I’ve discussed alternative energy technologies in past issues of The Energy Letter, which sets the table for the discussion of an entirely new market, biofuels. Most investors are aware that ethanol derived from corn is used as a fuel additive in the US. But the US is only the tip of the iceberg when it comes to biofuels--more than half of cars sold in Brazil last year, for example, were equipped to run solely on ethanol. And in Europe a diesel-like fuel derived from canola oil (rapeseed) is rapidly catching on in France and Germany. The European Union (EU) has set a goal that 5.75 percent of its total transportation energy needs come from alternative fuels by 2012.

Fuel From Food

While nuclear power, coal and natural gas can all be used to produce electricity, refined products derived from crude oil are the world's primary transportation fuels. The vast majority of all oil used in the world is used for transportation.

Global Energy Use by Fuel Type (Quadrillion BTUs)

Source: Energy Information Administration

The chart above depicts total global energy consumption for 2003 by fuel type. In total, the world used some 421.5 quadrillion (1015) BTUs of energy in 2003; this includes energy for electricity generation, direct heat, and transportation. Crude oil is by far the most important energy source, accounting for some 40 percent of all energy consumed worldwide; most crude is consumed in cars, trucks, airplanes and trains. Any fuel that could be substituted for oil--even on a small scale--could have a large potential market.

One fuel type that is gaining traction in parts of the world as a partial crude oil replacement is biofuel. The term biofuel describes a number of different fuels and alcohols that can be produced from organic matter. In most cases, the organic matter used is some sort of agricultural product such as corn or sugarcane.

One obvious factor supporting biofuels is that they're a renewable resource. Crops can be replanted each year. Unlike crude oil, biofuels aren't a diminishing resource. Furthermore, a variety of crops can be used as the basis for biofuels. Such crops can be grown almost anywhere in the world.

Biofuels are also environmentally friendly and significantly reduce emissions of carbon dioxide as compared to traditional petroleum-based fuels. While carbon reductions vary depending on what crops are used to produce biofuel and a number of other factors, carbon dioxide reductions are on the order of 35 to 70 percent.

Current Use

Ethanol, an alcohol that can be derived from a variety of agricultural products, is probably the biofuel that's best known globally. Brazil has gone the furthest in promoting and popularizing ethanol; the South American country has actively promoted and subsidized ethanol production for more than 20 years as a response to the 1970s oil crises.\

In recent years, as gasoline and diesel fuel prices have been on the rise, ethanol has become an extraordinarily popular fuel in Brazil. Production topped 13 billion liters (roughly 3.25 billion gallons) there in 2005, nearly half the total global production of ethanol for the year. Brazil is also a major exporter of ethanol to the US, Japan and the European Union.

Brazilian ethanol is produced almost exclusively from sugarcane. Sugar is a highly efficient crop for producing ethanol for a number of reasons. The yield from sugarcane is higher than for some other agricultural commodities such as corn, and Brazil enjoys a favorable climate for producing sugar. Thanks to the long growing season Brazilian farmers can grow more crops on an acre of land than their US counterparts. And the labor involved in farming is much less expensive in Brazil.

Raw sugarcane is grown primarily in two regions of Brazil, the Northeast and the South Central. Due to a favorable climate, both regions can be replanted twice per year (two crops annually). Based on 2003 prices, and figures produced by the US Dept of Agriculture, Brazil's South Central region sported some of the lowest costs for raw sugar production in the world, 5.5 cents per pound, compared to closer to 8 to 10 cents per pound in the US.

Thanks to these factors, Brazil is the world's low-cost ethanol producer, selling ethanol for approximately $25 per barrel, less than one-half the cost of a barrel of crude oil at the time of this writing.

Most modern cars can tolerate ethanol mixed with conventional gasoline or diesel fuel. Typically, conventional cars can handle mixes as high as 20 to 25 percent ethanol. In the US, for example, ethanol is regularly used as a gasoline additive for cars.

In Brazil, the most popular cars today are known as flex-fuel vehicles. These cars are capable of burning any mixture of conventional derived fuel and ethanol--and can run on 100 percent biofuel. Surging energy costs made flex-fuel cars the most popular cars sold in Brazil in 2005; according to the Brazilian government just under 54 percent of the cars sold in the nation last year were capable of handling flex-fuels.

