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Washington Just Made Biofuels A Priority

by | published June 25th, 2010

On June 24th, U.S. Secretary of Agriculture Tom Vilsack announced that the White House had returned to pushing a renewable energy agenda. Against the backdrop of a continuing tragedy unraveling in the Gulf of Mexico, politicians on both sides of the aisle are once again touting non-fossil-fuel solutions for American energy needs.

Vilsack signaled the latest initiative – emphasizing the use of biofuels – by announcing that $62.5 million would become available in development funds, following this week’s release of the USDA’s newest biofuel report (you can find it here).

Three factors have now aligned to put biofuels back on the priority list: an intensified drive to reduce dependence on fossil fuels, an emphasis on domestic production to meet energy needs, and the commitment to combat global warming. This latest move clearly calls investors to take note of rising support for renewable sources.

Two other rationales, now widely used in Washington, also support the push for biofuels.

One is the argument that it will generate domestic jobs. The second casts biofuels as a central ingredient in the drive to reinvigorate rural economies. The former will take some time to develop. The latter, however, may well have a shorter-term impact.

All of this adds up to some significant investment opportunities once the process begins in earnest. The energy balance will certainly be changing, with space made for more sources contributing portions of market needs than the current mix allows.

Makes for a very interesting investment environment moving forward…

However, you should be positioning in this sector, rather than jumping in with both feet.

This will take some time; the most promising plays remain little more than start-ups at this stage. Government development support will certainly help, but the market needs further structuring before it takes off.

But don’t worry. In just a moment, I’ll show you the easy way to track how the market is proceeding and to know when it’s ripe for profit-taking…

Biofuels Infrastructure Is Still in Its Infancy

Renewables (like biofuels) have been the staple of a “beyond oil” political rhetoric for some time. But the tragic Deepwater Horizon oil spill has given the movement greater traction.

And with Interior Secretary Ken Salazar certain to file for another drilling moratorium (to get around a recent court decision that ruled the first one “too expansive” in its application), the policy focus now turns to crafting a new energy initiative.

(By the way, Salazar performed some cosmetic surgery by renaming the now-infamous Mineral Management Service (the offshore regulatory agency whose lax oversight contributed to the Gulf blowout). As of June 21st, it is now the Bureau of Ocean Energy Management, Regulation, and Enforcement, to be headed up by no-nonsense former Justice Department Inspector General Michael Bromwich. It may be the policy-making equivalent of closing a certain barn door after the proverbial horse has left the confines… but it is at least something.)

On the other hand, it is certain that a national plan must now aim for a different balance of energy sources. Even before BP (NYSE:BP) showed its ineptness in dealing with a disaster (one largely of its own making), Washington had expected expanding offshore drilling to balance off an increasing emphasis on green technology and alternative energy sourcing. That was the essential tradeoff in an energy bill now rendered politically unpalatable by the spill.

Biofuels cannot immediately fill the void left by offshore drilling. They’re not ready to occupy a main position in the energy market – too many developments need to take place. Still, some interesting and promising breakthroughs have taken place, like marrying coal technology and biofuels into a hybrid approach that may be a welcome shot in the arm for both this new industry and one of the most traditional of American energy sources.

One thing is clear: The biofuels infrastructure is still in its infancy.

The Renewable Fuels Standard currently on the books (RFS2) mandates that there be 36 billion gallons of biofuel in the annual U.S. fuel supply by 2022. And current levels do not come anywhere close to that total: There are presently fewer than 200 companies in the U.S. producing biodiesel at facilities with a combined capacity that should reach only 3.5 billion gallons a year in 2010.

We await a comprehensive and defined plan to develop integrated regional strategies meant to increase biofuels production, marketing and distribution. (The USDA report I mentioned above does recognize both of these, providing initial grant prospects for each.)

Further investments are needed in feedstock research and development, sustainable production and management systems, more efficient and reliable conversion technologies, better analytical tools, and what the Department of Agriculture calls “high-value bio products.”

And that means additional government subsidies… and expanding opportunities for investors.

One drawback from the renewed emphasis in biofuels is the continuing mention of ethanol production. This has become a political necessity, given the central position of corn-growing states in the election equation.

Yet the net effect may be limited. Make no mistake – corn-sourced (or “white”) ethanol will be part of the energy mix moving forward. Nonetheless, I have maintained for several years that it will provide no more than about 6% of our overall energy needs, even as it approaches about 20% of our motor fuel stock (by 2020). It requires too much energy to produce, provides us with insufficient power for the fossil fuels replaced, and creates excessive price increases in other uses of corn if emphasized. This is why the government is now highlighting research into alternative feedstock to corn. That certainly holds a major key. But while some promising experimental developments have emerged, there is no silver bullet on the horizon as yet.

Now, back to the profits…

Tracking Biofuels as an Investment Alternative

The easiest way to track how the market is gearing up for the charge into biofuels, and the best way to determine when to think seriously about adding a biofuels component to your portfolio, is to follow the performance of exchange-traded funds (ETFs) and exchange-traded notes (ETNs).

Only one biofuels stock is sufficiently structured to provide an adequate gauge of the sector – the Elements MLCX Biofuels Index Total Return ETN (NYSEArca:FUE). However, given the low capitalization and volatility in such an infant market, FUE is prone to significant volatility and subject to liquidity concerns.

The preferred approach in estimating where the market is going is to parallel FUE reads with results in several more liquid (and wider) alternative energy or bio-related ETFs. These include Market Vectors Global Alternative Energy ETF (NYSEArca:GEX), Powershares Cleantech ETF (NYSEArca:PZD), and Market Vectors Agribusiness ETF (having one of my favorite descriptive ticker symbols – NYSEArca:MOO).

Biofuels as an investment alternative is approaching. However, you need to recognize that this remains a thin market. We will require additional capitalization moving in before seriously testing the waters.

I’ll keep you posted…

Kent

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