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Fuel For Thought

In the post-apocalyptic world of the action movie “Mad Max Beyond the Thunderdome”, road warriors dueled in muscle cars fueled by pig waste. Now that’s what I call complete recycling.

Fortunately for us today, extreme gasoline shortages are not a reality, though record pump prices are. This means we won't be replacing refineries with swine farms anytime soon. Still, high-energy costs, the toll taken on the environment and a steady decline in easily recoverable sources of oil and gas do mean the hunt for alternatives to traditional fossil fuels is gathering momentum.

The alternative energy vision in Mad Max may not so far-fetched after all. Biomass, which includes biodegradable waste that can be burnt as fuel, is a reality today.

Canada-based Alternative Green Energy Systems, which promises to “convert your waste into energy”, burns manure from horses, turkeys and chickens to produce steam, hot water and electricity. The energy produced "replaces fossil fuels and therefore reduces greenhouse emissions and creates Kyoto accord credits, and avoids serious land fill problems," the company's website says.

From an industry and investment perspective, perhaps the most visible form of biofuel today is bioethanol. The recent well-publicized surge in global crude oil prices well past $70 a barrel has accelerated the development of alternative sources of energy. As traditional fuel costs soar, alternatives become more economically viable. That explains why investors and companies have started flocking to biofuel producers.

Bioethanol can be produced from a number of different agricultural feedstocks such as sugar cane, corn and wheat. That's created its fair share of controversy.

Looking to cash in on demand for alternative energy, grain farmers are setting aside more acreage for planting crops destined for bioethanol. Farmers seem to have unwittingly sowed the seeds of discontent in Mexico. Thousands took to the streets of the country's capital earlier this year to protest the surging cost tortillas -- corn supplies that should have gone to the production of the food staple were being squeezed because of the demand for corn for ethanol.

A solution proposed by DaimlerChrysler is to produce biofuel from non-food crops. The answer may be jatropha plant, which is currently used for making biodiesel in India. In fact, trains plying between Mumbai and New Delhi run on as much as 20% jatropha-originated biodiesel. The plant's rugged nature (it can grow in wastelands and even deserts) makes it particularly well suited for harsh climates in developing countries. Plus it's high yielding -- it offers four times as much fuel per hectare as soybean, and more than ten times that of corn.

For now though investor sentiment is fixated with the potential returns on bioethanol. How best then to leverage off the green revolution for alternative fuels? As this column consistently warns, the average investor would be well advised to leave the straight punt on the commodity -- be it corn, wheat or sugar -- to the professionals.

Analysts agree the fundamentals for the market look strong. A.G. Edwards' grains-market analyst Bill Nelson has been quoted as saying ethanol-related demand could push corn prices from $2.05 a bushel to $2.50 over the next five years. Sure, that's going to underpin the companies exposed to the biofuels boom though strategists warn investors not to jump in with both feet. Some characterize seemingly unbridled investor demand for biofuel-related stocks as akin to the dotcom frenzy. And we know how that ended.

Caveats aside, the large listed agricultural names -- Archer Daniels Midland , Bunge and Monsanto -- provide a starting point. Fortune magazine points out that ADM stock has climbed 22% to $28, since it recommended the agribusiness' shares in its 2006 Investor’s Guide.

Meanwhile, investors have zeroed in on one of the few listed ethanol plays. Pacific Ethanol stock has jumped more than six fold from its low in September 2005 to its peak in May of 2006.

But here's the kicker: Pacific Ethanol is losing money right now. "It trades for 21 times book value and 6 times sales," writes Chris Mayer in The Daily Reckoning, the investment newsletter. "Analysts project earnings of 45 cents a shares in 2007, which means Pacific is trading for more than 50 times 2007 earnings. Those are rich prices in any era and reflect investor euphoria."

A novel recommendation for a backdoor play into the ethanol is, quite literally, muck. Ethanol eats up a lot of corn in the production process and corn has one of the highest fertilizer applications of any crop. "Farmers will need more fertilizer as more of their acreage is devoted to the production of corn," Mayer observes. "Therefore companies that provide fertilizer products to a variety of customers in agricultural, industrial, specialty and export markets may be worth a look."

Hmmmm, maybe we’re not that far away from Mad Max than I first thought …

Send your questions and comments to us at commoditystore@cnbc.com. We will answer as many of your e-mails as possible on ‘CNBC’s Asia Squawk Box’ every Friday, 7 am to 10 am Hong Kong/Singapore time.

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