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Biofuels Carry Upside for Early Investors

Source: Zig Lambo of The Energy Report (2/16/12)
February 18th, 2012

The biofuel sector, already an $80 billion a year industry, is still in its infancy. In this exclusive interview with The Energy Report, Biofuels Digest Publisher Jim Lane discusses the exponential growth slated for this once-obscure energy source, and how its market resembles the traditional oil and gas industry in many ways. While biofuels are not for the faint of heart, as Lane cautions, investors who do their homework can get in early on companies that offer incredible upside potential.

Companies Mentioned: Amyris, Inc. - Archer Daniels Midland Co. - BP Plc. - Codexis Inc. - Gevo Inc. - KiOR, Inc. - Renewable Energy Group Inc. - Royal Dutch Shell Plc - Solazyme, Inc. - Valero Energy Corp.

The Energy Report: Many investors have some level of familiarity with biofuels, but don't have the depth of understanding required to enter that market with confidence. As the publisher of Biofuels Digest, which focuses exclusively on this sector, what do you think is the best way for investors to dip their toes into these equities?

Jim Lane: The biofuels sector has grown into an $80 billion (B) industry today, even though it's only in its infancy. Why be interested in the sector? Because it's big and it's going to get bigger. There's lots of money to be made and lots of good to be done.

TER: What exactly is a biofuel?

JL: Biofuels include any fuel molecule produced from a plant source using tools and microorganisms from synthetic biology. It could be a residue from agricultural waste, forest waste, municipal solid waste, animal waste, or something made using a biological process. There are about 100 different plants that can be used to produce biofuels, and many can be grown in areas that won't support traditional food agriculture. The main plant sources are still corn, sugar cane and soy beans, but biofuels can also be made synthetically from carbon dioxide and water, or carbon monoxide and water. Biofuel processes can turn pollutant waste streams with little or negative value into value streams sometimes worth thousands of dollars per ton.

The main basis to date has been using traditional processes, such as yeast fermentation, to produce an alcohol fuel known as ethanol. We also have a process that takes plant or waste oils and turns that into what's called biodiesel. Those are pretty built-out industries in many ways. They'll grow, but they won't grow quite as much in the future as what we call advanced biofuels, which use exotic processing techniques to extract value from unusual feed stocks.

TER: Are investors making money in this space at this time? What segments are doing best at this point and why would that be?

JL: Yes, investors can make money in this market. It depends on the stage of the company. It generally takes about 10 years to go from the original lab or research work to producing on a commercial or industrial scale. Depending on a company's stage of development, investors may see early-stage cash burn, the beginnings of commercialization, or substantial profitability. The companies that are further along on their path are very profitable. For example, Valero Energy Corp. (VLO:NYSE) is a major U.S. oil refiner, and last quarter its most profitable division was ethanol production, based on about 1,100 million gallons in capacity. But the bigger opportunities for investors are in selectively picking the winners of tomorrow, because those will offer more upside.

TER: Is there a lot of research going on in different areas that aren't anywhere close to commercialization at this point, or has commercial production been largely standardized?

JL: While there are well over 200 companies currently developing projects around the world using advanced biofuel techniques at various stages of development, there are three basic areas for investors to consider, much like the oil and gas market. We designate these areas as upstream, midstream and downstream.

The upstream segment includes companies that are developing advanced feed stocks with higher yields that grow under more exotic conditions. They're working on genetics and seed development.

Midstream companies utilize processing technologies that extract fuel from plants or waste material, similar to an oil refinery, whereas upstream is comparative to traditional oil and gas exploration. Consider the feed stocks an above-ground oil fuel, if you will.

Downstream companies are the ones that get the fuel to market, such as the pipelines or the gas stations that are delivering those fuels to consumers.

TER: What would you say to those critics who suggest that biofuels are just another passing fad? What are the growth prospects for this industry?

JL: Any business that's gotten to $80B in sales is real, and in the United States and Brazil it's now an unsubsidized business. Ethanol, in Brazil, is unsubsidized and actually outsells gasoline. The International Energy Agency projects that 30% of all transportation fuels could be biofuels by 2050. We use 1.2 trillion gallons of traditional fossil fuels worldwide, so the demand potential is in the hundreds of billions of gallons and the sales will be in the trillions of dollars. It's definitely not a passing fad; the potential is just being unlocked now.

