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Before the Chesapeake (CHK) announcement earlier this week that it would invest $1 billion over the next 10 years in the proliferation of natural gas vehicle technologies, we had some serious concerns about Clean Energy's (CLNE) financial health. After all, the cost of developing natural gas fueling stations is not small potatoes, and the current number of these facilities is undoubtedly insufficient in the U.S. Clean Energy's major barrier to success, in our opinion, is that it needs more places for natural gas vehicles to fill up such that demand for the purchase of natural gas vehicles will increase, and the firm would then subsequently reap the benefits of this self-reinforcing trend through its revenue model.

But this huge barrier to Clean Energy's success - the fact that it by itself must throw a huge amount of capital at the development of this industry (and natural gas facilities) - seems to now be off the table. With the implicit backing of the second-largest producer of natural gas in the U.S., Chesapeake Energy, it's obvious to us that Clean Energy is now at the forefront of an industry that will actually proliferate on a large scale in the future. We previously had doubts that Clean Energy would be able to fund the industry's development largely by itself. But now, Chesapeake's $150 million investment in Clean Energy alone will spur the development of 150 natural gas filling stations - that's almost double the current 224 stations that Clean Energy operated at the end of 2010. Chesapeake, to some extent, is laying the groundwork for Clean Energy's future success.

We now believe the Clean Energy story is solely about execution and the possibility of additional tailwinds due to the extension of tax credits (for the sale of natural gas for vehicles and for the purchase of natural gas running vehicles), which are set to expire in December of this year (if not continued by Congress). In other words, should Clean Energy encounter any financial problems down the road, we would not be surprised if Chesapeake or another natural gas producer steps in to buy the company outright or offers an additional capital infusion. Though a capital infusion scenario may dilute existing shareholders to some extent, the potential for Clean Energy is absolute huge, and if successful, its existing $1 billion market cap will be a drop in the bucket in the years ahead. Clean Energy has legitimate backers in the free-market world (e.g. Chesapeake), and while government subsidies are nice, we think the former, which now has been attained, is paramount for the company to build value for shareholders.

For those unfamiliar with the Clean Energy story, the company is the largest provider of natural gas fuel for transportation in North America. It has operations in CNG (compressed natural gas) and LNG (liquefied natural gas) vehicle fueling and to a lesser extent the construction and operation of CNG and LNG fueling stations (it operates four times the number of CNG facilities than its next largest competitor). CNG is generally used in automobiles, light to medium-duty vehicles, garbage trucks and transit buses, while LNG is generally used in trucks and other medium/heavy-duty vehicles. Clean Energy generates revenue primarily by delivering CNG and LNG to its customers, and recent trends are outlined below.

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Image Source: Clean Energy's 2010 10-K

As crude oil remains at elevated levels, the company continues to benefit from the cost savings of CNG and LNG compared to diesel fuel, which is outlined below.

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Image Source: Clean Energy's 2010 10-K

As readers are aware, gasoline and diesel represent the vast majority of vehicle fuel consumed in the U.S., while CNG and LNG represent less than 5% of this consumption, by our estimates. However, natural gas as an alternative fuel has been widely used outside of the U.S. for many years (Europe and Latin America in particular). We think there are over 13 million natural gas vehicles in the world compared to about 100,000 to 120,000 vehicles in the U.S. - Clean Energy's growth region. By these numbers, the U.S. has a lot of room to expand, even perhaps 20-fold over the long run, and Chesapeake is laying the infrastructure for Clean Energy to reap the benefits of this future growth. In the U.S. solid-waste industry alone, there are 200,000 refuse vehicles operating on diesel power, and just 2,700 operating on natural gas. But with roughly 40% of new refuse trucks that are delivered powered by natural gas, we expect such an increasing trend toward natural gas use in the solid waste industry to only continue in the years ahead.

And once the proliferation of natural gas facilities occurs in coming years, look for the car manufacturers to start producing more natural gas passenger vehicles. In North America, Honda (HMC) offers a factory-built natural gas vehicle, its Civic 4-door Sedan called the GX, and Fiat may also have plans to bring natural gas vehicles to the U.S., a key positive for the industry's development. And the domestic car makers, GM (GM) and Ford (F), will probably start producing these passenger vehicles in the coming years as well, if only to keep up with foreign peers and emerging trends.

Though tax incentives are important for Clean Energy at this time, reducing the reliance on imported oil for diesel/gasoline (over 98% of the natural gas used in the U.S. is from the U.S. or Canada) coupled with the reduction in vehicle emissions make for some interesting political talking points that may keep the government incentives for natural gas vehicles on the table beyond their expected expiration in December of this year. But even if Congress fails to pass a continuance of this tax break, the economics of the industry are starting to make more and more sense, particularly as the costs of converting a diesel truck to natural gas becomes much more affordable. And the emissions benefits have been well-documented, which we outline below.

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Image Source: Clean Energy's 2010 10-K

In all, Clean Energy has a huge market opportunity and its economic interests are tied with a partner that has deep pockets, Chesapeake Energy. The firm is still struggling to turn a profit, and capital investment will be huge in coming years at Clean Energy. But we're positive on the story and believe Clean Energy is one of the best positioned players to capitalize on the trend from diesel to natural gas in vehicles. We're not ready to pull the trigger on the company yet, but we're watching the name closely for an entry point, which may present itself after the firm's next quarterly release.

Source: Clean Energy Fuels: An Interesting Long-Term Play on Natural Gas