Investing in Biofuels

Many pundits who listened to the President's State of the Union speech, including Jon Stewart (my favorite) on the Daily Show, were scratching their heads at Bush's statement about making gasoline out of "switch grass and wood chips". What he is talking about is cellulosic ethanol, and it truly does have many people believing that it will carry us to energy independence.

Ethanol has been around for decades. It enjoyed a brief moment in the spotlight during the energy shortages of the Jimmy Carter era, when subsidies were dished out by the truckload to heartland farmers to make the stuff out of corn. Back then, the engines of the day were not prepared for ethanol, and the slow uptake of the fuel relegated it to fringe use. Today, ethanol works just as well as gasoline in most engines. In Brazil, flex fuel engines, which cost no more than $200 to install, 73 percent of drivers have this modification, and as a result, the country is not dependent at all on foreign sources of oil, instead relying on ethanol made from sugarcane.
These technologies are here today, and it does not require a massive change to the infrastructure the way that a hydrogen economy would.

Cellulosic ethanol is just ethanol made from different plants, and yes, switch grass and wood chips are potential feedstocks. The process is basically the same as that used by Kentucky Moonshiners to get grain alcohol. Distillation forces the cellulose (the material that holds cells together) to convert into alcohol and sugars. The promise of cellulosic ethanol is that it can use agricultural waste, of which we have tons.

So, how does one invest in this market? The only pure play is a company called Pacific Ethanol (NASDAQ:PEIX). This smallish company has built ethanol refineries in California, and has garnered investment from Bill Gates. However, the company is already in the hands of speculators. Just last week, thanks to the State of the Union speech, the company rocketed from $12 to almost $19, and back below $17. The higher prices make the fundamentals look very bubble-ish.

Safer bets include:

1. Archer Daniels Midland (NYSE:ADM) which has about 5 percent of revenue, but 20 percent of profit from its ethanol business.
2. Bunge (NYSE:BG), which processes soy and rapeseed.
3. Monsanto (NYSE:MON), whose genetically modified soy and corn seeds are well suited to ethanol production (according to Fortune Magazine).

Another strategy, albeit potentially more risky, is to buy commodity contracts on the crops involved in the process. Sugar, especially, is widely traded. Commodities have gotten a bad rap as too risky, but it is more often leverage that gets people in trouble, not the instruments themselves.

I have said in this space before that the physics of the much-hyped hydrogen fuel cell cars are too problematic for transportation. Ethanol burns cleaner, and is grown right here in the USA. Combine this with more fuel efficient cars, and the road to energy independence could be a lot less bumpy. Let's hope that the Bushies are not just paying lip service.