Sunday, July 29, 2007

Economically Viable Alternative Energy?

Despite my staunch belief that we do need to alleviate our dependence on fossil fuels, I cannot help but become irritated with the incessant din streaming from the mouths of farmers, greenies and congressmen alike. You can't escape it, so why don't we all stop trying. From television commercials, to corporate branding and our elected puppets, everyone is deputizing alternative energy and more specifically biofuels as the be all and end all to our energy dilemma.

What many fail to realize however is the sheer immensity of this task. The amount of energy we collectively produce from fossil fuels is astronomical. At this point, instead of delving into numerical data, I would like to try a metaphor. Imagine yourself in modern day Beijing. You need to get yourself, your wife and your two kids to some remote destination 30 miles away. Now try to picture the expression on an unsuspecting rickshaw driver's face as you ask him to cart you and your family that very distance, all for a cost of $3.00.

In other words, this stuff is useful, versatile and at this point, relatively cheap. With the emerging economies of China and India posting nearly double digit year over year growth, energy intensity, in particular demand for oil is expected to expand well into the 21st century. I could elaborate using widely accessible date, but I find this redundant since society is largely in agreement that energy demand is here to stay. I will instead, save the monotonous numerical crunching for later on in this editorial.

Now if we are in agreement on the aforementioned, we can agree that we need to identify viable alternative sources. I use the word viable here because it is so often omitted when discussing alternative energy. By viable, I mean a source that is renewable, easily integrated into existing infrastructures and most importantly; economically attractive when compared to its fossil fuel counter parts. This excludes you hydrogen and your cohort corn ethanol.

By this premise, only one fuel source comes to mind, and that is in fact biodiesel. Biodiesel refers to a diesel-equivalent manufactured from biological (renewable) sources which can be combusted in unmodified diesel vehicles. Wikipedia describes this chemical compound as: "Alkyl esters made from the transesterification of vegetable or animal fats."

Biodiesel is enticing for several reasons. First, it can be easily integrated and utilized into existing fueling infrastructures and vehicles. By vehicles, I am not referring to our average America commuter, but to the tens of millions of trucks, trains and boats which burn diesel on a daily basis. Unfortunately in the US, only around 3% of the vehicles on the road use diesel. While this is paltry compared to Europe's 50%, these numbers are expected to increase.

This brings me to my next point. Unlike ethanol, the alternative for gasoline; biodiesel and diesel boost comparable energy content at 37.8 MJ/kg and 48.1 MJ/kg, respectively. Unlike ethanol's 30% compromise in fuel efficiency, a truck powered by biodiesel will average nearly identical fuel economy compared to its diesel powered counterpart.

This brings me to my final point. Biodiesel is renewable. Some will attempt to argue that there is an endless supply of oil yet to be discovered, but the most fundamental principle of economics states there is endless demand for finite resources. While this doesn't mean we will run out of oil tomorrow or in ten years, it does indicate that as supply diminishes and demand increases oil will become more expensive.

Currently on the commercial scale, biodiesel is produced using virgin plant oils. While this is great in theory the numbers aren't as enticing. What would happen to these producers if the $1.00 per gallon federal tax credit were withdrawn? More importantly, what would happen if the spot price of crude oil were to drop significantly? While these two scenarios seem unlikely given the current political environment, they do poise interesting concerns regarding biodiesel's economic viability.

Where concern dwells so too does opportunity. Theoretically, biodiesel producers could cut costs using economics of scale such as Imperium Renewables and Archer Daniels Midland are attempting to do. These companies and many more like them may in fact prove successful, but there lies an even more efficient method for drastically cutting variable costs.

Last month a micro cap, by the name of Syntroleum launched a joint venture with Tyson Foods to build and co-operate a 75 million per year refinery. This venture is exciting because they intend to use fats, greases and reclaimed vegetables oils as their primary feedstock. For producers this truly is the holy grail of biodiesel. Since the feedstock is the largest variable cost, the more inexpensive the feedstock the more profitable the producer. While SYNM and TSN are targeting 2010 as their completion date, there is in fact one biodiesel producer whose been doing this continuously at a 80,000 gallon pilot plant since 2003 and commercially since October of 2006. Before I get into the specifics of this company, I believe it is prudent to walk through the basic economics.

