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Shell (NYSE:RDS.A) and Cosan (NYSE:CZZ) have signed an agreement to form a $12 billion joint venture that could be an alternative fuel major in the future. The joint venture, with assets from both companies, will be focused on the production of ethanol, sugar and power, and the supply, distribution and retail of transportation fuels.

Each company is contributing the following assets:

Cosan Shell
  • Sugar cane crushing capacity: currently ~60 million tonnes per annum from 23 mills
  • Ethanol production capacity: currently ~2 billion litres per annum
  • Co-generation: seven existing plants, two under construction and a further three to be built in the next three-to-four years.
  • Brazilian downstream assets, including ~1,730 retail sites and supply and distribution assets.
  • Ethanol logistics assets
  • Stake in ethanol trading company
  • Net debt of approximately $2.5billion
  • Brazilian downstream assets, including ~2,740 branded retail sites, supply and distribution assets, and the aviation fuel business, including the one recently acquired from Cosan.
  • Its 50% share interest in Iogen Energy (operates a demonstration scale facility to convert biomass to cellulosic ethanol using enzyme technology)
  • Its 14.7% share interest in Codexis (developer of clean bio-catalytic process technologies)
  • $1.625 billion in cash, paid over two years.

This JV will be a significant retail fuel marketing player in Brazil with around 4500 fuel retailing outlets. In addition to this, the JV will also be one of the largest alternative fuel producing companies in the region. It remains to be seen if this JV will also operate outside Brazil, although the demand outside the US and Brazil is limited for now.

In 2008, Brazil produced 24.5 billion litres (6.47 billion gallons) which represents 37.3% of the world's total ethanol used as fuel (Source: Wikipedia). The world Ethanol production as per Renewable fuels association was 17 billion gallons in 2008 - a sharp growth over 13 Billion gallons in 2007. U.S. has been the largest producer of ethanol at 9 billion gallons in 2008 with a consumption of 9.6 billion gallons.

The business divestiture into a JV allows management focus that is necessary to grow a niche business with dynamics different from the overall operations of Shell. Also, with Cosan's expertise on Ethanol as a fuel and Shell's financing powers, the business could grow at a much faster pace than it would with both companies operating independently.

As alternative fuel takes center stage over the next few decades, conventional fuel is likely to loose market share to alternative fuels. Already some countries have taken up ethanol-blending with gasoline (up to 5%) and as the shift towards alternative fuels grows the business for the JV will grow, especially if this JV also operates outside Brazil. A win-win for both Shell and Cosan shareholder's in the long-run.

Full Disclosure: No positions