Verenium: Set to Benefit from U.S. Ethanol Policy

Includes: BP, VRNM
by: Andy Obermueller

Less than a month ago I told my newsletter readers about what amounted to a rule change at the Environmental Protection Agency (EPA). The Obama administration adjusted an output timetable for the production of cellulosic ethanol, an advanced biofuel.

Now, if you didn't hear this gripping news from me, you probably didn't hear about it. It's inside baseball for environmental wonks. The nation's Page One editors did not scramble to redesign the covers of their newspapers to make room for the story.

But that doesn’t mean that it's not vital.

First, a little background.

Ethanol, or ethyl alcohol, is pure alcohol typically fermented from the starches in corn that can be blended with gasoline to make motor vehicle fuel. Henry Ford's first car, in fact, ran on the stuff. Today, though most cars use fossil-fuel based gasoline, federal law nevertheless calls for billions of gallons of ethanol each year.

There are some problems with this. The most important is that people eat corn. More specifically, poor people depend on corn as a staple. The ethanol market can increase demand, which tends to increase prices. This makes it harder for many people to afford food.

There's another way to make ethanol, however -- and it's a much better way. All plant matter on earth contains a substance called cellulose. As you might remember from your chemistry classes, words ending in -ose are sugars, and any sugar can be fermented into ethanol.

Breaking down the cell wall to access that cellulose has been tricky, but the process -- driven by specially engineered enzymes -- is ready for prime time. And not a moment too soon, either. Federal timetables originally mandated the production of 100 million gallons of cellulosic ethanol in 2010.

But we're not quite ready for that. The technology is ready, but the actual cellulosic ethanol production facilities haven't been built yet. There are a few pilot plants around the United States, and in other countries, but there's nowhere near enough capacity to turn out 100 million gallons, let alone the 16 billion gallons the federal timetable mandates for 2022.

So Team Obama, when it became clear they were too far out to kick a field goal, simply moved the uprights closer. Instead of 100 million gallons of production, the revised timetable called for only 6.5 million gallons of ethanol. My take on this: The administration, which has yet to engineer a major policy win, would like to knock the environmental ball out of the park. So it lowered the target -- knowing no one would notice -- so that when they approved the plants that could achieve the new output target, they'd have something to take credit for.

And, not to gloat, but that's exactly what happened today.

The U.S. Department of Agriculture guarantee for a commercial-scale cellulosic ethanol plant to be built in Georgia.

The $80 million loan guarantee will help finance a plant with 20 million gallons in annual capacity. That's more than three times the 2010 output target. This one plant alone gives the president the chance to say he delivered 300% more than was expected.

I don't think he's going to stop there.

I don't think there's any chance of it. In fact, I wouldn't be surprised at all if the administration is secretly aiming for the 100 million gallon number it revised. I have two reasons for saying this: The first is that the Department of Agriculture said it would co-sign this note before Bush even left office.

Second, there are plenty of other cellulosic ethanol plants in the works, from facilities that will use corn cobs and other agricultural waste to those that will derive fuel from heretofore untapped resources like waste paper.

Now, many of these plants, alas, are private ventures. There's no way for investors to profit. But investors can get in on at least one plant, to be built in Florida, which is poised to deliver serious results to its shareholders.

That company is Verenium (NASDAQ:VRNM), which built the nation's first demonstration-scale cellulosic ethanol plant in Jennings, La. in 2008. Verenium is the leader in the enzymes that are crucial to the cellulosic ethanol fermentation process. (It also has a host of other enzymes, including one that "degums" the world's largest soybean processing plant, in Argentina.) The company, for its part, expects to break ground this year. The actual date is unknown.

So what's the holdup? It's not expertise: Verenium is an industry leader in enzymes and it has wisely partnered up with BP Plc (NYSE:BP) to construct the plant. No one has commercial-scale chemical expertise like the major oil companies, and BP just extended its partnership with Verenium and will deploy its expertise as soon as one last thing transpires.

That one thing? It's a federal loan guarantee. BP and Verenium are financing the plant and its lenders have sought a federal loan guarantee on the project. This clearly has nothing to do with money -- BP's latest filing showed $67.7 billion in current assets on its balance sheet -- it's about the output quotas. All parties involved want to be sure that if they devote the not insignificant resources to building these plants there will be markets for the ethanol they produce.

The federal loan guarantee -- just like the one issued today by the Department of Agriculture for Range Fuels' Georgia plant -- is the best way for the federal government to clarify its intentions. You see, a loan guarantee doesn’t cost a dime. Uncle Sam isn't writing a check, he's co-signing the credit application. If the market Washington promised dries up, then Washington is on the hook to compensate the investors who risked their money to supply a market lawmakers created.

That's not likely. What's far more likely, and, as I predicted a month ago, is that Team Obama will point to the success of the cellulosic ethanol loan guarantees as a way to strengthen the economy, create jobs and reduce our dependence on foreign oil.

That's an excellent political move from a White House that severely needs a win. Truth be told, it's not terrible policy. And the steps to exceed the output quota and build more plants are utterly fantastic news for Verenium shareholders, who could well see the value of their stock rise to match the dramatic +24,515% increase in cellulosic output that federal law calls for between now and 2022.

Disclosure: Long VRNM