Liquid Coal a Slippery Business

What is more, its champions contend, greater energy independence breeds economic strength. Petrodollars would stay at home, injecting needed money into domestic rural communities instead of OPEC coffers.

CTL's problem is global warming. The production and use of CTL diesel releases nearly twice the carbon dioxide of oil diesel. CTL's champions argue that carbon sequestration technology will enable producers to capture carbon dioxide during the production process and bury it underground. However, that technology is untested on an industrial scale and even if it worked as promised, net greenhouse gas emissions would still be no better than oil diesel.

As an investor weighing the trade-offs between security, economics and environmental concerns that determine CTL prospects, it makes sense to examine CTL's promise from three political angles: near-term domestic, near-term international and long-term global.

Near-Term Domestic

A showdown over CTL is shaping-up in Congress that will determine its near-term prospects in the U.S.

The Democratic leadership is working urgently on a new energy bill that would provide a variety of incentives to promote renewable fuels but none to promote CTL. In opposition, a coalition of Republicans and coal-state Democrats, backed by unprecedented coal industry lobbying, is proposing a rash of CTL incentives, including a 51-cent-per-gallon tax credit for CTL fuel, loan guarantees for six to 10 CTL plants likely to cost at least $3 billion each and leave for the Air Force to sign a 25-year supply deal for CTL jet fuel.

While Democratic sentiment runs against CTL, political timing and geography favor it. Heading into the 2008 elections, Democrats see their chance to recapture the Oval Office and grow their one-seat Senate majority turning on the votes of coal-producing "Blue Dog Democrat" states like West Virginia, Montana, Illinois, Ohio and Pennsylvania.

CTL's fate will likely be determined by the Senate as House leadership appears unwilling to risk battleground districts in coal-producing states to block incentives. Senate debate pits coal state Democrats like presidential aspirant Barack Obama and Senate Finance Chairman Max Baucus (D., Mont.) against the party rank-and-file.

The outcome is unclear but time seems to be on CTL's side. The combination of increased summer gasoline prices, growing frustration with Iraq and heightened tensions over Iran's nuclear program by the time the House and Senate energy bills reach conference proceedings in July should only increase the odds of some CTL incentives passing this session.

If incentives are enacted, both downstream CTL producers and upstream coal suppliers stand to gain.

Domestic CTL producers have fared poorly this year with all major producers' stocks down 10% to 30%. If Congress opens its purse, however, Rentech(RTK Quote) is probably the best CTL pure-play in the market. The company just announced a cooperative effort with Peabody Energy(BTU Quote) to convert an existing Illinois Rentech fertilizer factory into a 400,000 barrels-per-year CTL plant and has plans for additional plants that loan guarantees and subsidies would accelerate.