A Green Play on Rising Gas Prices

03/22/2011 3:12 pm EST

Focus: STOCKS

Biofuel specialist Codexis is working to extract more energy from grains and sugar at a lower cost, writes Brendan Coffey, editor of Cabot Green Investor.

Last week, the average cost of a gallon of gasoline in the US was $3.56, according to the Department of Energy. That’s up a whopping 80 cents from a year ago. Five years ago, a gallon was $2.70; ten years ago, it was $1.60.

Given that demand rises in the summer driving season, it’s a good bet that $4-a-gallon gasoline will be on tap by Memorial Day.

The uncertainty of the world’s energy flow promises to continue to roil markets. Between Libya and other Middle East unrest, and the increased demand after Japan’s disasters to import energy to make up for the destroyed nuclear plants, the pressure is bound to continue.

Plus, there are the fundamental supply and demand pressures that exist anyway, as world economic activity rebounds from the recession.

All of that means biofuels are likely here to stay as a part of the world energy supply.

Today, biofuels are just 3% of the world supply (in terms of refining capacity). But last autumn, when gasoline prices were under control, they were projected to grow at least at a 7% clip for the foreseeable future.

However, there is a problem with biofuels. Here in the US, for instance, 40% of the latest corn crop went to ethanol. That’s a stunning figure—especially considering that world grain markets are under intense pressure because of poor wheat crops in Russia and Ukraine, poor corn crops in China, and disappointing harvests here in the US in both corn and soy.

Squeezing Every Drop from Kernels
The ability to get more from each bit of corn—whether extracting more energy from it, or using less energy to extract the same amount of energy—is a key hurdle to overcome. So is creating the ability to produce suitable ethanol or other biofuels from other, non-food sources.

My stock recommendation is making great strides in those areas. It’s a California company called Codexis (CDXS). Specifically, Codexis produces biocatalysts, which create ethanol faster and cleaner than traditional methods.

In the past, biocatalysts have been too unstable to use reliably, but because they can be utilized at room temperature and without the creation of hazardous byproducts, stable, reliable biocatalysts have long been sought after.

Codexis identifies and isolates the microorganisms that produce the best enzymes, then performs a series of intricate processes, including gene shuffling and mutation identification, to breed proprietary “superenzymes” that can be used more cheaply and efficiently in the creation of biofuels.

The benefits include being able to use water as a solvent at normal atmospheric pressure, eliminating the need for purification actions later on, and using less energy overall.

For biodiesel, which is chemically different from bioethanol (the latter is an alcohol, the former an oil), Codexis believes it has discovered a process that allows it to be made faster and cheaper.

Right now, biodiesel requires intricate steps from start to finish—including halting the production process at one point to chemically modify the intermediate product—and other costly side steps. Codexis believes its process eliminates the need to chemically modify the intermediate product, allowing the process to run continually and slash expenses.

Because biodiesel is chemically identical to fossil-fuel diesel, this may in fact be the more promising of the two biofuel areas. Ethanol, being chemically different from gasoline, requires additional infrastructure “drop in” fuels that biodiesel does not.

Next: Drug Businses a Nice Sideline

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Drug Business a Nice Sideline
There are plenty of other companies pursuing advances in biofuels and catalysts, such as Gevo (GEVO), Verenium (VRNM) and PetroAlgae (PALG), but Codexis has two characteristics that give it an edge.

One is that Codexis also has a market for its superenzymes in the pharmaceutical industry. If you take Lipitor, you’ve experienced the end result of a process that includes Codexis. The company’s superenzymes are also sold to Dr. Reddy’s Labs (RDY), Teva Phamaceuticals (TEVA) and Arch Chemicals (ARJ), among others.

That gives the company a solid revenue stream while it looks to ramp up the biofuels business.

And the biofuels business is looking good. In early February, long-time partner Royal Dutch Shell (RDS-A) said it will use Codexis technology to produce biofuels directly from straw and sugar-cane waste by year’s end. This is potentially important because Shell has also teamed with Cosan (CZZ), Brazil’s largest ethanol producer, which uses sugar cane as its raw material.

A potential long-term bonus: Codexis recently announced it has made progress in a carbon sequestration technique using custom enzymes that can be deployed in coal-fired power plants.

In its most recent fiscal year, ended December 31, Codexis made $107 million (up 77%) and shrunk its net loss to $8.5 million (35 cents per share) from $20.3 million. Shares look like they are in the midst of building a rock-solid base between $10.50 and $11 per share to work higher in coming months.

The higher gas prices go, the better the outlook for Codexis.

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