With the Environmental Protection Agency’s approval of the new Renewable Fuels Standard (RFS) mandating a steady increase in the amount of next generation ethanol produced in the U.S. year over year, you might think that the burgeoning industry would have an easy time of finding the money to build their new facilities—bringing them from pilot scale experiments to full-on commercial production. By 2016, the RFS calls for the production of 16 billion gallons of this type of ethanol, up from almost nothing today.

This next generation of ethanol, known as cellulosic ethanol, is a far cry from the highly controversial (and environmentally questionable) corn ethanol that has become so pervasive. Cellulosic ethanol is made from non-food sources including waste agricultural products such as corn stover, wheat straw, and thinned forest residues, as well as purpose-planted non-food crops such as switchgrass and hybrid poplar. Given its much better environmental performance, lack of competition with food, and the new RFS mandates, cellulosic ethanol appeared to have an easy task ahead of it.

But recently the EPA has been reneging on its self-imposed RFS requirements. The mandate for cellulosic ethanol production in the U.S. was supposed to be at 100 million gallons this year, but the EPA reduced it to a mere 6.5 million. And last month the EPA said that its 2011 requirements for cellulosic ethanol would be reduced from 250 million gallons (as required in the RFS) to less than 17 million gallons. The EPA’s reasoning is that there just aren’t enough commercial facilities yet to support that level of production. But the industry is starting to cry foul.

A Stick in the Back of Oil Companies

Many of the major players in the cellulosic biofuels industry say that, yes, they are years behind schedule on building the facilities, but it’s not because they can’t make the product yet. They claim that, due to the EPA’s drastic reduction in targets, they are finding almost no one to finance the $500 million or so that each facility will take to build. By keeping to the commitments set under the RFS, and penalizing oil companies for not buying enough cellulosic ethanol (even if that ethanol doesn’t yet exist), the biofuel industry says the oil companies would be forced to finance the cellulosic ethanol plants and, as a result, the cellulosic ethanol would start flowing quickly.

“There are production facilities that are queued up to be built, but they’re getting hung up by the capital markets and the bankers,” said John McCarthy, CEO of the cellulosic ethanol startup Qteros, in an article over at MIT’s Technology Review. “Unless the EPA and the White House hold firm on the level of mandated demand, then you might as well not have a Renewable Fuels Standard.”

But the problem isn’t that easy to fix. A law passed by Congress requires that the EPA lower targets set in the RFS based on what supplies are actually available on the market. The cellulosic ethanol industry is trying to convince the powers that be that the law needs to be changed so that if the amount of cellulosic fuel that was mandated wasn’t available, the oil companies would pay a per-gallon penalty. In this way oil companies, and the banks that depend on them, would be forced to loan out some serious cash quickly.

“You need to put a stick in the oil companies’ backs to say, you need to start building something to meet your obligation under the Renewable Fuels Standard,” said Wes Bolsen, VP of government affairs at Coskata, another cellulosic ethanol startup, in the same Technology Review article.

But it’s unclear if cellulosic ethanol companies will have enough sway to force the change given that they are at a bit of a disadvantage when it comes to political power. Corn ethanol relies heavily on help from the King Corn lobby, and the oil industry is one of the largest lobbying organizations on the planet.