TESTIMONY OF WILLIAM NASSER,
CEO Energy BioSystems Corporation The Woodlands, Texas
Before the Senate Environment and Public Works
Subcommittee on Clean Air, Wetlands, Private Property & Nuclear Safety
May 18, 1999

Mr. Chairman and Members of the Panel, thank you for inviting me to testify today. I have a brief oral statement and ask that my written statement be included in the record.

Energy BioSystems is a biotechnology company whose aim is to address major environmental and industrial issues through recent advances in microbiology, genetic engineering and bioengineering. Most are aware of the significant advances in genetics and bioengineering in the pharmaceutical industry and in agriculture. Our company has positioned itself to be a leader in the third wave of the biotechnology revolution into the chemical and energy industries.

I am not here today to validate, support or criticize the proposed EPA regulations of lowering sulfur standards in gasoline and diesel fuel. It is up to you in Congress to determine whether that standard is necessary, to what level and on what timetable. I am here to talk about new alternatives to achieving sulfur reductions in fuel being developed by our company.

There is current technology, hydrodesulfurization or HDS, which is now used to reduce the sulfur content in fuels. Unfortunately, HDS has many disadvantages including:

1) It is old technology, having been in existence for over 40 years.

2) It is enormously energy intensive as it requires high temperatures and pressure.

3) Because of its large appetite for energy, it results in large greenhouse gas emissions.

4) It is enormously costly to install and very costly to operate.

I can understand the reluctance of the refining industry, where margins are thin, to invest the billions of dollars to install such old technology with so many adverse consequences. In fact, for smaller refiners, prohibitive costs of installing and operating this technology may well force them to close. I also find it ironic that the EPA's goal of decreasing sulfur in fuels will result in a direct and adverse impact on the Administration's goal of reducing greenhouse gas emissions.

We at EBC have developed a new process, which also promises to lower sulfur in gasoline and diesel, but at half the cost and without the huge increase in emissions inherent in current technology. Our process is called biodesulfurization or BDS. Basically, we have identified a microorganism that is naturally occurring in the soil that can be genetically enhanced to "eat" sulfur out of gasoline and diesel fuels. The organism can also be enhanced to "eat" sulfur out of coal and crude oil, which current HDS technology cannot do.

The benefits of this BDS technology are several. The headline on a DOE fact sheet issued in January of this year states that "Biodesulfurization will yield lower sulfur gasoline at lower production costs." Our studies show that capital costs for our technology will be half that of current technology and that the operating costs for our technology will be some 20 percent lower.

In addition to cost savings, BDS will result in up to 80 percent less greenhouse gas emissions over current technology. This is because our process operates at essentially room temperature and pressure. HDS requires large increases in both to reduce sulfur.

Another benefit is that our process yields beneficial and commercially viable byproducts. We can alter the enzymes to produce surfactants from the sulfur, which currently sell for about 50 cents per pound and are used in detergents. Other byproduct applications may include resins, polymers and other usable products. HDS produces either large amounts of elemental sulfur or sulfuric acid, neither of which is highly valued commercially, thereby presenting an added problem for refiners.

A final benefit of our technology is its flexibility. It can be inserted at various stages of the refining process. In addition, it can be used in conjunction with HDS technology. Large refiners with HDS operations presently in use can tap our technology to complement its current operations to reach ultralow sulfur levels.

Our pilot projects already have demonstrated the ability of our technology to reach sulfur levels of 75 parts per million. We believe that we can easily achieve a 30 ppm and commercial viability within the next three years, contingent upon the level of investment we receive. In fact, we are confident that we can reach a sulfur level of zero using BDS.

While our technology is extremely promising, Mr. Chairman, there remain hurdles. The primary hurdle being investment in research and development. With oil prices low, refining margins practically nonexistent, and small capitalization stocks battered, we face an enormous difficulty in raising capital to complete our technology. To date, we have spent some $68 million on our technology; about $65 million of that coming from private investors. We have been the recipients of a small amount of funding from the DOE.

