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Bluefire Ethanol Fuels: Speculative DOE Darling

Bluefire Ethanol Fuels (BFRE:OB) is a development stage company based in Irvine, CA. Their business model is based on the future production and sale of cellulosic ethanol, to be produced in two plants currently in development, one in Lancaster, CA, and the other in Fulton, MS.

Cellulosic Ethanol As US Government Sock Puppet

Cellulosic ethanol in general has been debated and studied by activists, scholars, and entrepreneurs, but generalized assertions of relative merit do not produce actionable investment decisions - what is of interest about BFRE:OB is the degree of committment to them shown by the Department of Energy (DOE).

(Information from open press sources, Bluefire's investors' website, and SEC filings)

In 2008, Bluefire received $40 million from the DOE for the development, design, and permitting of its first commercial-scale production plant in Lancaster  (bluefireethanol.com/pr/55/ ). The grant was initially approved in 2007. After a much-longer-than-expected permitting process, largely induced by the Byzantine requirements of the State of California, Bluefire received all the necessary permits to begin construction, just in time for the financial crisis to cut off likely sources of construction funding ( bluefireethanol.com/pr/70/ , www.reuters.com/finance/stocks/keyDevelo... ). In reaction to the counter-productive California regulatory conditions, Bluefire petitioned and was granted permission by the DOE to relocate its second planned production facility to Fulton, MS ( bluefireethanol.com/pr/75/ ).

At this point, sound arguments could have been made that Bluefire was poised to languish in credit facility limbo, watching its 20-month permitting effort in CA wasted, and being unable to capitalize its encouraging and strategically intelligent move to MS.

Then, last week, the DOE disbursed $3.8 million to be used for pre-construction activities on the Fulton plant. Yesterday (Nov 12, 2009), the DOE announced that Bluefire has successfully completed Phase 1 of its application process for a $56 million loan gaurantee to build the Lancaster plant ( money.cnn.com/news/newsfeeds/articles/pr... ).

Coincident with this announcement (two days earlier, but the DOE Phase I completion was likely already known at Bluefire), Bluefire CEO Arnold Klann annouced he will join Under Secretary for the Department of Energy Dr. Kristina M. Johnson, at the 4th Annual Cellulosic Biofuels Summit in Washington, DC on November 17, 2009 ( money.cnn.com/news/newsfeeds/articles/pr... ). Klann plans to discuss difficulties finding financing for construction of cellulosic production facilities.

Bluefire's patented Arkanol process depends upon landfill and waste products, rather than food stocks, so their planned facilities are co-located at landfills. Whether or not the 3-million-gallon CA plant, or the 18-million-gallon MS plant contribute to a future burgeoning cellulosic ethanol marketplace; whether cellulosic ethanol is or is not a good fuel or fuel additive in grand environmetal terms is of no interest to me: the DOE's actions in the case of Bluefire support a conclusion that the current administration has already spent too much, said too much and done too much ( www.whitehouse.gov/the_press_office/Pres... ) to allow Bluefire to fail.

The Company

Bluefire's most recent 10Q lists assets of 1,026,054 and liabilities of $6,332,110. With 28.17 million shares outstanding, trading at $0.97, the current market capitalization of $27.33 million makes Bluefire a micro-cap stock with substantial downside risk, consisting mainly in their ability to actually build, then operate, working facilities, then produce, then sell a projected 21 million gallons of ethanol. Each of these risks poses the possibility of a total loss of investment in Bluefire.

Speculating upon those risks however, CBOE ethanol prices for 2009 resemble the hypotenuse of a right triangle, currently trading at $1.98/gallon, and an historical (since 2006) average close to $2, Bluefire's operating revenues from production would be in the neighborhood of $42 million per year.

Assuming Bluefire operates at a level of efficiency on par with available comparison companies, they would need to generate those gallons at a gross margin of over $0.25/gallon to have a chance at profitability.

Share Price Risks and Catalysts

Risks to Bluefire's $0.97 current share price include adverse DOE decision on the Phase 2 loan guarantee application, unforeseen construction delays at its two planned facilities, unforeseen engineering obstacles during construction, regulatory risk from the Obama administration and Congress (including a recent possible adverse tax provision included in the most recent House healthcare bill forwarded to the Senate), the market price volatility in the commodity value of ethanol, and the advancing age and health condition of Bluefire's CEO, Arnold Klann.

Catalysts include DOE approval of the Phase 2 loan guarantee (within the next 6 months), an announcement of financing from a source other than DOE (possible anytime), an announcement of actual ground-breaking (most likely no sooner than Q3-2010), and an announcement of actual ethanol production from either Lancaster or Fulton (most likely no sooner than mid-2011).

Valuation

Given the DOE's track record to date of commitment, the administration's position on cellulosic ethanol, the patent license value of the Arkanol Process, and the relocation to MS of plant 2, Bluefire appears to rate as a small-position speculative stock play with potential downside target of  $0.96 (21 million gallons X $0.26 gross margin - $0.25 cost = EBITDA income of $210,000, or $0.007/share X P/E of 10 = $21,000,000, or $0.96/share), a modest-estimate upside target, within three years, of $1.86 (21 million gallons X $0.50 gross margin - $0.25 cost = EBITDA income of $5,250,000 or $0.24/share X P/E of 10 = $52,500,000, or $1.86/share), and a rosy upside target of $5.67 (21 million gallons X $0.76 NET margin = EBITDA income of $15,960,000 or $0.57/share X P/E of 10 = $159,600,000, or $5.67/share). All of this is purely speculative, and, in addition to the assumptions below, ignores the risk of total loss possible. This is a spec play.

The downside target assumes:
1. The low end of profitability compared to historical industry performance. This assumption, though, is based on comparison to food-crop inputs. Bluefire may realize lower operating costs, since their feedstock is garbage, and available at considerably lower costs and volatilities.
2. A P/E of 10, comparable to other profitable micro-, small-, and mid-cap energy producers.
3. Actual production at planned capacities.
4. The ability of Bluefire to avoid debilitating adverse tax burdens.

The modest upside target assumes:
1. The high end of profitability compared to historical industry performance. This assumption, though, is based on comparison to food-crop inputs. Bluefire may realize lower operating costs, since their feedstock is garbage, and available at considerably lower costs and volatilities.
2. A P/E of 10, comparable to other profitable micro-, small-, and mid-cap energy producers.
3. Actual production at planned capacities.
4. The ability of Bluefire to avoid debilitating adverse tax burdens.

The rosy upside target assumes:
1. The high end of profitability supported by a Booz-Allen-Hamilton study suggesting Bluefire's costs could result in $0.76/gallon EBITDA income. That study should be considered as carefully as any prospectus, since it also makes assumptions, and provides multiple scenarios, some of which are considerably less optimistic. It is available here: bluefireethanol.com/pdf/Booz-Allen_Hamil...
2. A P/E of 10, comparable to other profitable micro-, small-, and mid-cap energy producers.
3. Actual production at planned capacities.
4. The ability of Bluefire to avoid debilitating adverse tax burdens.

Bluefire is the only cellulosic ethanol producer to have a proven and patented production methodology in the United States.

Disclosure: the author is long a small, speculative position in BFRE:OB. No content in this article constitutes a recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any person. An investment in any security is subject to risks and this article does not contain a list or description of all relevant risk factors. You alone are solely responsible for determining whether any investment, security, or strategy, or any other product or service, is appropriate or suitable for you based on your investment objectives and personal and financial situation.