Cellulosic Ethanol: The Fuel of the Future?

Second-gen biofuel companies could be on a rising tide

   
Cellulosic Ethanol: The Fuel of the Future?

As oil prices continue to rise, so has the cost to fill up our tanks. According to AAA, the average price for a gallon of gas hit $3.90 on Wednesday — the 19th consecutive day it has risen. While there are myriad factors that go into what we pay at the pump, the underlying point is that it still hurts our wallets.

However, some pricing relief might be on the horizon. Escalating petroleum prices have once again led to renewed interest in biofuels. While traditional corn and sugarcane ethanol have provoked an intense backlash from both policymakers and the public, second-generation biofuels made from plant wastes or non-food crops, known as cellulosic ethanol, are beginning to gain acceptance. While it will be some time before we fill our tanks with wood chips, recent activity in the sector is certainly indicative of bullish news.

For investors with a long-term timeline and some risk capital to play with, the cellulosic ethanol sector could be an interesting speculation.

Yard Waste & Scraps For Fuel

Nothing in the alternative and renewable sector creates such a debate as corn ethanol. However, as the impassioned battle continues to rage about whether carbon emissions from ethanol production are actually lower than those from oil — or whether the 33% of the U.S. corn crop used in ethanol production actually drives up food prices — second-generation biofuel companies are hard at work.

At its core, advanced biofuels are those that do not rely on the corn kernel starch to make sugar-based or alcohol fuels. Cellulosic ethanol producers hope to create energy from plant material such as switch grass, forest waste and wood chips. The tricky part stems from converting cellulose from feedstocks of faster-growing trees like bamboo, into usable sugars. Once these sugars are produced, they can be converted to standard ethanol using conventional processes.

There certainly is plenty of incentive to do so. First, feedstock costs are next to nil. By using wheat straw, sugar-cane bagasse (the cellulose-rich waste from cane processing), yard trimmings or even trash itself, these companies hope to overcome one of the major hurdles of corn-based ethanol: competition for food.

One of the major criticisms of corn-based ethanol is that federal mandates for blending have been driving up food costs. Famed value investor Jeremy Grantham has calculated that ethanol demand increases the global price of a bushel of corn by 20%. This seems to echo similar findings by Texas A&M researchers. A university study also traced an increase in corn and grain prices to ethanol production. By using waste, cellulosic producers hope to avoid this issue altogether.

The second strike against corn-based ethanol is shipping costs. Several second-generation biofuel companies hope to produce hydrocarbon-like fuels. These molecules are chemically similar to those that already power planes, trains and automobiles. These “drop-in” fuels won’t absorb water like ethanol, nor are they corrosive, meaning they can be put directly into fuel tanks and pumped through pipelines, just like regular traditional oil-based fuels.

A Long Road Ahead

The 2007 Energy Security and Independence Act mandated that oil companies use 36 billion gallons of biofuels annually by 2022. Of that, 16 billion gallons are to be made from lighter environmentally footprinted advanced feedstocks such as cellulosic ethanol or algae. Globally, biofuel requirements call for at least 72 billion gallons by 2021.

According to the EPA, no commercial volumes of cellulosic ethanol are currently being produced. However, several startups and advances are currently under way that could turn the tide.

Ethanol giant POET recently broke ground on a new $250 million facility designed to use leftover corn stalks and cobs. Using enzymes, POET plans to produce about 25 million gallons of cellulosic ethanol per year and could be the first commercial plant in the country. Likewise, DuPont (NYSE:DD) will break ground on a similar facility later this year. There also have been a handful of strategic partnerships between major oil firms and various cellulosic firms.

Given the potential promise of finally unlocking the “holy grail” of biofuels, investors might want to give some of the companies involved a go. While I wouldn’t sell my traditional hydrocarbon-based energy stocks just yet, these cellulosic players could provide a nice counterpoint to an oil & gas portfolio.

Interestingly enough, the two furthest along — Codexis (NASDAQ:CDXS) and Amyris (NASDAQ:AMRS) — have directly partnered with oil majors.

Codexis is hoping to use an enzyme-based technology that will make biofuels from wheat straw and sugar-cane bagasse. Collaborating with Royal Dutch Shell (NYSE:RDS.A, RDS.B) and Brazil’s Cosan (NYSE:CZZ), the firm will build a plant capable of producing 105 million gallons of drop-in fuel every year.

Similarly, biotech company Amyris and French oil major Total (NYSE:TOT) are planning on using genetically engineered yeast to crack the cellulose.

Both companies went public in 2010 and currently can be bought for well below their IPO prices — in fact, both CDXS and AMRS are near all-time lows. And while it might take a while to see real scale from their efforts, investors with longer timelines might want to consider the firms.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2012/03/cellulosic-ethanol-the-fuel-of-the-future-cdxs-amrs/.

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