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                                                                                BUSINESS, Page 46

Chasing the American Dream

Two old-fashioned American inventors with a promising
alternative to conventional fuels run up against bureaucracy,
bad timing and a society unwilling to take risks

By BARRETT SEAMAN


    It all began, appropriately, in the afterglow of an Optimist
club meeting in Lafayette, N.Y., on a Thursday night in the
winter of 1972. Over a couple of beers, Doug Keller was telling
fellow Optimist Clay Smith about an experiment one of his
Syracuse University graduate students was doing. As part of
Keller's graduate class in materials science, the student was
trying out various chemicals to see if there was some agent
that would allow drills to penetrate coal more easily. When he
applied ammonia, explained Keller, the raw coal broke down into
fine particles, separating the purer hydrocarbons from rock and
pyritic sulfur and significantly reducing its ash content.

    There was real promise here, Keller said. Ash and sulfur are
the principal pollutants in coal. Without them, the remaining
fuel would burn clean, unlike the dirty coal used by many big
utility plants in the U.S. If the process Keller was describing
could be duplicated on a mass scale, it would provide an
attractive alternative to oil.

    Smith grew excited. An engineer and refrigeration expert who
had installed systems for factories and ice-skating rinks, he
had the engineering skills to produce such a clean fuel on an
operating scale. "Let's get a patent," Keller suggested. "Start
a company."

    It seemed so right. Here was a convergence of skills, needs
and timing. Two years earlier the nation had celebrated the
first Earth Day and Congress had passed the Clean Air Act.
Another year would bring the Arab oil embargo, long lines at
gas stations and an unnerving sense that the industrial Western
world could no longer count on endless supplies of cheap oil.
Meanwhile, under American soil lay a quarter of the world's
coal supply -- easily enough to power the nation into the 22nd
century. If Smith and Keller -- two smart, practical fellows
who cared about the environment -- could develop a process to
burn coal cleaner and at a price that was competitive with
Middle East oil, they could help fill a national need and win
themselves a place alongside great American
inventor-entrepreneurs like Thomas Edison, Henry Ford,
Alexander Graham Bell and Thomas Watson. And maybe strike it
rich in the bargain. After all, that's the American Dream.

    Smith and Keller adopted the Iroquois word otisca, meaning
"water that has gone away," as a name for their process and
their company. They worked nights in a garage on a back road
southeast of town, won the patent rights and sold the idea to
local investors who shared their conviction that a
clean-burning, coal-based fuel was potentially an economic gold
mine. They interested possible customers -- big customers like
Florida Power & Light, American Electric Power, General
Electric, General Motors -- and they raised nearly $8 million
through a sale of preferred stock.

    Yet more than 20 years later, Otisca is essentially broke.
Keller, in need of money to feed and educate his family, has
returned to teaching at Syracuse. Smith still toils stoically in
the all but abandoned laboratory the pair converted from an idle
brewery on Butternut Street in Syracuse -- producing occasional
fuel samples, testing equipment and working the phones in search
of a big utility or any company that could offer him the chance
to demonstrate Otisca Fuel. There is hope yet, but friends have
begun to joke that Smith has raised tenacity to the height of
insanity.

    The American Dream is not so easy to achieve these days. In
the century since Edison, Ford, Bell and Watson turned simple
ideas into products and technologies that transformed society,
entrepreneurship in America has become more complicated, less
nimble. In capitalism's grand struggle between risk and reward,
the forces of caution and liability have subtly, sadly, gained
the upper hand. It is not enough just to have a good idea. These
days one must know the intricacies of corporate finance,
government regulation, patent protection, pricing strategy and
sophisticated marketing. And even then, in the utility industry
anyway, resistance to change, hardened under multiple layers of
bureaucracy and regulation, is likely to stop even a great idea
dead in its tracks. The tale of Otisca Industries is instructive
and ultimately disturbing.

    "Clay kicked in a couple of hundred dollars, I kicked in a
couple of hundred dollars, and we rented a garage down in
Lafayette for 30 bucks a month that we could use after 7
o'clock at night," recalls Keller. After the auto mechanics
left, the pair would hook up the pipes and tubes and tinker into
the night. Their coal came courtesy of Keller's brother-in-law
Fletcher, who got it from a Union Carbide plant south of
Charleston, W. Va., and shipped it up in feed bags to Syracuse
on the Greyhound bus.

