The mania over ethanol as fuel didn't play out so well for investors last time, but there might be a new way to profit from the renewable energy industry as companies rush to commercialize what is being dubbed second-generation biofuel production.
The big winners are expected to be enzyme makers, forest companies, and the agricultural sector.
That's the view of a team of analysts at investment bank UBS, who have picked a handful of firms they believe will benefit if, as they expect, ethanol and biodiesel from new technologies become the predominant renewable source of energy for transportation by 2020.
The call by UBS for investors to take a plunge back into biofuels is one of the first by a major investment firm since a disastrous crash in the sector two years ago. The shares of many companies that were trying to make ethanol from corn, for blending into gasoline, have plunged, and scientific critics have assailed the idea of using food as fuel, saying it had few environmental benefits.
UBS analysts are selecting as investments companies such as forestry giant Weyerhaeuser Co., which might be able to turn trees no longer needed for paper in the digital era into fuel, and enzyme makers, such as Novozymes and Danisco, whose products make it possible to break down tough plant fibres into ethanol.
It's almost been on the level of hypothesis and fantasy, if you like, so some people are still wondering what the balance of rhetoric to reality is. UBS analyst Shirley Morgan-Knott
Its picks are bigger, more-established companies whose businesses will receive an overall boost from biofuels, rather than the more speculative entities that captivated investors in the previous biofuel boom. Typical of that era was Biofuel Energy Corp., a former high flier that is still losing money. Its stock has been hovering around $1.65 (U.S.) a share, a fraction of the $10.50 the shares fetched at its IPO in 2007 at the height of the last craze over renewable fuels.
But UBS analysts believe it's safe to shake the dice with the sector again because companies are developing new technology to derive ethanol from the biomass of leftover crop residues and trees, rather than using foods like corn.
That previous approach is known as first-generation technology, and has fallen out of favour because it crimps the food supply and has modest greenhouse gas emission benefits. Because the new technology is still in its early days, there is skepticism about it, although UBS believes it is misplaced.
"It's almost been on the level of hypothesis and fantasy, if you like, so some people are still wondering what the balance of rhetoric to reality is," said Shirley Morgan-Knott, a U.K.-based analyst at UBS who is a co-author of the report.
We really strongly believe in the potential of second-generation biofuels, but we also believe that there need to be tests along the way. Alice McKeown Jasperson, Worldwatch Institute
The idea that second-generation biofuels will approach commercialization over the next five to 10 years is shared by some independent experts, although more research needs to be done to ensure that these techniques deliver environmental benefits.
"We really strongly believe in the potential of second-generation biofuels, but we also believe that there need to be tests along the way," says Alice McKeown Jasperson, a researcher associated at Worldwatch Institute, a Washington-based think tank.
Biofuels production, as a winning investment theme, also has the benefit of many governments pushing for its use as a way to boost their farm sectors and to reduce reliance on foreign oil.
In the U.S., for instance, the Environmental Protection Agency is increasing the amount of renewables required to be blended into transportation fuel fourfold from 34 billion litres in 2008 to 136 billion litres by 2022. Only about 40 per cent of the total in 2020 can come from corn-based ethanol.
UBS projects that worldwide output of bioethanol from trees, agricultural residues, and non-food plant residues could have a value of $80-billion (U.S.) by 2022, up from virtually nothing currently.
Among specific companies, UBS says Weyerhaeuser will benefit because the supply of biomass will be the limiting factor in this type of fuel production, and the company, as a large timberland owner, "will ultimately command a position of strength." Sweden's SCA is the largest forest owner in Europe and will likewise benefit.
Novozymes and Danisco, two Denmark-based companies, are the world's only two large enzyme-technology companies of any consequence, with about 90 per cent of the market for the chemicals, which are needed in ethanol production.
Linde, a German engineering firm, is developing practical ways of extracting biofuels from algae. Syngenta was given the nod because it is the world's largest seller of crop protection chemicals and also has a large seed operation.