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Friday, February 5, 2010 - 15:02
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Thursday, April 1, 2010 - 03:26
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Friday, February 5, 2010 - 15:02

The Fine Print Behind a $12 Billion Deal

Friday, February 05, 2010 3:02 PM

This week brought a significant bit of news in the ethanol world.

Industry-watchers might assume I'm talking about President Obama's Wednesday announcement with the Energy and Agriculture secretaries that a federal biofuel output quota schedule had been finalized, a move that will encourage the production of 36 billion gallons in the United States by 2022.

That was a significant announcement. In fact, it was outright huge. It's splendiferous news for shareholders of companies that participate in the biofuel industry, especially cellulosic ethanol, an advanced biofuel that can be made from any plant material. (Traditional ethanol is derived from corn.)

The announcement I'm referring to, however, happened earlier in the week. And outside of the country: Brazilian sugar and ethanol producer Cosan Industria a Comericio (NYSE: CZZ) struck a deal with Royal Dutch Shell (NYSE: RDS-B) to create Brazil's third-largest fuel distribution network. It also gives Shell a piece of the world's largest ethanol producer in the top ethanol-producing country.

The joint venture is valued at $12 billion.

But here's the kicker: Shell has interests in Codexis, which provides enzymes for fuel production and pharmaceuticals, and Iogen, a cellulosic ethanol pioneer that Shell funds along with Goldman Sachs and the Canadian government, among others. Shell is folding those interests into this deal. It's going all in on ethanol.

Fact: Codexis relies on other companies' technology. It said so in an SEC filing in late December 2009 as it enumerated the risk factors facing the company:

"If we are unable to maintain license rights to a commercial scale expression system for enzymes that convert cellulosic biomass to sugars, our business may be materially adversely affected."

The filing continues: "[Codexis] entered into a license agreement with Dyadic … in November 2008 to obtain access to an expression system that is capable of producing the necessary biocatalysts for the commercialization of cellulosic biofuels."

In other words, if Codexis loses the right to use technology owned by Jupiter, Fla.-based Dyadic International, Inc (OTC: DYAI) it will find itself up the proverbial creek. It simply doesn't have a way to ferment the natural sugars found in plant-cell walls into alcohol without Dyadic's proprietary enyzmes.

Think of the production of cellulosic ethanol as a road.

Now imagine a toll bridge on that road.

Inside the toll booth: Dyadic. For every gallon of the stuff that this new joint venture produces, Dyadic is due a royalty.

And believe it or not, this story gets even better.

You see, the license that Dyadic has with Codexis is non-exclusive. That means Dyadic can dance with other suitors. And that's why I mentioned the President's announcement.

The federal timetable with the nation's output targets calls for the production, this year, of 100 million gallons of cellulosic ethanol. That might seem like a lot, and it is -- because the United States doesn't produce much of the stuff right now. The reason is simple: There's not a commercial-scale cellulosic plant operating anywhere in the country.

That is going to change, and quickly. It has to. That's the law. By 2022, in fact, the law says the United States must produce 16 billion gallons of cellulosic ethanol. That's a +15,900% increase.

Dyadic shares may well match it. They've certainly performed well so far: I added them to my Government-Driven Investing portfolio in early July 2009 and they've since already returned +220%. Dyadic already has licensed its cellulosic technology to one other company, Abengoa Bioenergy, and the company is working on signing other deals, too.

There are two ways to make money from biofuels: Start buying farmland in the hope that it will appreciate as cellulosic ethanol opens new agricultural markets that will increase the land's value -- or start buying essential technology developers like Dyadic. Its remarkable performance in 2009 is likely the first chapter in an epic saga of profits.

Andy Obermueller does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.