    Those were the first heady days, when the learning curve was
steep and the flexibility almost unlimited. They switched from
ammonia to the refrigerant Freon as the separating agent without
filing a single proposal, cost analysis or environmental-impact
statement, without any of the constraints big corporations face
daily. If something worked, they used it; if it didn't, they
tried something else.

    It would be easy to dismiss Smith and Keller as just a
couple of upstate kooks with a harebrained scheme. But from the
beginning, virtually everyone involved -- engineers and
environmentalists, utility executives and officials at the
Department of Energy -- has agreed that the Otisca coal/water
slurry process is a solid idea. Acknowledges W. Henson Moore,
former U.S. Deputy Secretary of Energy: "This precleaning
process of theirs looked very good to the experts."

    The mechanics and science behind Otisca are clear and
simple. Its advantages in terms of transportation and use in
various engines, including diesels and turbines, put it in
direct competition with oil and gas. Coal's chief disadvantages
are that it is bulky and dirty. Sulfur oxides (SOx) and
nitrogen oxides (NOx) have been indicted as principal villains
in the formation of acid rain. More than half the nation's
electricity is produced by power plants that burn coal. By
running finely ground coal through a chemical bath (currently
pentane, a hydrocarbon similar to butane), the Otisca process
separates out all but 1% of the mineral content, or ash, and
0.5% of the sulfur that forms sulfur oxides when it burns.
Because it is half water, Otisca Fuel produces a cooler flame
than straight coal does and hence about half the nitrogen
oxides.

    The 1970s were promising years. Soaring oil prices prompted
industry to search seriously for alternative energy sources.
Otisca's first pilot project was done with Island Creek Coal Co.
-- a 15-ton-per-hr. operation in Bayard, W. Va., at the
headwaters of the Potomac. Smith and Keller also did some early
business with General Public Utilities in western Pennsylvania,
until the Three Mile Island nuclear disaster thoroughly
distracted GPU's management.

    They didn't make any money to speak of. But on the side,
Smith invented a process for extracting oil from tar sand and
sold it to Amoco for $1 million. American Electric Power, one of
the more enlightened utilities, signed on to build a
125-ton-per-hr. Otisca coal-cleaning plant in Beverly, Ohio.
AEP, which serves seven Midwestern states, and by itself
produces 3% of the nation's electricity, budgeted $6 million
for the project. "We went from a bare field to a fully
operational plant within 20 months," recalls Smith proudly. The
product of the venture was a powdered coal fuel that was 90%
free of ash, a new record for such coal.

    But successful as the science was, the business at AEP was
disastrous. Smith, who managed the project, chafed at the
complex corporate oversight the giant utility placed on the
operation. Even small changes in the engineering required
approval by as many as five separate authorities, he says.
Company auditors questioned his cost accounting. And though the
plant was producing the coal on schedule, AEP managers were
dissatisfied with the comparative costs they were achieving.

    And then there was the Freon. About the time the Beverly
plant was begun in 1979, scientists were speculating that
chlorofluorocarbons were a significant depletor of the earth's
ozone layer. In earlier, smaller facilities, Otisca had been
able to recover all but 0.1% of the Freon, motivated to do so by
the sheer economics of recycling the expensive chemical. But in
the big plant in Beverly, it was losing as much as 5%. Smith
discovered that he had installed the wrong kind of compressor to
recover the Freon, then argued with AEP over how to fix it. "I
tried to save it too long," admits Smith. "I think their
confidence in me waned tremendously." AEP lost interest and
moved on to testing other coal-cleaning technologies.

    The AEP experience was not a total loss. During the early
'80s, Keller was able to advance the cleaning efficiency, and
Smith made the switch from Freon to pentane. The Department of
Energy began taking an interest. Through its Clean Coal
program, DOE was awarding matching funds to private-sector
coal-powered projects that demonstrated an ability to both meet
new environmental standards and compete economically.

    There were new clients coming onboard as well. Florida Power
& Light funded the pilot plant on Butternut Street. GE placed
an order for more than $60,000 worth of Otisca Fuel to run a
4,000-h.p. coal-powered diesel locomotive. Westinghouse was
interested in coal-powered turbine engines. So was GM, which
developed an experimental coal-powered Cadillac, dubbed the
Coal-dorado, that ran on Otisca Fuel. Five big companies -- GE,
Norfolk Southern Railway, Eastern Fuels, Westmoreland Coal and
Zurn Industries -- jointly invested $8 million in Smith and
Keller's little outfit. In November 1984 Smith took a flight
from Syracuse to New York City as president of a company with
a net worth of minus $350,000. That afternoon he flew home
president of a company with a net worth of more than $7
million. "That," he recalls, "was a nice trip to New York." With
the money, they bought an old cement factory in Jamesville,
N.Y., and converted it into a 15-ton-per-hr. production
facility.