In conclusion Mr. Chairman, this proposed rule will require enormous investment. Because of the short amount of time in which to reach the rule's targets, I am concerned that the rule will "lock" industry into an old technology that will be expensive, waste energy and result in vast increases in greenhouse gas emissions. We believe that the rule and the federal government should help to fully develop alternative technologies such as biodesulfurization. Not only will refiners be the beneficiaries, but so will the environment and fuel consumers.

Again, thank you Mr. Chairman for inviting me to testify and I will be happy to answer any questions from the Panel.



ENERGY BIOSYSTEMS
May 18, 1999
OVERVIEW OF THE COMPANY

Energy BioSystems Corporation ("ENBC" or "the Company") is a development-stage publicly traded biotechnology company located in The Woodlands north of Houston, Texas. Since its incorporation in 1989, ENBC has been engaged in the research, development, and testing of a variety of genetically engineered microbes for use in the petroleum refining industry, a technology collectively known as "biorefining". To date, the majority of the Company's efforts have focused on the development of a biologically based method of selectively removing sulfur from petroleum distillates such as diesel fuel and gasoline as well as from raw crude oil. ENBC has termed this process "biodesulfurization", or "BDS". The Company's most advanced biocatalyst technology also adds further value by converting the sulfur removed from the distillates to potentially valuable commodity chemicals. Having proven the viability of the BDS process using small-scale pilot plants, the Company is now working to complete the development and commercialization of its proprietary technology. In addition, the Company intends to explore the use of microorganisms in a variety of other fields, including heavy metals removal, nitrogen removal, crude oil upgrading, and coal desulfurization.

At present, Energy BioSystems employs 37 individuals and leases approximately 25,000 square feet of office and laboratory space. The Company conducted its initial public offering in March of 1993.

THE MARKET PROBLEMS

The presence of sulfur in raw crude oil is one of the most pervasive problems facing the refining industry today. The sulfur is troublesome for a number of different reasons. First of all, sulfur is a constituent element of sulfur oxides (SOx). Sulfur oxides are end products of the burning of fossil fuels and have been specifically identified as one of the principal causes of "acid rain". Sulfur oxides are also believed to reduce the efficiency of the catalytic converters in automobiles, leading to increased tailpipe emissions of both oxides of nitrogen (NOX) and carbon dioxide (CO2). NOX and CO2 are thought by many to be the primary causes of urban "smog" as well as "greenhouse gas" accumulation. To the U.S. refiner these problems are a stiff challenge due to the fact that the average sulfur content of crude oil fed to U.S. refineries is steadily increasing at the same time that proposed sulfur limits are dramatically decreasing. This higher sulfur content extends to all of the distillates of raw crude oil, including gasoline, diesel fuel, and heating oil.

The Company has elected to focus on the diesel fuel and gasoline markets for its initial applications of its BDS technology. Due to the widespread belief that the most likely route to more fuel-efficient vehicles is through the use of new diesel engine technology, a large proportion of ENBC's development efforts have been targeted on diesel fuel. In order to take full advantage of the benefits of this advanced engine technology, sulfur must first be removed from the diesel fuel.

The reported actual average sulfur content currently in both gasoline and diesel fuel in the U.S. is about 340-350 parts per million (ppm). In order to meet this standard, the petroleum refining industry currently uses large operating plants for desulfurization. Using conventional technology, these plants are very costly, due to their need to operate at very high temperatures and pressures. The single most expensive production component is hydrogen gas, which is injected at high pressure into the reactor, thus, giving the process its name: "hydrodesulfurization", or "HDS". Despite these limitations, the industry is, nevertheless, able to meet the current regulatory standards at an acceptable cost using existing HDS technology, successfully producing approximately 31 billion gallons of highway diesel fuel and 124 billion gallons of gasoline per year in the United States alone. It is notable that the new proposed, more stringent environmental quality standards for the U.S. (already adopted by the governments of several other industrialized nations) will force the maximum allowable sulfur level of these fuels to be significantly reduced in the coming years. Specifically, the European Union has set a sulfur content standard of no more than 350 ppmthat will be in effect by the year 2000 and a standard of 50 ppm for the year 2005. The United States and the industrialized nations of the Far East are following the European Union's example.