TER: What are the job creation possibilities in this industry?

JL: It's a very robust job outlook, according to a recent report by Bloomberg called Moving Towards the Next-Generation Ethanol Economy. Looking just at U.S. ethanol, which is a small piece of the pie, they expect that by 2030, 2.4 million man years of employment would be created. A lot of that is in construction—680-odd thousand man years between now and 2030. This includes engineering talent, operators, laborers, people who collect and transport the biomass and the fuel and also the administration and management. These are very similar to jobs in traditional oil and gas facilities, with a few more biologists.

TER: What factors and investment criteria should investors consider if they want to get involved in this industry space?

JL: Investors should look at three main factors. First is the extent to which the processing technology is proven or demonstrated at scale. Has it been done at pilot? The earlier you take that on, the more risk you have that the technology may fail along the line. A later-stage technology gives you more confidence. But, the returns are going to be commensurately smaller. So, the more research you do on the processing technologies, the earlier you can invest with confidence; which should give you a bigger return. I think that goes for every kind of high technology.

Next is feedstock. To what extent does the processing technology have a guaranteed price at which that feedstock can be acquired? A company that has a 20-year contract for municipal solid waste at a fixed price is on solid ground. If it is buying a commodity crop with fluctuating prices, investors need to understand how the company has hedged that, because you don't want to be buying $8 feedstock to make $3 fuel.

On the downstream, you want to make sure there is an offtake contract with a credit-worthy buyer. You certainly don't want to have a long-term contract with a company that may go bankrupt. Investors should look for companies that have done a really good job of locking in feedstock costs as well as a reliable offtake contract.

The more certainty investors have on those three fronts, the less risk they will shoulder. On the other hand, less risk usually means less potential reward.

TER: What are some of the leading companies in the industry at this point, and what are they up to?

JL: We've had seven companies with successful IPOs in the last 18 months, with 10 in the IPO queue right now. Of the entire cleantech sector, 75% of the companies in the IPO queue are biofuel companies. That tells you a little bit about where Wall Street is putting its emphasis and which of these sectors is going to succeed in the short term. The biggest success stories include companies like KiOR, Inc. (KIOR:NASDAQ), which went public last year. It's a company that uses a technique called Biomass Fluid Catalytic Cracking. KiOR creates diesel, jet fuel and gasoline from wood chips very cost effectively. The company already has over $1B valuation. It's now building its first commercial facility in Mississippi with very strong support from former Governor Haley Barbour to build a total of six plants in the area.

Renewable Energy Group Inc. (REGI:NASDAQ) is another company that just did its IPO. That company is the number-one biodiesel producer in the United States, at about 300 million gallons a year, and had strong revenue growth last year.

TER: What other companies look interesting?

JL: Solazyme, Inc. (SZYM:NAS) is a company that makes renewable oils from algae using advanced synthetic fermentation. It also makes skin creams, which are selling on the Home Shopping Channel very successfully. Solazyme is making fuel and also has a joint venture with Roquette Group. It is also making algae cookies and has all kinds of products it can make from renewable oils. We expect them to be very successful not only in food and skin care but also in making jet fuel for the Navy and in all kinds of applications across the spectrum.

Gevo Inc. (GEVO:NASDAQ), went public last year and makes isobutanol, which is an alcohol-based fuel. Isobutanol also a very important component in the chemical industry. Gevo is just building its first commercial facility, which will be open in the first half of this year. That's a very exciting company to watch.

Amyris, Inc. (AMRS:NASDAQ) is based out of Silicon Valley. Its technology uses sugar cane syrup and is being commercialized now in Brazil. Amyris makes an exotic collection of fuels and chemicals and lubricants and all kinds of great products from sugar cane, as well as a renewable jet fuel and diesel being commercializing in Brazil.

