viernes, marzo 23, 2007

USA: Biofuel Boom

by Kenneth Reid
Around the time that we entered the 21st century, it became clear that energy security and national security were two sides of the same geopolitical coin. For most of the succeeding six years, investors have focused on oil, natural gas, coal and uranium, the dominant sources of global energy supply, producing a huge bull market in this sector.

While we continue to endorse the long-term bull market in conventional energy, we have noticed a new level of buying interest in alternative energy plays that seems qualitatively different than the fickle short-term manias we have periodically witnessed before. As the Age of Cheap Oil is now gone forever, we surmise that institutional investors are now accumulating shares of certain leading alternative energy companies for the long haul.

Most crude oil pumped from the ground eventually finds its way into an internal combustion engine used for transportation, not for producing electricity. Accordingly, any liquid fuel that could be blended economically with oil distillates is guaranteed to have a large market potential in the vehicle industry.

This point was driven home to the American investor last spring as the MBTE additive was being withdrawn from gasoline and ethanol stood next in line as the blending agent. Ethanol and other biofuel stocks skyrocketed in a mini-mania.

A case in point: Earth Biofuels, a Bulletin Board biofuels play, got famous overnight due to a celebrity endorsement from Willie Nelson for its "BioWillie" product, a 20% biodiesel/petrodiesel mix. At the height of the biofuels craze in early May, the company soared to a market capitalization of $1.5 billion. After peaking at $7.23, shares have fallen like an unplugged dot-com to just $0.39, which still gives the revenue-light company a market cap of $85 million. Don't lose sleep at night by investing in unproven biofuel microcaps. The investment grade companies in this area are not the glamour stocks.

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The term "biofuel" describes a number of different fuels (principally ethanol and biodiesel) that can be produced from organic matter and used as a partial replacement for gasoline or diesel. In most cases, the agricultural source is corn or sugarcane, but new technology is being developed to utilize forest and farming waste products as well as various types of fast-growing weeds and ground cover.

The concept of producing fuel from renewable sources is appealing for a number of reasons. First, biofuels have a patriotic-sounding ring, as consumers imagine they reduce dependence on imported oil. That is mostly a myth, but it is a factor in generating government subsidies for this segment of the alternative energy market. Not surprisingly, the European Union and the U.S. are mandating aggressive targets for biofuels expansion during the next three years.

Second, compared with hydrocarbons, biofuels are environmentally friendly because they contain little sulfur (a pollutant) and are "carbon neutral." That term refers to whether a fuel emits greenhouse gases, mainly carbon dioxide (a regulated pollutant in Europe), into the atmosphere. Crops are carbon neutral because they actually consume carbon dioxide during the growing cycle and then emit it during combustion, in a balanced fashion.

Ethanol is the world's most popular biofuel, and Brazil has been the world's largest producer for decades, with a current output of over 4 billion gallons annually. Brazil, a country where sugarcane is easy to grow, diverts about half its total crop to ethanol production. Most cars in that country are flex-fuel--they can run on ethanol or gasoline, but even in the U.S., most cars can tolerate ethanol at a 15%-20% ratio to gasoline. A higher blend of ethanol fuel, E85, is also available in the U.S., and flex-fuel capable vehicles are becoming more common here as well.

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Increasingly, however, demand for biofuel is conflicting with end user demand for food crops. China, which has a fledgling ethanol industry, will soon become a major importer of corn and will be looking to the U.S. for supplies. With over 100 ethanol plants already in operation and 78 more under construction, the U.S. is diverting an increasing proportion of the corn crop (as much as 50% this year) to produce ethanol. Moreover, there are 105 biodiesel plants in the U.S. producing more than 100 million gallons of biodiesel annually from soybeans, with many more on the way.

Instead of investing in microcap Bulletin Board stocks, there are two "investment grade" ways to play the biofuel boom. First, the supply squeeze for high-grade biomass will lead to a secular bull market in certain agricultural products such as corn and sugarcane, so buying companies with a global footprint that participate in this segment of the agriculture industry makes sense. Ethanol production is already soaring around the globe. Brazil, for example, is planning to increase its ethanol output by 50% over the next five years, and its sugarcane crop is fertilizer-intensive.

In this regard, we recommend a fertilizer company named Mosaic , a Minnesota-based outfit with operations not only in the U.S. but also in Argentina, Brazil, Canada, China, India and Thailand.

Another, more speculative way to play the biofuel boom is with SunOpta, a well-established company ($598 million in revenues in 2006) that we believe will be a player in the emerging cellulosic ethanol industry.

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Ethanol can be made from the fermentation of high-carbohydrate foods such as corn and sugarcane, but it can also be produced from high-cellulose biomass (such as corn husks and stalks) through the use of a process that uses heat and sulfuric acid to break down the cellulose. This is an energy-intensive process, however, and fortunately an alternative is on the horizon.

The greatest potential for ethanol production from biomass lies in the enzymatic hydrolysis of cellulose. The same enzyme now used in the textile industry to "stone wash" denim can be used at room temperature to break cellulose down into sugars and ferment them into ethanol. In the long run, cellulosic enzyme technology should provide cost reductions four times greater than the sulfuric acid process. SunOpta, a highly profitable Canadian natural food distributor, is branching out into the cellulosic ethanol business.

Primarily a company that sources, packages and distributes a range of natural, organic, kosher and specialty food products, SunOpta has a development-stage business segment, its BioProcess Group, that designs and markets proprietary steam explosion technology systems for the emerging biofuel industry. The company is involved in an ethanol pilot facility in Nebraska funded by the U.S. Department of Energy and has a contract to provide Europe's largest ethanol producer, Abener Energia of Seville, Spain, with its patented steam explosion equipment and process technology for the first commercial production facility in the world to convert wheat straw into ethanol.

During the fourth quarter, the BioProcess Group's technology was operating around the clock in China producing cellulosic ethanol. The BioProcess Group is soliciting private equity investors to build cellulosic ethanol production facilities in Canada. We expect a spinoff in 2008. SunOpta achieved record revenues for the three months ended Dec. 31, 2006, its 37th consecutive quarter of increased revenue growth. Sales were up 34% to $163.5 million, while net earnings in the quarter rose 33.4% to $2.08 million or $0.04 per share. This still leaves the company with a high price-to-earnings ratio but very interesting long-term prospects.

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