Friday, April 24, 2009

California Dreamin'

California dreamin’
On such a winters day...
All the leaves are brown
And the sky is grey….

The Mamas and The Papas



Look who is dreaming now! The California Air Resources Board recently approved the country’s first low-carbon fuel regulations. The rule requires the carbon content of fuels…yes that includes new biofuels…to be reduced 10% by 2020.

There was one lone dissenter on the ten member board and the rule faces serious opposition in the courts from opponents. The rule more nightmare than dream for many, since the measurement of carbon content under the rule extends beyond the fuel itself. The impact of transporting the fuel and cultivating land to grow feed stock must be included as well. This puts ethanol at a disadvantage since it is a hungry user of land resources and must be transported by truck rather than tapping into low-cost oil pipelines.

The rule adds several variables to the efficiency equation for biofuel - variables that ethanol producers in particular have tried to keep out of the alternative fuels discussion. Then again that is what the California regulators are after - the inclusion of all environmental benefits and costs for every fuel so that each can be fairly priced. It falls a bit short by not requiring the same approach for fossil fuels, but we expect that in the end litigation will encourage a revision.

It might seem like a dream, but California’s decision should spark a considerable amount of discussion over the next few years. We have been quite bearish on ethanol stocks over the last couple of years, arguing that it was not properly priced against the environmental impact of transport and feedstock requirements. (See a series of Small Cap Strategist posts beginning in January 2007.)

As imperfect as the rule might be, we see it as a significant step forward in bringing more of the right variables into the energy-environment cost equation. In the end this will mean more efficient pricing….a boon to investors in alternative energy and fossil fuel alike.

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