Given that the feed stock comprises 60-75% of the finished products cost, it becomes imperative to process the lest expensive sources. The problem is, the cheaper the feedstock, the higher the fatty free acid(FFA) content and in turn the greater the difficulty to refine.

Corn oil for example, fetches around $.30-.34 per pound with a FFA of around 1%. While this feedstock is incredibly easy to process, its usage equates to a variable cost of ($.30 x 8lb = $2.40 per gallon)(8lb = 1 gallon).

With operational costs ranging from $.42-.53 and diesel rack prices nearing $3.11, there isn't much room for profit margins or excess funds to recoup the plant's initial capital cost. However, with the current federal tax credit biodiesel producers can remain competitive if they sell the biodiesel for $3.11($2.40+.45= 2.85, $3.11-2.85+1.00= $1.20 profit per gallon).

The story is even more appealing when we cut feedstock costs. Take yellow grease for example. When the FFA exceeds >20% the cost drops to under $.15. With these prices a producer could refine biodiesel for half the cost($.15 x 8lb = $1.20+.45= $1.65, $3.11-1.65+1.00= $2.46 profit per gallon). Note: these numbers exclude the Oklahoma $.25 tax credit as well as the $.50 federal BTU sludge tax credit.

One final thought on numbers. The company which I shall mention shortly will have a combined annual capacity online by Q2 2008 of 70 million gallons. Interestingly, all of the feed stocks and refined biodiesel are already locked up in contracts signed last year. This means that as of next year they will be netting close to $172,200,000. Given the 109,998,692 shares outstanding and an industry average P/E of 9.9, the company should post an EPS of $.64 and a PPS of $6.34(9.9x.64). These numbers, although estimations indicate an extreme discount when compared to current market valuations.

As I mentioned before the company, Nova Biosource Fuels, Inc.(NBF) isn't talking about doing it they are doing it. Currently, the company is in various stages of permitting and building three refineries for their own portfolio with the capacity to process 25 various feed stocks into biodiesel which meet and exceeds ASTM D 6751 standards.

Why do I believe this company will succeed? Aside from the hurdles of finding funding and pioneering new technology, I look to management. Who is running the company and why? When concerning quality, NBF boosts one of the most impressive micro cap management lineups I have ever seen. Interestingly, they are all high caliber ex-oil men originating from the likes of Texaco, Halliburton Energy Services, Vanco Energy, Mobil Exploration, and Kerr-McGee Chemical.

The next question is why? Why are all of these ex-oil executives and presidents running a $300 million micro cap start-up? Basic speculation brings me to a logical answer. Big oil is in the business of making money. They have been 'banking coin' for years and they will continue to do so for many more to come. So to answer my question, the real reason these men choose NBF, is they know its technology enables them to produce biodiesel and do so economically.

Disclosure: The author owns shares of NBF.


The Stockhead said...

you've done your research.

thanks for the info.

Woodshedder said...

C- when I try to pull up NBF on bigcharts, it looks like it trades on a Canadian exchange?

CNL said...

I see that also. I don't use big charts and the same problem doesn't seem to happen with But yes, NBF(different company) is also traded on the Canadian exchange.

Parker said...

Hi Cnl -- I thought you might want to check out -- it's like wikipedia, for investing. In particular, I thought you'd be interested in the articles about alternative energy (there are many on our site). You may find some of the research useful.

Contributing to wikinvest is a great way to promote your blog -- you'll get credit for your contributions and can link back to your blog from your Wikinvest profile page.

Let me know what you think of the site and if you'd like to talk furter. You can reach me at (remove the nospam)

scmfinance said...

CNL, thanks for visiting my blog and posting the comment.

You've done some nice research on NBF, especially with regard to running the numbers and projected EPS.

- Sean

herb said...

would like to hear more about potential pitfalls and uncertainties in regards to this company. Just as useful or even more useful to me when making an investment decision.


herb said...

in the post.. could you verify the EPS calculation
net earning $172/109shares = $1.58 vs. $.64 posted

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