don’t flow down horizontal pipes. The end result? We usually just process gold ore on-site (h/t Teddy Feldmann).

What about a solid raw material with plenty of potential end applications, and a decentralized supply? Plastic waste is ubiquitous, but unless you can centralize processing, you can’t benefit from geometric scaling laws. And, like gold ore, nobody is going to build plastic waste pipelines.

I could go on, but you get the point. The scaling potential of a raw material is constrained by factors that are out of your control. The only way to compensate for this disadvantage is by accepting smaller scales, or by defeating unsustainable alternatives on both raw material and energy costs. (Or you can drastically improve selectivity and/or conversion, or skip a link in the value chain.)

To be clear, this is just a framework for thinking about how raw materials constrain scale. It’s a great way to spot check whether a chemical startup’s narrative is aligned to its potential, but it doesn’t tell you anything about that startup’s ability to make a profit. You don’t always need scale to make money. There’s plenty of room for chemical startups to snag single end applications one at a time in a decentralized manner. But if the pitch is scale, then talking the talk only works until investors are educated enough to see the dissonance.