Another Silicon Valley company, Codexis Inc. (CDXS:NASDAQ), is an enzyme, fuels and chemicals developer. Its major investor is Shell, and it is producing enzymes and other components of fuel creation in its work. The company recently bought its chemical rights back from its original parent, Maxygen, Inc.(MAXY:NASDAQ). Codexis is now deploying a wide variety of solutions to make low-cost sugars for the chemical industry. That's important because you need sugar in order to turn something into a chemical. This company is going to be the "Intel-inside" of the industry.

Then there's Rentech, Inc. (RTK:NYSE.A), which has a very advanced process making diesel and jet fuel through what's called gasification. It's based in Los Angeles and commercializing its technology in Ontario, Mississippi and Colorado. These companies are examples that are at, or are going to commercial scale right now, in which investors can take a position today.

TER: Are these companies making money, breaking even, or are they still in the "trying to get there" stage?

JL: Most of them came out quite early. Biotech stocks often come out either pre-revenue or early stage. Renewable Energy Group came out a little bit later in its evolution. The other ones are still in the cash-burn phase. I think Amyris is deploying its second commercial plant and the others are in the process of building their first commercial facility. Amyris will need to get three or four up to be solidly profitable and cover the overall administration and R&D costs. You would expect to see most of those in the black around 2014 or early 2015. The most important thing for an investor is not current profitability, but where they are on their path to profitability. Waiting until they are totally in the black and everything is already established is less risky, but you're going to be sacrificing some of the upside.

TER: What sort of capital costs are involved in putting a commercial plant into production?

JL: The first commercial plant is usually the most expensive due to the R&D involved, and can cost anywhere from $250-400M. Larger projects can be up to a billion dollars apiece. As the industry develops standard designs, costs could drop to somewhere in the range of about $200-300M per project. So this is not for the faint of heart. Certainly these companies will be accessing project financing for the debt component. This is a very capital-intensive industry similar to the traditional oil and gas industry.

TER: You also publish the Biofuels Digest Index composed of 30 component stocks that seem to cover a pretty broad range of companies. How do you determine who you cover?

JL: We look at the 30 companies that have the largest capacity and also include some pure plays. So, we have companies like BP Plc. (BP:NYSE; BP:LSE) and Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE). BP's biofuels unit alone has 4,000 employees. It's a very heavy investor in biofuels. Shell also just did an $8B acquisition or joint venture and merger last year. We also have Archer Daniels Midland Co. (ADM:NYSE). From large-caps we go down to some of the smaller ones I've mentioned like Solazyme, KiOR, Gevo, Amyris, Rentech, Codexis and Renewable Energy Group. The key there is that all of them are fully focused on biofuels and chemicals, or it's a significant part of their operations and profit flow. We change them around a little bit, of course, as we've had a lot of recent IPO activity. It has been a pretty good sector to invest in over the last 18-24 months.

TER: Do you have any other points you'd like to discuss and closing thoughts you'd like to leave with our readers?

JL: Investors usually ask me what the best way is to pick winners and avoid losers. The answer to that is to read a lot and study up on the technology. Never buy anything that you're not sure of, or you don't know. These are exotic technologies. A lot of them are early stage. It's very important for investors in early-stage, high-technology companies to be fluent in understanding a company's upstream feedstock strategy, if its processing technology is proven, and who's the offtaker. And is that represented in hope or is that represented in hard contracts and real dollars? If you've done your homework, you can find a lot of value, which plenty of investors have. It's all based on being a knowledge worker before you are an investor.

TER: We greatly appreciate your time and input today on a sector that certainly provides another growth area for investors to consider. We'll look forward to talking with you again to see how these companies progress.

JL: Much appreciated.

Jim Lane is the editor and publisher of Biofuels Digest, the most widely read biofuels daily newsletter. The Digest covers producer news, research, policy, policymakers, conferences, fleets and financial news. It is home to the Biofuels Digest Index™, The 30 Most Transformative Technologies, and the "50 Hottest Companies in Bioenergy" annual rankings.

Source: Zig Lambo of The Energy Report (2/16/12)
February 18th, 2012

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DISCLOSURE: 1) Zig Lambo of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Royal Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for services.
3) Jim Lane: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise for this interview.

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