Overall these increasingly restrictive sulfur-content regulations for gasoline and, especially, for diesel fuel cannot be met with existing HDS capacity. Consequently, in order to achieve the 30 ppm standard using existing technology, the worldwide refining industry will have no choice but to invest an estimated $50 billion in new capital equipment over the next five years. It is important to note that this capital investment will have to be made regardless of the prevailing level of crude oil prices on the open market or the short-term profitability to the refiner. Therefore, the questions essentially become: What is the cheapest and most efficient way to meet these new benchmarks? Is there a real probability that a new technology will provide refiners with a decent opportunity for long term profitability while offering substantial environmental benefits?

In addition to its refining limitations, current hydrodesulfurization technology is very energy- intensive, thus creating high emissions, and produces elemental sulfur as its principal by-product. This represents a tremendous waste of raw material that could potentially be put to profitable use. For these reasons, the Company feels that any new technology which could allow the refining industry to meet the new regulatory standards at a significantly reduced cost while simultaneously producing a commercially marketable co-product should generate a great deal of enthusiasm among oil company executives.

THE ENERGY BIOSYSTEMS SOLUTION

The Company believes that it has developed an effective solution to these problems using a naturally-occurring, benign species of bacteria that was originally isolated from soil. In Energy BioSystems' biodesulfurization ("BDS") process, a genetically engineered variant of the Rhodococcus ery~hropolis strain of bacteria is used with water and the fuel to be treated. The bacterium first internalize the sulfur containing hydrocarbon molecule and then employs an enzymatic reaction to cleanly cleave a sulfur-carbon bond in the molecule. The oxidized sulfur- bearing molecule is then released by the bacterium into the water medium. The Company believes that when employed en masse, this bacterium can be used to effectively remove sulfur

from fuels on a commercially viable scale. In 1992, the relevant genes from the bacterium were identified, sequenced, and successfully cloned. As a result, the Company has received numerous patents on the specific genetic sequence of the modified bacterium as well as other separate "method-of-use" patents covering the biodesulfurization process itself. In total, the Company possesses 47 issued patents and has 81 additional patents pending. The oldest of these patents is not scheduled to expire until the year 2010, providing excellent proprietary protection to the Company for the foreseeable future.

The Rhodococcus bacterium is a benign species and poses no threat to humans, animals, or plant life in the event of an industrial accident. It is easily sustainable by means of an inexpensive nutrient solution and reproduces itself under process conditions. Moreover, the bacterium is able to process large quantities of fuel before its effectiveness begins to wane. Finally, it is easily killed by a simple application of heat and/or chemicals.

The actual BDS process consists of simply adding refined fuel to a slurry composed of water, nutrients, and bacteria, intimately contacting the mixture for a time, and then using standard process manufacturing methods to separate the bacteria, water and dissolved organo-sulfur products from the newly-desulfurized diesel fuel. It is important to note that unlike current hydrodesulfurization plants, the BDS process operates at basically both ambient temperature and standard atmospheric pressure, offering significant cost and safety advantages.

The BDS process also yields a sulfur-based chemical product that is potentially suited to a wide variety of industrial applications. For one, this product has can be used as the base molecule for the synthesis of surfactants that are suitable for use in detergents. These model surfactants appear to have properties comparable to LAS, a commercial surfactant with a $2 billion worldwide market. Other potential applications of the BDS product are in the areas of adhesives, resins, and polymers. The Company believes that these products will have significant commercial value and will further reduce the net costs of using the BDS system relative to conventional hydrodesulfurization technology.

