The Wall Street Journal featured ethanol on the front cover last week. Here at home, The Baltimore Sun touted ethanol as an “emerging energy star.” Even our president called in an interview earlier this year for the U.S. “to not only advance that technology of deriving fuel from corn, but also deriving fuel from waste materials.”

That’s bold talk for a one-time oilman, but it is becoming more and more apparent that alternatives to the traditional barrel of crude will have to become more prevalent in this age of political tension and dwindling natural resources.

Today’s Sleuth will focus on one of the hottest oil alternatives — ethanol.

For those of you who may not know, ethanol is made from the sugar of corn or sugarcane — and is basically grain alcohol that can be mixed in varying amounts into gasoline.  Brazil has successfully reduced 40% of its oil demand by using ethanol fuels and ethanol-burning vehicles.

And it is starting to make its way into the United States as well.

The U.S. Energy Policy Act of 2005 required that ethanol production increase to 7.5 billion gallons a year by 2012. (Right now, production is at 4 billion gallons annually.) And some local jurisdictions are jumping ahead with their own ethanol laws.

Take Hawaii, for instance — a state that has passed a law requiring 85% of all its gas to contain at least 10 percent ethanol by next month. According to the Associated Press, some companies don’t think they can make the transition by the deadline set for April 2: “The would-be producers say they are a year or more away from having production facilities in place… Oil companies in Hawaii are importing ethanol in order to meet the April 2 deadline.”

In other states — especially in corn country — news of new ethanol facilities seems to come out every week. 

Once total funding is secured, the Southeast Missourian reports that a new ethanol plant could be constructed as early as this year…and it’s not the region’s first facility. The plant would produce 100 million gallons of ethanol a year:

“Construction of a second new ethanol plant in Southeast Missouri could start as early as this summer on more than 100 acres along Nash Road and be fully operational 18 months later, officials said Wednesday…

“The news on Danforth’s plant comes just four months after Bootheel Agri-Energy LLC, headed by Chaffee farmer David Herbst, announced its intentions to build a $175 million plant near Sikeston to manufacture 100 million gallons of ethanol per year.”

Same goes for North Dakota’s corn country. From the Associated Press:

“Two companies plan to build North Dakota’s largest ethanol factory here in southeastern North Dakota’s corn country, with construction beginning late this summer. Officials of Gold Energy LLC of Wahpeton and US BioEnergy Corp., which is based in Brookings, S.D., announced the project Wednesday. The plant will cost about $145 million to construct, and will be designed to produce 100 million gallons of ethanol annually.”

This is happening all over the country — Wherever corn is being grown, there is talk of ethanol. Governments will begin mandating its use and it could be the rehab program our oil addiction so desperately needs.

And with bio-fuels in such strong demand, small producers are bound to get their share of the business. The government is even helping the small-cap company along in this case, offering a “small producer biodiesel and ethanol credit.”

This credit will benefit small biodiesel producers by giving them a 10-cent per gallon tax credit for up to 15 million gallons of agri-biodiesel produced. In addition, the limit on production capacity for small ethanol producers increased from 30 million to 60 million gallons.  This is effective until the end of 2008.

Even gas stations themselves are being thrown incentives. Gas stations are eligible for a 30% credit for the cost of installing clean-fuel equipment, like E-85 ethanol pumping stations, effective through December 31, 2010. According the U.S. Department of Energy, a clean fuel is “any fuel that consists of at least 85% ethanol, natural gas, compressed natural gas, liquefied natural gas, liquefied petroleum gas, or hydrogen and any mixture of diesel fuel and biodiesel containing at least 20% biodiesel.” 

On that note, let’s check out three innovative small-caps linked to the alternative energy business that stand to benefit as ethanol gains a foothold in this market…

1) 02Diesel Corporation (AMEX: OTD) Market cap: $27 million; share price: $0.64; 52-week high: $1.91.

02Diesel develops additive products that help fuels burn cleaner by adding ethanol. 02Diesel’s main product is called O2D05 — a fuel additive that can be made from soybean oil, vegetable oil or animal fats. It is designed to stabilize blending of fuel grade ethanol with diesel fuel, with the end result being a clean burning fuel called 02Diesel.

Possibly even more important to 02Diesel’s business is its ties to Brazil — a country that has successfully reduced 40% of its oil demand by using ethanol fuels and ethanol-burning vehicles. In 2004, 02Diesel began operations in Brazil through its 75%-owned subsidiary, O2Diesel Químicos Ltda.

2) Pacific Ethanol Inc. (NASDAQ: PEIX) Market cap: $547 million; share price: $19; 52-week high: $20.55.

Pacific Ethanol makes corn-based ethanol, and also sells products generated from the manufacture of ethanol, such as grain and carbon dioxide. Pacific sells its ethanol through its fuel-marketing subsidiary, Kinergy Marketing.

3) MGP Ingredients Inc. (NASDAQ: MGPI) Market cap: $236 million; share price: $14.40; 52-week high: $19.22.

MGP Ingredients distills wheat starches and wheat proteins for wheat starches and vital wheat gluten and mill feeds. The company makes alcohol used in beverages and industrial alcohol — like ethanol. Like Pacific, MGP also deals in the grain and carbon dioxide byproducts of its distillery operations.

Feel free to add these three companies to your watch list. With new regulations and oil prices consistently above $60, ethanol is set to gain a lot of traction in this market.

Until next week,

Gunner
March 20, 2006

New Laws and Tax Breaks Could Energize These Small-Cap Alternative Energy Outfits was originally featured in the Penny Sleuth.