Theo Lee is an innovator in the spirit of Henry David Thoreau. As a chemical engineer, he toiled in quiet desperation for 20 years until 1995 when he and two other chemical engineers formed Hydrocarbon Technologies Inc. (HTI).Their plan was to develop chemical agents that would easily and quickly transform substances, like coal, into other substances, like oil. They wanted to do nothing less than change matter itself.

Mr. Lee and the other HTI founders--Alfred Comolli and David Tanner--immediately focused their research on problems affecting the energy industry. Backed by the founders' own funds and about $5 million in grants over two years from the U.S. Department of Energy, HTI developed a modest portfolio of products and consulting services that generated $7 million in annual revenue. HTI's creations included a process to upgrade old motor oil for re-use and another to convert solid municipal waste into clean-burning liquid fuels. The revenue from HTI's early breakthroughs supported a much larger effort: the transformation of coal into cleaner-burning gasoline and diesel fuel. Whereas competing approaches involve catalysis and chemical agents, HTI set out to develop a process to manipulate coal, molecule by molecule, with great precision and efficiency. "It may not seem it," says Mr. Lee, "but the liquefaction of coal makes technical and economic sense."

Mr. Lee and his colleagues drew upon the nascent field of nanotechnology. They figured out how to use heat to separate coal into individual molecules so that molecules of sulfur, nitrogen, ash, and other impurities can be removed efficiently and inexpensively. Then they took the purified coal molecules, enriched them with hydrogen and produced liquid fuel. "With this technology," says Mr. Lee, "we clean the coal up before it is used as fuel instead of after."

"Theo Lee is a wonderful example of someone beavering around in an old, dirty industry and coming up with a nano-manipulation that gives the industry a new, clean life," says Tim Harper, CEO of CMP Cientifica, a nanotechnology consulting company.

Yet the discovery and the economic return of this modern-day alchemy would elude HTI for more than five years. At one point the founders had to borrow money to stay afloat. "We were brave enough to sign away our houses and our personal assets," says Mr. Lee. In 2000, they courted several venture capital firms, but the terms offered were "not favorable," says Mr. Lee diplomatically. "Instead we almost totally reinvested all our net incomes back into R&D."

Meanwhile, thanks to the U.S. Department of Energy, HTI won the attention of the U.S. Department of Commerce and the U.S. Trade and Development Agency. These government agencies found a customer that wanted exactly what HTI was developing. That customer was China, a nation with vast coal resources but limited foreign cash to buy imported oil. The first meeting between HTI and its Chinese counterparts occurred in December 1996.

By the start of 2001, HTI was five years into negotiations with the Shenhua Group, China's largest coal company with a production capacity of 60 million tons per year and 220 billion tons in reserves. "It was very difficult for a small firm like ours to wait that long for a contract," says Mr. Lee. In fact, the company had developed a working coal liquefaction process with only $7 million in annual revenue and 40 employees.

In August 2001, Headwaters, a United States-based alternative-energy company that saw the global market for these transformative processes to be worth some $10 billion annually, bought HTI. Valued at $17 million, the deal involved a combination of cash, assumption of HTI's debt, and a portion of Headwaters shares (Nasdaq: HDWR). Mr. Lee remained president of HTI.

In July Headwaters announced that it had finally signed a contract with the Shenhua Group. HTI will help Shenhua build a $2 billion plant capable of converting 4,300 tons of coal to 50,000 barrels of liquid fuel per day.

Construction of the plant is slated to begin early next year, with production starting in 2005. Headwaters will earn an undisclosed initial licensing fee and recurring royalties from the contract.

Ten more coal conversion plants in China could eventually be built as well. After that, Mr. Lee says he will try and sell his technology to other countries, like Japan, that are net importers of oil. "When you've sold one license," Mr. Lee says, "it's not the end. It's the beginning of a lot more work."

Sources From:RED HERRING 2002