In summary, Energy BioSystems' BDS technology offers the following four benefits:

1) Cost effectiveness - The BDS system is designed to operate at essentially ambient temperature and pressure, thereby removing the need for the expensive thick-walled reactors and other plant systems now required for hydrodesulfurization. Additionally, BDS does not require the addition of hydrogen, the single most expensive component of the overall operating cost of hydrodesulfurization.

2) Reduced greenhouse gas emissions and energy consumption - As compared to HDS, the Company believes that its BDS system will operate with up to 80 percent less energy consumption and carbon dioxide emissions in achieving the dramatic new low sulfur levels proposed.

3) Ease of integration and svuerav with existing refinery operations - The Company believes that the BDS system can be integrated with the existing physical plants of refining companies without significant difficulty. In larger more complex refineries BDS systems will most likely be used in combination with existing HDS facilities, although in small refineries BDS is likely to be the only viable option. Furthermore, in certain highly energy intensive refinery applications such as coking, BDS offers a refiner a very real opportunity for improved profitability and environmental improvement. It should be noted that the sulfur compounds that are the most difficult to remove using HDS are the same compounds that are most readily removed using BDS. Therefore, when used in conjunction with an HDS system, BDS can provide the refiner with a synergy that results in a minimized total cost of desulfurization.

4) Generation of a sulfur-based byproduct readily converted to profitable uses - The Company believes that its biologically-based method of sulfur extraction can be easily modified to produce a marketable product that can be readily adapted to a variety of commercial uses, thereby adding significant value and lowering overall costs.

COMMERCIALIZATION STATUS

Energy BioSystems has validated its BDS technology by constructing and operating a five- barrel-per-day pilot plant. Using the knowledge gained from the operation of that pilot unit, other smaller pilot plants were built and are operated. The Company is now working with Petro Star, Inc. to proceed with the design of a 5~000 barrel-per-day BDS facility to be constructed at their Valdez, Alaska refinery. Petro Star is a subsidiary of the Arctic Slope Regional Corporation and is ENBC's first commercial licensee. Based upon ENBC's recent technical progress, the company expects detailed engineering to start in late 1999, and that the facility will commence full operations in the second half of the year 2001. The construction of this facility is a key step towards the Company's ultimate goal of being able to desulfurize diesel fuel at a rate of 40~000 barrels per day (a level which would meet the needs of the industry's largest players) as well as the eventual expansion of BDS technology into the processing of raw crude oil, gasoline, and other distillates.

While the production technology is being scaled up, the Company intends to complete work on the development of the BDS process itself. Further improvements in the performance of the biocatalyst in the reaction system are necessary to successfully commercialize ENBC's technology. Currently, the BDS process is capable of meeting the 30 ppm target for diesel fuel when the feedstock has a sulfur content of 200 ppm or below. In order to gain widespread commercial acceptance, the process must be improved to accept feedstocks with sulfur levels of up to 500 ppm. Improvements in the rate of desulfurization will also be required to bring the overall costs of the process down to competitive levels. Finally, ENBC is now producing samples of the organo-sulfur end products of BDS for evaluation by potential alliance partners for manufacturing and marketing them on a commercial scale.

The petroleum industry is the single largest industry in the world and is responsible for the refining of over 23 billion barrels of crude oil annually. The Company believes that its technology will be most attractive to refiners that currently lack sufficient HDS capacity to meet both existing and anticipated demand (such as Petro Star). Successful demonstration of the technology with these customers is expected to lead to the sale of BDS systems to larger, more sophisticated refiners who can take advantage of the synergies between BDS and HDS.

CORPORATE ALLIANCES

In order to accelerate the commercial development of its core BDS technology, the Company has entered into a number of technology development alliances with established companies. Specifically, ENBC has agreements in place with TOTAL Raffinage Distribution S.A. of France (development of the BDS process for diesel fuel streams), with Koch Refining Company (development of the BDS process for certain gasoline streams), and with the Exploration & Production Division of Texaco, Inc. (the development of the BDS process for crude oil). In addition, the Company has an agreement with Kellogg, Brown & Root for the basic engineering services required for the installation of BDS systems at commercial sites.