Ideas for Investing in Cellulosic Ethanol

 |  Includes: DNSCY, NVZMY
by: Investment U

By Tony D’Altorio

Biofuel certainly seems like an up and coming global growth industry.

The International Energy Agency sees worldwide consumption increasing from an annual 55 million tons of oil equivalent to 750 million in 2050.

Right now, biofuel makes up a mere two percent of the transportation fuel market. But analysts expect it to increase to 27 percent in four decades.

Here in the U.S., however, the issue is controversial. Rising corn prices have renewed debate over ethanol, a corn-based fuel for vehicles.

The argument comes down to a matter of food vs. fuel. After all, the U.S. uses 40 percent of its corn crop to create ethanol every year.

That demand is one of the factors driving up corn prices around the world.

Fortunately, there is a viable alternative in cellulosic ethanol.

Cellulosic Ethanol

Cellulosic ethanol, a second-generation ethanol, is derived from agricultural waste. Because it comes from straw husks, sugar cane off-cuts and the like, it does not compete with food production.

McKinsey predicts this market will amount to $75 – $140 billion worldwide by 2020. The consultancy firm sees this happening as the U.S., Europe, China and others promote biofuels to reduce carbon emissions and oil dependency.

But the cellulosic ethanol industry has not taken off yet.

Doubts about its economic viability remain. And the U.S. corn industry has objected too, since it doesn’t like competing for space at the government trough.

Yet Italy just began construction on the world’s first commercial-scale production facility. Due for completion next year, the plant will have a 13 million gallon per year capacity.

With production costs around $2.50 a gallon – similar to corn-based ethanol – it will be competitive with current fuel prices.

Before this point, the U.S. had the lead in this new market. President Obama had aimed for 250 million gallons this year alone, but his administration cut the target to just 6.6 million after delays to planned U.S. production facilities.

And now, Europe, China and Brazil all have plans to start full-scale production by 2013.

DuPont and Danisco

Because of its nearly $6 billion takeover bid for the number two company in the cellulosic ethanol industry, DuPont (NYSE: DD) looks likely to come out ahead in this market.

Its target, the Danish company Danisco ADR (Other OTC: DNSCY.PK), makes food ingredients. It also produces enzymes that allow biomass, such as switchgrass, to ferment into ethanol.

The two companies already jointly develop cellulosic ethanol at a demonstration plant in Tennessee. But the planned acquisition would give DuPont full control.

Currently, the fuel contributes a fraction of Danisco’s $2.67 billion of annual revenues. But if second-generation ethanol fulfills even a fraction of its forecast potential, it could transform the company’s growth prospects.

The same goes for Novozymes ADR (Other OTC: NVZMY.PK), the market leader. It invests heavily in the fuel and plans to build a demonstration plant in China this year.

Enzyme makers expect just a sliver of the billions the industry should generate. But analysts think it could still double the size of the market to over $5 billion annually.

If so, Danisco seems like a wise acquisition for DuPont to make. Though the deal could still fail…

Danisco shareholders don’t seem to like the offer. They think DuPont should pay more for the company’s green energy potential.

In order to win over those investors, DuPont will probably have to raise its bid. But even so, that takeover will pay off in the long term.

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