This amazing popularity is, not surprisingly, having some profound ramifications for the global sugar market. Brazil, already the world's largest producer of sugar by a wide margin, diverts about half its total crop to ethanol production.

And Roberto Rodriguez, the country's agricultural minister, stated earlier this year that due to rapidly rising demand for the flex-fuel, Brazil will need to spend $10 billion during the next six years to build out 73 new ethanol producing mills and convert another 2.5 million hectares of land to sugar cane production. This would constitute a roughly 50 percent increase in production.

Beyond Ethanol

Ethanol isn't the only biofuel at use in the world today. Some crops can be distilled into vegetable oils and used to produce an organic form of diesel fuel dubbed biodiesel. Like ethanol, biodiesel is easier on the environment and is a renewable resource.

The EU has been particularly aggressive in promoting the production of biodiesel, with Germany and France being the two largest producers. The EU has set a target to derive 5.75 percent of transportation energy from biofuels (a combination of ethanol and biodiesel).

Already, considerable progress has been made toward ramping up capacity.

In Germany, for example, more than half of all cars run on diesel and can tolerate a mix of 20 to 25 percent biodiesel with conventional diesel. In France, closer to 65 percent of all cars operate on diesel, making France another attractive market for biodiesel. In addition, there are tax breaks for many individual EU member states to encourage the further use of biodiesel.

Roughly 80 percent of all biodiesel produced in the EU comes from rapeseed, an oilseed that is used to make canola oil, a popular edible oil the world over. Just as Brazilian ethanol use is pushing demand for sugarcane, biodiesel demand in the EU is currently consuming roughly one-third of the total EU rapeseed crop. With production slated to rise sharply in coming years, you can imagine the effects on rapeseed demand: Production of rapeseed and crushing plant capacity (to convert rapeseed to oil) will need to ramp up considerably if the EU is to come close to meeting its goal of biodiesel production.

Outside the EU, the other crop that's gaining traction in biodiesel production is soybeans. Like rapeseed, soybeans can be easily converted to oil. Right now, demand for biodiesel is only a small part of the picture for beans but that could certainly change in coming years.

How to Play It

Unfortunately, there are very few direct plays on the biodiesel business. However, as I mentioned above, the increased use of biodiesel is having a profound effect on demand and pricing for agricultural commodities like sugar and rapeseed. Companies that serve and supply the agricultural industry, process crops and provide fertilizers will all benefit from growing demand for biofuels.

My favorite play on this market is US-based agribusiness giant Bunge (NYSE: BG). Bunge doesn't actually grow its own soybeans and rape; rather, it buys these commodities and then processes them into oil, meal and other usable products. Bunge is the world's largest oilseed processor, a class of crops that includes both soybeans and rape, and has an enormous fertilizer business. It's South America's top fertilizer producer and owns a commanding position in the all-important Brazilian market.

The importance of Bunge's fertilizer business in South America can't be overstated. To maintain crop yields at economical levels most arable lands must be properly fertilized. Brazil is also an unusually fertilizer-intensive market due to the composition of soil in the country; for Brazil to maintain high crop yields for key crops like sugarcane and soybeans fertilizer is absolutely necessary.

Many investors mistakenly believe fertilizer is a renewable resource. Many key fertilizers are based on minerals mined form the earth, and these minerals are a depleting resource. A perfect example is potash, a mineral that includes potassium carbonate and is usually strip-mined. Another key nutrient used in agriculture is phosphate; phosphate rock also must be mined and there are limited economically exploitable deposits of phosphate in Brazil. Bunge has a solid position in the Brazilian potash industry and owns five of the six largest phosphate mines in the nation. Bunge is a great back-door play on biofuels.

© 2006 Elliott H. Gue
Editorial Archive

While Bunge is poised for a big year, it is just one small part of the biofuel story that I’m currently developing for The Energy Strategist. My subscribers have made money in alternative fuel. They have also made money in refiners, integrated oils, and oil service companies. In fact, they’re making more money by being in the right energy stocks, then they would have by just buying the OSX or some other oil index or fund. But that’s only the beginning.