    But the dream had not yet come true. Otisca began to feel
the constraints of a business that had grown complicated as it
sought to serve many masters. Several dozen employees,
burgeoning paperwork, outside investors with varying and not
always complementary interests, government requirements -- all
conspired to drain the fun out of it. More troubling were the
shifts in market forces beyond the company's control. By the
spring of 1986, world oil prices had dropped below $15 per bbl.
The impetus to seek out alternative fuels withered. Florida
Power & Light cut a deal with surrounding Southern utilities to
buy inexpensive power from a regional grid; it successfully
completed construction of a nuclear plant and signed an
enticing deal to buy cheap oil from Venezuela.

    Then, in 1988, Otisca won a Clean Coal matching grant from
doe -- $7.1 million, provided that a third of the money come
from the private sector. The grant was to pay for the
reconfiguration of several Syracuse-area boilers to use Otisca
Fuel.

    But the status quo in the utility business is tough to
shake. "A lot of people don't want to be the first to get their
toes in the water," observes William Speicher, a Zurn executive
who sits on Otisca's board. Concurs Ted Rosiak, a project
manager with Duke Fluor Daniels: "Utilities tend to be very
conservative and try not to take a lot of risks." In fact, risk
aversion in the utility business is not just a tendency, it has
been a way of life. Since 1935 most of the power suppliers in
the U.S. had operated a gridwork of cushy monopolies that
allowed them to earn a guaranteed rate of return, limited their
exposure to loss and actually punished them for experimenting
with anything that didn't meet strict standards of "prudency."
Under the banner of protecting consumers of electricity from
being overcharged, a maze of federal, state and local
regulations had built up that stifled incentive to change.

    When Otisca's preferred stockholders, the five companies
that had invested $8 million in the company, were asked to pony
up the private portion of the doe matching grant, they bailed
out. GE, the largest and most influential of the five, was more
interested in the locomotive business, not in fixed boilers,
which were the concern of the particular Energy Department
office in Pittsburgh that sponsored the Otisca application. At
Norfolk Southern, the two top corporate executives who had
supported Otisca had retired and their successors were focusing
on near-term marketing projects. Only one of the five, Zurn
Industries, makers of boilers and pollution-control equipment
for power plants, was interested in backing the grant. But Zurn
was not prepared to carry the $3.5 million freight alone. In
December 1990 Otisca reluctantly withdrew from the DOE Clean
Coal Round No. 2 and forfeited its grant. Otisca still had
contracts with clients to supply varying amounts of its fuel.
But none of them was willing to put up the big stakes necessary
to convert significant power plants from oil to Otisca Fuel.

    Amid all this disappointment came yet another prospect for
survival. CSX Corp., parent of the Chesapeake & Ohio railroad,
took an interest in Otisca as a possible source of fuel for a
pilot cogeneration plant it was planning at the Greenbrier
Resort in West Virginia. As the nation's largest transporter of
coal, CSX had an interest in promoting its use and export.
Engineer Mack Shelor, an executive with CSX's energy resources
and logistics division, learned through some contacts that
Otisca was the only firm capable of producing a coal-based
liquid fuel that would meet the specifications he was seeking.
The Greenbrier was an ideal demonstration site because the
venerable resort was cherished for its pristine Appalachian
environment, yet required an energy supply equal to that of a
small town. Shelor phoned Smith in Syracuse. "Best call I'd had
in 10 years," recalls Smith.

    Shelor first put the CSX Greenbrier project up for Round No.
4 of the DOE Clean Coal grants, counting on one advantage Otisca
had lacked: built-in private funding. But despite solid science
and engineering, the project was not one of the nine applicants
selected last September. DOE had chosen to husband its funds for
larger programs designed to produce new power-plant technologies
for beyond the year 2000.

    But Shelor and CSX did not give up on Otisca. For the past
few months they have been negotiating a deal that would take
advantage of a small chink in the monopoly armor of big
utilities: IPPS, independent power producers, which are allowed
by Congress to produce electric power and sell it to utilities.
IPPS are the junkyard dogs of the energy business, producing
power any way they can under the rubric of cogeneration and
operating without many of the constraints placed on public
utilities.

