Monday, February 23, 2009

Biofuel Trend is Back!

In addition to the public’s increasing environmentally awareness in recent years, the US$825 billion economic stimulus plan under the U.S. President Obama’s administration also supported the development in renewable energy by spending about $20 billion on renewable energy research and tax credit for renewable energy production. This environmentally-friendly development is slowly starting to gain traction which will certainly permeate through the energy sector to other sectors as well.

Last week, British Petroleum PLC (NYSE: BP) announced a 50-50 joint venture partnership with Verenium Corp. (Nasdaq: VRNM) which includes committing $45 million in funding and assets to the joint venture company and building the world’s biggest biofuel facility in Florida. This facility will apply an innovative biofuel technology to ferment inedible plants such as grass or crushed sugarcane to produce cellulosic ethanol. The Florida facility will cost between $250 million and $300 million, will be completed by 2010, and expects to start its production in 2012.

By using a wide array of non-food feedstocks, such as agricultural waste instead of corn and sugarcane – the major raw materials in the conventional ethanol production method – this manufacturing method will reduce the price fluctuation in corn and sugarcane, etc. Moreover, this new ethanol production method not only generates a renewable energy source for the public in an efficient way, but is also environmentally-friendly by recycling the agricultural waste into energy production. Based on the biofuel’s production cycle, we can estimate a potential earning increase in agricultural companies, which can reduce its cost of agricultural production. Instead of paying a fee to dump the agricultural waste in the designated disposal sites, they can sell their agricultural waste to BP and Verenium’s biofuel facilities for a profit. This potential positive earning effect is yet to be reflected in the agricultural companies’ current stock price. If the whole process follows through, those agricultural companies’ stock prices are probably undervalued in terms of a 5-year outlook.

The ethanol can be used as a substitute for gasoline in fueling transportation vehicles. According to Verenium’s estimation, the Florida facility will make 36 million gallons of fuel a year and is aiming for a cost of $2 a gallon. However, the variable cost of the inputs might change depending on the production scale and demand of the market. The earnings of BP and Verenium depend on the price of the biofuel, which is affected by its close substitution, crude oil, and its complementary, cars that use biofuel. If the public has a positive perception to driving biofuel cars, then auto companies which produces cars with biofuel compatibility will gain a first-mover profit from this trend.

As we can see, BP and Verenium’s biofuel deal will create a chain effect to businesses and long term investments across several industries. If this next-generation biofuel is strongly welcomed by the public, we can expect more energy companies to jump onto the biofuel bandwagon and create another hot issue in the market.

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