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'Stranded' Fuel Could Boost Energy Stocks

Syntroleum and Rentech see profits in converting gas and coal into liquid fuel.

Anyone with at least a few neurons firing in should know that the current arrangement by which the U.S. obtains its energy is, well, inconvenient.

We are passengers of the world's largest economy, which is almost entirely dependent on the importation of fossil fuels. The majority of these fuels are sold to us by gangs of warlords, communist revolutionaries and religious extremists who don't exactly have America's best interests at heart.

The recent political and economic shift toward developing alternative (meaning nonfossil fuel) energy sources is largely meant to address these issues. However, even in the best-case scenario, we are years away from having a self-reliant and environmentally friendly energy policy.

While the domestic reserves of crude oil are pretty much tapped out, the U.S. continues to have abundant reserves of natural gas and coal. Thus, it is frustrating to know that only about half of our reserves of natural gas and coal are economic to produce and market, according to the Energy Information Administration.

Converting these "stranded" reserves into fuel for transportation and other outlets could go a long way to reducing our state of dependence on crude oil imports until alternative energy sources reach critical mass.

A small handful of technologies aimed at recovering stranded energy sources are in the works. One, called GTL (gas to liquid), converts natural gas into liquid fuels like diesel and jet fuel. Another, CTL (coal to liquid), converts coal into liquid fuels.

GTL and CTL plays must fit within strict economic limits. According to analysts at Morningstar, CTL is only profitable when oil is above $40 a barrel. For GTL to work, oil must clear the more manageable $20-a-barrel hurdle.

Syntroleum

(SYNM)

is one of a handful of companies active in pursuing these technologies. Syntroleum builds GTL and CTL plants that are scalable so that they can be moved to remote areas where the hydrocarbons are extracted from the ground.

Once its technologies are perfected, Syntroleum plans to build and operate its own GTL and CTL plants, rather than license the technologies to larger competitors.

But Syntroleum is a risky play. It is a small-cap company ($200 million market cap) that has never made a profit, and it is constantly looking for new sources of funding. So far, the GTL and CTL plants it has built aren't commercially viable, but are rather showcase plants meant to display the technologies and lure investor interest. According to Morningstar analyst Catharina Milostan, Syntroleum is at least five years away from creating a plant with output on an industrial scale.

Last February, the company signed a five-year deal with

China Petroleum

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to share its technology in exchange for a $20-million-a-year cash stream. This deal gives Syntroleum some breathing room as it continues to develop its technologies.

A major competitor of Syntroleum is

Rentech

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(RTK)

, a $350 million company that has been in the coal-to-liquids game for 25 years. Rentech developed an iron catalyst for the CTL process that is 10 times cheaper than the traditional cobalt catalyst. Its technology allows for much smaller CTL plants to plug into shallower coal beds and operate profitably.

Rentech acquired RCN, an Illinois fertilizer plant, in April 2006. Rentech plans to change RCN's feedstock from natural gas to coal and show off the abilities of its iron catalyst, in the hope of luring investors in the process. Rentech's future profit potential likely involves licensing its iron catalyst technology, rather than in building and operating fuel plants like Syntroleum, according to Morningstar analyst Michael Tan.

Rentech is also partnering with

Peabody Energy

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, the largest coal producer in the U.S., to investigate various CTL projects in the Midwest.

Syntroleum and Rentech look like Silicon Valley start-ups when compared to South Africa's

Sasol

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, the largest and most experienced player in the GTL and CTL arenas. Sasol is an integrated oil, gas and chemical company with a market cap of $21.78 billion.

Sasol developed its expertise in stranded gas and coal technologies out of geopolitical necessity. Because of its past apartheid policy, foreign trade with South Africa was embargoed until 1994. While the country doesn't have any domestic oil reserves, it does have plenty of coal. Thus, it concentrated on developing CTL technologies in order to be self-sufficient energywise.

Sasol now has an operational gas-to-diesel plant in Qatar, and it is in partnership with

Chevron

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to build another GTL facility in Nigeria. It is also involved in CTL feasibility studies in China, Australia and the U.S.

Syntroleum, Rentech and Sasol all are currently trading near their fair values, according to Morningstar estimates. They are all engaged in projects with long time horizons, making them relatively risky investments. Their stocks tend to move sporadically as news about their technologies reaches financial markets. One should probably not invest in these companies without keeping a watchful eye on their stock trends.

It is important to remember that these technologies aim to fill a niche market that may shrink as green energy technologies swallow market share. However, investors who buy in at the right time could win big if the technologies pay out.