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.