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Biofuels Will be as Profitable as the Oil Industry

69 views  2012-05-07 12:39   Tagsthe  energy  oil  profits 

By Peter Byrne, The Energy Report

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Biofuel expert, Mark McHugh, is a big fan of miscanthus, the generic name for a robust grass (also known as elephant grass, switch grass) that thrives in tropical climates. In an interview with The Energy Report, McHugh says that the hybrid plants represent the future of biofuel and right now is a good time for smart investors to get in on miscanthus, especially in Brazil, where McHugh heads an energy consulting firm, CenAm Energy Partners SA.

"The World Energy Council projects that by the year 2050, biofuels will source 15-25% of global energy consumption," McHugh told me in a telephone interview in early April. "That means that the biofuel industry will be as profitable as the oil industry is today."

He explained that miscanthus is in demand as a "second generation" biofuel. Because these grasses are perennials, they do not have to be replanted each season. They can be processed to provide either liquid ethanol or solid, burnable pellets. And miscanthus enjoys a smaller carbon footprint than the current generation of biofuel feedstocks, primarily corn, sugar beet, and sugar cane. As an added attraction, because it is not edible, miscanthus is less politically volatile than food-based biofuels. McHugh calls it a "lignocellulosic" energy crop, which means is it basically wood.

I asked the former Shell executive what biofuel companies are using miscanthus? "It's very patchy. Developmentally, miscanthus is in the early stages. There are some plantations in Europe and the U.S. In Brazil, Embrapa, the agricultural research institute, is developing new strains of miscanthus to obtain optimum yields. New Energy Farms (private) is a key developer of miscanthus as a feedstock in the U.S., Canada and the U.K.," he remarked.

Since there is already substantial global demand for miscanthus-based products, the investment trick, McHugh opines, is positioning to control supply. "The Europeans are converting existing coal-fired plants to burn biomass pellets. But there isn't enough agricultural land available in Europe to produce a sufficient quantity. Brazil is a prime candidate for growing miscanthus to produce biomass pellets, but substantial investment is needed to kick this off. "

Turning the energy-laden grass into liquid biofuel can be done by thermal cracking. Or by using enzymes to convert the cellulose into sugar and then fermenting the sugar into alcohol. McHugh is bullish on Dow Chemical (NYSE: DOW), which is leading the biofuel pack with research on enzyme technology.

Miscanthus futures aside, Brazil is the second-largest market in the world for food crop-derived bioethanol (a gasoline additive). The U.S. is the largest market for bioethanol. Inside Brazil, the investor buzz word is merger. "There are a lot of small, family-owned wood milling businesses for sale," says McHugh. "Brazil is inwardly focused at the moment, trying to improve efficiencies with consolidation. The biofuel business is very much defined by national boundaries."

Raizen S.A. is a McHugh favorite. The firm is a joint venture between Royal Dutch Shell and Cosan S.A. Cosan was an ethanol producer that acquired Exxon Mobil Corp.'s (NYSE: XOM) downstream assets in Brazil three years ago. Raizen is the third player in the retail fuel distribution market behind Petróleo Brasileiro or Petrobras (NYSE: PBR) and Empresas Petróleo Ipiranga (state-owned). But it also produces and distributes biofuels.

"Because it is vertically integrated, Raizen can see the whole value chain and price accordingly," says McHugh. "That allows it to be more competitive, because the gasoline sold at the pump in Brazil is mandated to contain 25% ethanol."

On an international level, McHugh observes, "The evolution of the ethanol business is being driven by regulatory incentives, such as the Blender's Tax Credit in the U.S. and public subsidies for renewable fuels. In the U.S., biodiesel has been subject to major ups and downs as government subsidies have been set and removed and then put back. So, it makes sense to hedge regulatory risk by having a position in more than one export market."

And the Brazilian biodiesel market is hot. "That's also driven by policy mandates. The current blending target for biodiesel is 5%. There is talk of that going up to 7%. The margins are profitable for efficient local players."

McHugh cautions not to put too much emphasis on the artificial side of the business model. "A mature industry will not need subsidies. There needs to be healthy international trade in biofuels, just as there is in oil. And if biofuels are going to generate 15-25% of global energy consumption, the industry must develop miscanthus and other non-food energy crops. Sustainability is a key to this business."

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