Sunday, March 10

Week 88 - Biofuels

Situation: Grain reserves around the world have been falling at an average rate of 4%/yr for more than 10 yrs. This is not a good thing. Prices have doubled over that period and demand still remains strong for 3 reasons: a) there are ~220,000 more mouths to feed each day, b) more than 10,000,000 workers emerge from poverty each year, and c) grain is increasingly diverted from the food chain to make biofuels. (This also appears to have reduced per capita oil consumption by almost 2%/yr.)

It took just a few years for biofuel production to become a major industry in a number of countries. Brazil is the leader with 90% of the cars sold there equipped to run on 100% ethanol made from sugar cane. When the price of sugar on the world market is high, Brazil sells its sugar overseas instead of using it to make ethanol; car tanks are then filled up with gasoline. Brazil currently has enough sugar production to fuel its cars and sell ethanol abroad, e.g. to US refiners for $0.20 less than the US wholesale price for corn ethanol. How is that possible? Because it is so much cheaper to make ethanol from sugar cane than from corn kernels.

Okay so where is this discussion headed? The current goal is to find a commercially successful way to make ethanol from grass and wood chips, so-called cellulosic ethanol. We're not there yet but we can make diesel fuel on a competitive scale from algae and vegetable oil. This week's blog looks at companies that invest in biofuel production and have stock that has been publicly traded for at least 6 yrs (Table).

BP is the biofuels leader, and it currently is in court because of a horrific deepwater oil rig explosion that killed 11 workers. But neither bad publicity nor big fines will cripple this company because it has many strengths, not least of which is its long-standing commitment to renewable energy. If you want to make only one investment in biofuels, BP remains your best bet. The only other investment-grade companies subspecializing in biofuels are duPont (DD) and Valero (VLO). Valero owns 10 ethanol plants and duPont is developing biobutanol as a substitute for ethanol--one that doesn’t need to be made from grain. Biobutanol research is almost at the point where it can be made in a cost-effective manner from ethanol, glycerol (a byproduct of biodiesel production), cellulose, solar energy or algae. 100% butanol is a suitable fuel for motor vehicles and can be transported in gasoline pipelines, whereas, ethanol is too water-soluble to pull off either feat. REX American Resources is also worth a look, since it does manage to beat the S&P 500 Index (VFINX) in terms of Finance Value (Column E in the Table). REX owns ethanol plants and specializes in selling animal feed made from the distiller's grains, which are the major by-product of ethanol production. For small-capitalization companies that didn’t make it into our Table, we refer you to the Exchange-Traded Fund specializing in those (PBW, see line 10 in the Table).

BP is expanding production of bioethanol from sugar cane in Brazil. Recently, it announced that one plant will be doubled in size to process 5 million tons of sugar cane annually, enough to make 120 million gallons of ethanol. BP has taken the lead in research on cellulosic ethanol production by setting up a Biofuels Global Technology Center in San Diego after buying cellulosic ethanol assets from Verenium. As part of that effort, BP operates a 1.4 million gallon/yr cellulosic demonstration facility in Jennings, LA. Together with duPont (DD), BP has made a major push toward establishing biobutanol as a fuel of the future (because of the important advantages butanol has over ethanol). That joint venture is called Butamax Advanced Biofuels. For this work, MIT’s Technology Review magazine (December 2010) named duPont as one of the 50 most innovative companies in the world.

Bottom Line: Biofuel production isn't a mature industry. BP, duPont (DD), and Valero (VLO) are the only companies with investment-grade stock offerings. But more will come.

Risk Rating: 9.

Full Disclosure: I have stock in duPont (DD).

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