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Quadrise: disruptive technology on a budget

Quadrise Fuels provides a good example of how a 'blue-sky' minnow can develop a potentially market-disruptive technology with minimal capital outlay - all eyes are now on Denmark
September 16, 2016

Most investors will opt for 'blue-chip' over 'blue sky' any day of the week - and with good reason. The most successful portfolio strategies are usually bound up with long-term investments in sound (largely predictable) companies with proven earnings and vigilant management; companies whose prospects aren't obviously imperilled by the evolving commercial environment or through rapid technological change. Stack your portfolio with investments that largely fulfil this criterion, preferably with some well-backed income streams into the bargain, and let compounding do the rest.

IC TIP: Buy at 12.7p

Essentially, it's a question of eliminating unnecessary risk, where possible, and resisting the temptation to time markets. But staying invested doesn't always mean a passive investment strategy. Many investors, at least many investors on the right side of 40, are willing to seek out value plays in a bid to turbocharge their portfolios, or will apportion a certain amount of their capital in favour of blue-sky investments.

By definition this is obviously a higher risk/reward scenario, all the more so when the company in question isn't generating cash flows. Without some idea of how much cash a given company can generate, the determination of its intrinsic value (it's estimated worth in the future) becomes all the more subjective - and therefore illusive.

Which brings us on to Quadrise Fuels International (QFI); an Aim-traded alternative fuels producer that has been on the IC's radar since its debut on London's junior market 10 years ago. We feel Quadrise provides a prime example of the type of company that can galvanise and frustrate retail investors in equal measure; a function of a potentially lucrative product offering that - by necessity - has been subject to lengthy lead times to fruition. This is reflected by the intermittent surges in trading volumes throughout Quadrise's tenure on Aim, as a slow news beat and delays towards commercialisation have meant that periodic clamour for the shares has given way to profit-taking.

 

 

Oil and water do mix apparently

The company's commercial proposition is based on industry acceptance and subsequent rollout of its proprietary MSAR (Multiphase Superfine Atomised Residue) oil-in-water emulsified fuel. The production process, which was pioneered by a group of former British Petroleum (BP) specialists in conjunction with the national oil company of Venezuela, makes heavy hydrocarbons easier to use by producing a low viscosity fuel oil utilising water instead of expensive oil-based diluents.

This treatment of the raw resource adds significant value to the refining process at a low capital cost allowing the MSAR fuel to be priced competitively, while providing financial incentives to the user to switch from conventional heavy fuel oil (HFO).

In addition to significant cost savings, the fuel also delivers enhanced combustion and environmental benefits. Put another way: it provides a commercially viable alternative process for handling the sludge out of a barrel of crude oil without recourse to expensive additives or combination with lighter grades of hydrocarbons - thereby increasing profitability for both refiners and end users. The progressive tightening of combustion emissions standards by regulatory bodies, at national and international levels, has positive implications for MSAR fuels in the company's target markets.

 

 

Heavyweight friends abroad

Part of the reason why retail investors have been willing to buy into the MSAR narrative is that Quadrise has been able to establish a succession of commercial agreements with Akzo Nobel and Maersk. Saudi Aramco has also approved the use of Quadrise's technology in its refineries under a partnership deal, although commercialisation in the Desert Kingdom is some way off. A 'production to combustion' pilot programme has been delayed due to the launch of Saudi Arabia's Vision 2030 economic reform plan in April of this year, although subsequently Quadrise has signed a memorandum of understanding (MoU) to advance the production to combustion trial in the Kingdom of Saudi Arabia. The MoU is said to "define the basis of collaboration" between Quadrise and its clients to progress the trial at refinery and power plant facilities within Saudi Arabia. Management remains confident of demonstrating the value of the MSAR technology in Saudi Arabia on a commercial scale with combustion testing at a major power utility well aligned with its Vision 2030 Programme. After all, burning off high-grade distillate to power the Kingdom's air conditioners probably isn't the most effective use of a finite resource.

The good news is that Quadrise is in the home stretch with regard to its marine version of MSAR. The first batch of the emulsion fuel was successfully produced at the CEPSA San Roque refinery near Gibraltar, and is now being used in final sea trials on a vessel owned by Denmark's shipping giant, Maersk, with the sign-off expected during the first quarter of 2017. The operational trial is expected to run to 4,000 hours of engine operation on MSAR, over a period of approximately nine months.

The fact that companies of this magnitude are willing to back the development of MSAR adds considerable ballast to Quadrise's investment case, although one suspects that the immediate commercial imperative weighing on the UK company isn’t shared by its overseas partners.

 

 

A tortuous road towards commercialisation

The aforementioned 'industry acceptance' is predicated on both contractual and technological terms, so MSAR's road towards commercialisation, while not exactly tortuous, has been punctuated by lengthy trial periods and drawn-out negotiations over future commercial terms. And there's the rub: Quadrise and, by extension, its shareholders are effectively enthral to the diktats of its heavyweight partners - and there's no getting away from that reality.

That's obviously frustrating for investors, but in a sense the sheer thoroughness of the trial procedures firms up the business case for MSAR. These have included seaborne trials involving units from the world's leading marine engine manufacturers in Wärtsilä and MAN Diesel & Turbo, together with a detailed production review of an MSAR manufacturing unit at the San Roque refinery.

Shareholders may have also felt frustrated by the company's share price performance once crude prices locked into reverse midway through 2014. That's because MSAR's commercial proposition isn't directly linked to the price of Brent crude, but rather the price differential between HFO and distillate fuels. The economics of the MSAR emulsion bunker fuel held up in the face of chronically low oil prices, but it's the spread between those two fuel prices that is the chief determinant of commercial viability.