This column was originally published on RealMoney on Sept. 20 at 10:03 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.
I'm the first to admit it: Bubbles go hand-in-hand with innovation.
In the '90s, people couldn't tell if the Internet was a bubble or thefuture of all media and commerce. It turned out to be a little bit ofboth, but only when the right business models self-selected themselvesand emerged as the winners. The Internet turned everything upside downand forced traditional businesses to really question if we were in a"new economy." The answer was that we weren't, and traditional economicforces like supply and demand were still extant.
The same questions are being flirted with now that oil is at $70 and,if we believe Goldman Sachs, heading to $100 and beyond. In a world where energy is scarce and one of its biggest source areas, the Middle East, is in turmoil, the quest for a miracle fuel has sparked speculation in alternative fuel companies that rivals that in famous Internet bubble stocks like Pets.com and TheGlobe.com.
Ethanol and biofuels are glamorous and exciting. You can grow it in your backyard. You can eat it for dinner and then stuff it down your car and drive 1,000 miles. There's a Norman Rockwell vision of these homegrown fuels thatsatisfies our primal urge to be independent of the war-torn sources ofoil and the environmental problems of coal.
But it's coal that is more likely to solve the problem, in particular, technologies that convert coal to liquid fuel.
February, I wrote about the coal-to-liquid-fuel technology company
. This Denver-based outfit owns and licenses a proprietary and patented version of the Fischer-Tropsch method. Invented in the 1920s in Germany, the Fischer-Tropsch method converts coal, natural gas or biomass (woodchips, etc.) into synthesis gas, a combination of hydrogen and carbon dioxide, and then converts that gas into a liquid fuel. It was used by Germany andJapan during World War II to produce synthetic fuels.
This process would require no new product deliveryinfrastructure in the U.S. and it produces clean-burning fuels that meet all worldwide standards.
My thinking when I wrote about this stock was that people would realize this was the truely clean, alternative fuel as opposed to the scams being perpetrated by the ethanol and biofuel adherents. So far so good -- Rentech is up from $3.90 to about $4.60, but Wall Street is still unaware of it and pumping up the bubble in ethanol. (Full disclosure: I am along-term investor in Rentech).
The Problem With Ethanol
What's wrong with ethanol? First off, it's going to be impossible to grow enough corn and soybeans to have any impact on U.S. fuel supplies. The U.S. consumed close to 150 billion gallons of gasoline last year. TheEnergy Policy Act passed by Congress last year mandatesproduction of 7.5 billion gallons of ethanol by 2012. That won't even make a dent in the problem.
Another critical issue is that ethanol absorbswater, but gasoline doesn't. Because water tends to collect in petroleum pipelines, they would need to be drained to transport ethanol. Given the cost and small volumes involved, as well as concerns that ethanol has a corrosive effect on pipelines, the consensus is that it makes more sense to ship ethanol by truck, train and boat. Setting up the infrastructure to do this will be expensive and require wide-scale changes.
Let's not forget another critical feature of ethanol. Whether you aremaking it from corn or from soybeans, there's a huge competing use: Corn and soybeans are food.
Coal doesn't have a competing use. Nor does coal have thousands of traders hedging their feedstock (or just plain speculating), creatingvolatility in the prices. Coal companies know exactly how much theyhave and where it is: straight down (as opposed to being spreadout over hundreds of thousands of acres whose soil is being depleted eachyear). Coal prices are much less volatile because the supply is controlled by a handful of companies.
Perhaps most importantly, it's unclear that ramping up ethanol production would result in lower costs than oil. Most studies suggest that the process of making a gallon of ethanol actually uses more than a gallon of fossil fuels, making ethanol more expensive. By contrast, using coalliquefaction techniques such as the Fischer-Tropsch process, the break-even cost is somewhere in the range of $25 to $35 a barrel of oil.
Very few companies have commercialized orhave patents on FT technology.
of South Africa uses FT to produce most of that country's diesel fuel from low-grade coal. Chevron and Sasol have formed a joint venture to convert natural gas to liquid fuel, but this is cost-prohibitive in the U.S.; coal is plentiful here andit's a low-cost feedstock compared with natural gas. On a BTU basis,natural gas coming to a Rentech plant would cost $7 per million BTU vs. $1.75 million BTU for coal.
In July, Rentech and the leading coal miner
announced a deal to buildcoal-to-liquids plants. They expect them to be online in four to five years and produce minimally 40,000 barrels of oil per day. While the final split per plant has not been determined (it's 50-50 at the moment, but that will change pending a determination on final costs), the EBITDA on 40,000 barrels per day could be over $1 million a day. At this point, Rentech, with a $680 million market cap, is the only domestic U.S. provider of coal-to-liquids technology that has proposed a plant and developed the technology for it.
The major criticism for using coal as a fuel is that the conversion process would produce a large amount of carbon dioxide, one of the main gases causing global warming. However, Rentech says it's designing its plants to be "carbon capture ready" and is locating them inareas where carbon dioxide can be either used commercially in food-gradeproducts (resold to bottle manufacturers or fertilizer makers), or usedfor enhanced oil recovery and coal-bed methane production.
I expect that general awareness of the problems of ethanol will force analysts to look at the real alternative fuels out there. Companies like Rentech are likely to win as a result.
At the time of publication, Altucher and/or his fund was long Rentech, although positions may change at any time.
James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of
Trade Like a Hedge Fund
Trade Like Warren Buffett
. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback;
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