Biodiesel boom, boon?

By Ian Wyatt, Big Idea Investor | May 01, 2007 | comment

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Biodiesel boom, boon?

by Ray Cheung, Staff Writer, SmallCapInvestor.com

China's biodiesel industry boom could be a boon for investors as the country steps up development of the green fuel to meet its pressing energy needs. But, as with many apparent opportunities in China, prudence is the order of the day as the sector goes through its growing pains. 

The low carbon-gas emitting fuel made from vegetable and animal oil is in the midst of an investment and expansion explosion in China. In December, China Clean Energy Inc (OTCBB: CCGY) announced plans to build a new 100,000-ton-per-year biodiesel facility to be up and running by the end of 2008. The investment is one of the latest in an industry whose production capacity in China grew an estimated 600 percent, to 600,000 tons, between 2005-2006, according to Credit Suisse.

This growth is being fueled by China's surging oil consumption, which Beijing estimated at over 330 million tons last year, and which is conservatively projected to reach 450 million tons by 2020. To meet this demand, the country has become increasingly dependent on foreign oil, currently importing at least 40 percent of its oil supply. The United States, by contrast, imported about 60 percent of its 871 million ton consumption in 2006.

So with its potential to weigh on the country's foreign oil imports and cut greenhouse gases, a major concern in China's pollution-ridden skies, the Chinese government has made developing the biodiesel industry, as well as its cousin, bioethanol, a national priority. Beijing wants the green fuels to account for 15 percent of all transportation fuels by 2020, compared with 2 percent currently. That goal puts total biodiesel production on a track to reach 2 million tons by 2010, and 5 million tons by 2020.

To develop biodiesel, Beijing has unleashed a series of subsidies and tax incentives. In December, the State Administration of Taxation announced that biodiesel produced from animal fat or vegetable oil will not be subjected to consumption taxes. The government is also expected to introduce later this year new rules requiring conventional fuel to be blended with 5 percent biodiesel.

More important for investors is that Chinese biodiesel producers are reporting profit margins as high as 40 percent, the result of using waste vegetable oil and recycled cooking oil, both of which are one-third the price of the traditional rapeseed oil and half that of palm oil.

With so much going on, China's biodiesel wave indeed will provide opportunities for small-cap investors. While much of the biodiesel action is dominated by the major Chinese oil producers - Sinopec (NYSE: SHI), PetroChina (NYSE: PTR), and China National Offshore Oil Corp (NYSE:CEO) -- and many of the producers remain privately held, there is a growing list of foreign-listed Chinese biodiesel firms. These include China Biodiesel (LSE:CBI.L), which raised US$15 million in market capital during its July debut on the London AIM, as well as the aforementioned China Clean Energy Inc, which announced its development plans just days after its IPO in December. Another option is to invest in the international biodiesel firms that are having a growing presence in China, such as D-1 Oils (LSE: DOO) and Germany's Lurgi, a subsidiary of GEA Group, (XETRA: G1A.DE)
 
A caveat: be aware that the Chinese biodiesel sector is facing new challenges that could easily shake up the current boom. With the skyrocketing demand, there are at least 30 producers in the market, with the number growing all the time. This of course is igniting concerns about over capacity. The distribution of biodiesel is also weak, with the majority of the green fuel being sold mostly by private vendors, not via the major company gas stations in China.

A more worrisome issue is that the biodiesel feedstock is now in tight supply, thereby becoming more expensive. With demand for waste vegetable oil and recycled cooking oil outpacing supply, Chinese producers are now switching to the more expensive edible oils. The result is that edible oil prices are hitting two-year highs, with much of the supply now being imported from nearby Malaysia, Indonesia and as well as the United States. If this trend continues, Beijing will intervene because it touches the Chinese nerve of food security, which could disrupt cash flows. When Chinese bioethanol production was cutting into the nation's corn supplies, the government last September reduced its subsidies and in December issued an edict ordering that the biofuel must be produced from non-grain sources, such as sorghum and cassava. The government has also already signaled that it will closely regulate biodiesel from foreign investors in attempt to stop rising production costs.

Despite such worries, China's biodiesel industry is on a growth trajectory simply because of the country's desperate need for cleaner energy. For investors, the key is to buy shares of firms that have secured supply chains that do not solely rely on edible oils. With more biodiesel firms expected to list in the coming months, such choices should be plentiful.

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