Ethanol's Sweeter Side

Brazilian ethanol giant, Cosan(CZZ) recently debuted on Wall Street with little enthusiasm from investors. The company ultimately raised $1 billion of the sought after $2 billion. Wall Street's apparent cold shoulder could be attributed to bearish sentiment regarding ethanol, concerns over broader market weakness or even the company's predisposition to focus on its tried an true "projects" rather than technological innovation. What ever the reason for the less than stellar IPO performance, CZZ, the worlds second largest ethanol producer deserves a deeper evaluation.

Unlike the agricultural giant Archer Daniels Midland(ADM), CZZ distills its ethanol from energy rich sugar cane. Like corn based ethanol, this type of ethanol production is based off an aged technology which was implemented on a commercial scale during Brazil's "Pro Alchol" program in the 1970s. Even though the technology is dated, CZZ still operates a surprisingly economically attractive business model. So economical, that during a particularly strong harvest year CZZ can export ethanol to the United States even with the $.54 per gallon tariff! So why if both ADM and CZZ use comparable technology can CZZ operate completely independent of government incentives? The answer lies in the acronym EROEI, more specifically Energy Returned On Energy Invested.

According to the fundamental laws of Energetics and physics, EROEI is the ratio of the usable energy acquired from the expenditure of another energy resource. For example, the production of ethanol yields an energy balance of 1.3 to 1, or 1.3 units of corn ethanol produced for every unit of oil/diesel/coal. I should note that there is some dissemination concerning corn ethanol's true EROEI. For the sake of simplicity, attention should be focused on the superior yields of sugar cane as apposed to dwelling on the exact EROEI of corn. One can read more about this issue here.

According to recent publications in the New York Times, the currently accepted EROEI of sugar cane is 8.3 to 1, or nearly 8 times that of corn based ethanol production! Some researchers even argue that energy yields of 10 to 1 are a real possibility within a few years time. The question is why does sugar cane yield such an attractive energy balance?

As a feed stock, sugar cane has two significant advantages compared to corn ethanol. The first advantage is concerned with cogeneration or the simultaneous production of an end product as well as the energy required to run the plant. Sugar cane bagasse is the remaining biomass after the sugar cane juice(ethanol feedstock) has been extracted. In Brazil the vast majority of ethanol producers burn the bagasse as energy for their plants, effectively creating a CO2 neutral energy source. The burning of bagasse is deemed CO2 neutral, because the CO2 expelled during the burning is equal to the CO2 consumed by the plant during its life. When one compares the alternative of burning dirty coal to produce ethanol from corn, it is no wonder why so many are optimistic of sugar cane's potential. The other advantage is corn requires the transformation from a carbohydrate to a sugar prior to fermentation. Since sugar cane is in fact a sugar this step is unnecessary.

Before we generate excessive excitement we must remember that oil still boost a higher EROEI than even sugar cane, at 10 to 1. That being said, the bonanza of ultra cheap petroleum extraction in the 1950s, yielding an EROEI of nearly 100 to 1 is all but a distant memory. More interesting is oil's nearly vertical energy decline since then. According to www.energybulletin.net, the EROEI fell to 25 to 1 in 1970, and now stands at about 10 to 1 today. "This is because the size of the oil fields is shrinking, the depth at which oil is being found is growing deeper, and the quality of the oil that is being pumped is decreasing."

For me, further due diligence on CZZ is needed before I take the leap as an actual shareholder. After a preliminary analysis though, I do like the prospects of the company. Cosan most certainly shouldn't be complacently grouped with the major US ethanol producers. This type of generalization unfairly overlooks it's significant economical advantage of proper feed stock selection. Furthermore we must remember that unlike ADM or VeraSun(VSE), Cosan has operated profitably without government incentives for over a decade.

Back from New York

I am finally back from my excursions in NYC. It was a much needed vacation, but it feels great to be back in Seattle. I look forward to a return to normalcy, hopefully with some insightful posts to follow. During my break I did some slight portfolio tweaking, specifically cycling my MVIS September $5.00 call options into actual shares as well as adding more NBF today for $2.82.

Update IMAX NBF

IMAX earnings were out yesterday and they were less than stellar. Big surprise there! It appears as though my $5.00 August call options will expire worthless next week. I also added substantially to my holdings of NBF at $2.99. The company now comprises greater than >50% of my total portfolio assets. So much for diversification? I will also be in New York next week, so updates and posting will most likely be non-existent until after I return.

IMAX Update

As you may or may not know, IMAX is scheduled to report second quarter 2007 earnings tomorrow morning at 8:30 eastern time. To the best of my ability I can't identify any reason why IMAX should beat earnings tomorrow, aside from the impressive theatrical runs of 300, Spiderman III and most recently Harry Potter and the Order of the Phoenix. While these results are beneficial, IMAX's true revenue generating streams come from the actual signing of of theater installs. Due to the company's recently announced alteration in theater install revenue recognition, and massive theater backlog, it is exceedingly difficult to calculate install revenue.

Questionable revenue timing aside, IMAX's options activity was quite interesting today. As you can see in the schematic below, nearly 800 $5.00 August call options traded hands. This may seem small compared to the option activity seen in large equities such as Cisco or ExxonMobil, but today's volume effectively double the entire open interest volume(1,261) in one day of trading! Many investors and traders believe that abnormal or higher option activity can allude to events to come. With minuscule August $5.00 put option volume at 226, one could believe that good news is just around the corner. Earnings anyone?

PEMEX Reports Oil Depletion in 7 Years

Recently PEMEX, Mexico's largest integrated oil producer informed the United States that, "Supplies of its economically exploitable resource are running out." The company estimated proven reserves near 9 billion barrels in December of 2005. With current production near 1.3 billion, and demand stable; simple division extrapolates 7 years as the target depletion date.

PEMEX has long suffered from the stagnation of decreasing exploration investments as the company has been an exhausted cash cow of the Mexican government. According to the article, experts from the PFC Energy Advisory company in Washington estimated that in the event of heavy investment, new fields could take nearly 8 years for full maturation. Even with this optimistic view, "Mexico may have to import oil to satisfy its internal market." Jesus Reyes, director of PEMEX attributed the current state of affairs to declining capacity in Cantarell, Mexico's largest oil field.

Given that Cantarell is one of the world largest oil fields, with its discovery in 1976, exploitation in 1981 and peaking in 2004, this development could mark a startling corollary when compared to other elephant fields, notably the Ghawar field in Saudi Arabia.

For the energy intensive United States, this marks a chief concern as Mexico is our third largest importer at an estimated 1,469,000 barrels of crude daily. If and when Mexico does become a net importer of crude, the United States would require this differential to be recouped either internally or through the aid of existing importers. The question is where will this excess capacity come from?

Update IMAX

IMAX continues to oscillate between tests of previous highs and lows. It is important during this action that we continue appreciating higher volume on the upside as well as consolidation on weaker volume. This indicates the bulls are more aggressive than the sellers, at this point. While unable to break through recent highs in the range of $5.20-$5.15, IMAX has demonstrated surprising resilience in light of recent market dynamics. If and when the market can shrug off the current financial concerns IMAX should be poised to run.

Another interesting development is concerned with the insiders, specifically a 10% holder by the name of Kevin Douglas who's recent purchases have totaled almost $2.5 million. He may not be a true insider, i.e. an individual who runs the company on a daily basis, but his recent purchases and their increasing volumes do poise interesting questions.