The Right Way to Speculate in Ethanol

It can happen. But not in the same way that corn-based ethanol is produced...

The two biggest expenses in the production of corn-based ethanol are thecost of the corn and the cost of the natural gas used in the production process.

But what if you could produce ethanol from widely available and essentially useless resources, like the aforementioned yard clippings and wood chips? And what if one of the byproducts of that process – lignin – could replace natural gas as the heat source in ethanol production? That eliminates the two largest expenses in the production process and creates an economically viable alternative fuel.

Therein lays the promise of cellulosic ethanol.

Cellulose is the main component of plant cell walls and the most common organic compound on earth. It's more difficult to break down cellulose to convert it into useable sugars for ethanol production.

Yet, making ethanol from cellulose dramatically expands the types and amount of available material for ethanol production. This includes many materials now regarded as waste requiring disposal, as well as corn stalks, rice straw, wood chips, and "energy crops" of fast-growing trees and grasses.

Until 2005, companies had no financial motivation to aggressively pursue the production of cellulosic ethanol. But as I pointed out in yesterday's issue, that's all about to change. The increasing price of corn has rendered corn-based ethanol inefficient... and so large agricultural companies such as Archer Daniels Midland are pursuing cellulosic ethanol.

And why not? The government is right there to help with the funding...

The Energy Policy Act, signed into law in August 2005, contains several provisions designed to spur cellulosic ethanol production, including:

• A credit-trading program wherein one gallon of cellulosic biomass ethanol or waste-derived ethanol is equal to 2.5 gallons of renewable fuel.

• A cellulosic biomass program to produce 250 million gallons in 2013.

• A loan-guarantee program that provides up to $250 million for the construction of a cellulosic ethanol facility.

• Production incentives to deliver the first billion gallons of annual cellulosic ethanol production.

So here we have the potential for a renewable energy product that's made from otherwise useless resources. It's cheap, highly energy efficient, and funded by the government. And there are several terrific speculations on the future fuel...

Out of fairness to subscribers to The Big Trend Report, I can't name my favorite plays in the sector. However, I can tell you to the best cellulosic ethanol plays are in one of the great growth sectors of the next few years: Biotechnology.

One of the breakthrough companies in this area has studied the chemicals that make up the enzymes found in the intestinal tracts of termites. The most explosive growth should come from the companies like this one... that produce and market the enzymes used in cellulosic ethanol production.

It's still early in this ballgame... so cellulosic ethanol plays (like most biotech companies) trade on the potential for a breakthrough discovery, rather than on the basis of sound fundamental analysis.

But find the winners in this game, and you'll be profiting long after corn-based ethanol has gone the way of the mule and plow.