    "Cogen" plants produce power by burning oil, natural gas or
coal, translated into electricity or steam. The CSX Greenbrier
project was designed to burn both oil and Otisca Fuel to produce
electricity for Virginia Electric & Power, the local utility.
Even if they don't get federal assistance, Shelor hopes to build
the Greenbrier plant. Alternatively, he and Smith are discussing
a deal that would use coal wastes to make Otisca Fuel as a
direct substitute for No. 6 fuel oil. The prospect of making
money the old-fashioned way, by earning it through the sale of
cogenerated power to a utility, has given CSX reason to proceed.

    There are some other distant prospects. Poland, a country
rich in dirty coal, sent a team to Syracuse in February to
explore a deal with Otisca. They took a lot of notes and seemed
interested, says Smith, but have yet to follow up. A
representative of Pakistan has made inquiries. Markets in
Eastern Europe and the former Soviet Union have a lot of
potential but not much prospect of immediate payoff. For Smith,
who hasn't had a paycheck in two years, that's important.

    In the past, Otisca was approached by Japanese companies.
"The Japanese have a ton of coal/water slurries," says Keller.
"They're making it in Tokyo Bay and shipping it by the
tankerload to the north islands." So why not sell out to the
Japanese? "I'm very interested in having this be an American
accomplishment," says Smith. "One of the purposes in my wanting
to start a business was to show that the American thing can be
done."

    Otisca is not entirely a victim of others' shortsightedness
and bad timing. Customers, investors and board members
acknowledge that the company has made mistakes; its marketing
has been less than sophisticated, and Smith and Keller probably
should have moved the company closer to the mineheads and the
factories likely to buy their fuel. Some board members
questioned Smith's ability to run a corporation larger than an
extended machine shop. "He thinks there's only one way to do
things," says board member Speicher, "and that's his way." For
a time, Otisca employed a marketing specialist, but to little
effect. For all its potential, Otisca is not the only
alternative to oil that's out there. And some of its
competitors, entrenched or entrepreneurial, have the backing of
big, sophisticated companies that know which bureaucratic
buttons to press and which deep pockets to pick.

    "They represent something from the past in the sense that
the opportunity for a couple of entrepreneur inventors to take
an idea from inception to a production-level facility without
major corporate support today would be almost impossible," says
Shelor. "I'm amazed that they've managed to do that." Adds AEP
chief engineer Jim Markowsky: "You've got to admire their
tenacity."

    "I would hope that business would be more experimental and
more flexible," says Sidney Wertimer, recently retired professor
of economics at Hamilton College and an early investor in
Otisca. "Sure, we've made mistakes. I think probably somewhere
along the line Henry Ford and Thomas Watson made a mistake or
two."

    It may be that Otisca was born at the wrong time in the
wrong place. Other technologies and energy sources may leapfrog
over the concept of a precleaned coal slurry. In that case, the
Jamesville plant, Doug Keller and Clay Smith will be a brief,
forgotten chapter in American industrial and environmental
history. That would not be atypical. Nine out of 10 inventors
never see a penny from their ideas. Far fewer get to be Henry
Fords or Thomas Watsons.

    But there is something about the Otisca story that is more
troubling than mere missed chances and bad timing.
Statistically, Americans are not as inventive as they used to
be. And foreigners are taking a greater share of U.S. patents --
up from less than 20% in 1963 to nearly half in recent years. In
1990 the top four American patent winners were Japanese
companies. Innovation is also stifled by investment bankers and
venture capitalists, who all too often view start-up companies
not for the long-term potential of their new products but as
products themselves to be sold quickly for short-term profit.

    In the electric-energy field, regulatory policies have all
but stifled creativity. Utilities, says Jack Siegel, the doe's
coal expert, "are not rewarded for the successful risks they
take, but if they take a risk that fails, they are penalized.
It's lose-lose." And yet, according to the Kessler Exchange, a
small-business resource based in California, the only federal
program specifically oriented toward the needs of independent
inventors is the doe's Energy-Related Inventions Program, a
product of the 1974 Energy Act. To be sure, energy companies
take advantage of the limited governmental incentives to
experiment. But in the main, the budgeting and execution of the
experiments go only as far as the incentive requires.

    "Management in the U.S., it seems to me, is too
Druckerized," says Smith, now an experienced student of the
process. The management philosophies embodied in the works of
Peter Drucker, he observes, "may make mature industries work
more efficiently, but that does nothing to build new engines."

    Smith's engine is already built. He and Keller just need
someone to buy it and put it to use. That still just might
happen someday, though Otisca's 20-year record does not support
such optimism. But as Doug Keller says, "If you're not
optimistic, you're out of the game."