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Ethanol Part III - Go West, Young Man

I believe the Ethanol movement is getting ready to take a new direction over the next five years. It's going to the West. I'm not talking about the Western United States, where the corn ethanol model is flawed. I'm talking about West of Brazil, where the sugar cane model works.

The Republic of Peru is going to become the next big Ethanol frontier, and it lies directly west of Brazil. Here's a few factoids about Peru. There are about 28 million people- about the same population as the NY Metropolitan area. It's about 2/3rd the size of Mexico, and is bordered on the east by Brazil.

The beautiful Andes Mountains divide the country north/south. The east is rain forest similar to Brazil. To the west is an arid, temperate step region, hydrated by rivers flowing to the west off the Andes, over plains and to the Pacific Ocean.

Enter relatively obscure Stratos Renewables (OTC BB: SRNW). The stock has almost no following, and trades very little volume. However, this little known company happens to be one of the largest land holders in the entire county of Peru. 

Over the past year, Stratos has quietly accumulated about 24,000 hectares of land (about 60,000 acres) through 99 year leases, and is in negotiations to double that number. The leases are located in the northern part of the country, only about 40 kilometers from the major port city of Eten.
 

Peruvian Ethanol: The Lowest Production Costs on Earth

Stratos believes it will be the lowest cost Ethanol producer in the world. There are a number of reasons for this. Currently, Brazil produces the cheapest ethanol in the world. However, the Brazilian sugar cane grows in the rain forest, and it can only be harvested six months out of the year. The other six months are simply too rainy to make harvesting possible. Once harvested, sugar cane cannot be stored. It must be processed and distilled immediately.

Stratos projects its cost per gallon will be $.83 vs $1.18 in Brazil and $1.47 for US corn ethanol. Lower land costs and year round production will contribute to lower costs. 

The Stratos properties are located on the semi arid and more temperate coast line. The growing season is year round, and water will be provided through sophisticated irrigation systems that draw on the massive water flow off the Andes mountains to the east. The temperatures are ideal for growing sugar cane- you just have to add the water. Furthermore, the land costs are lower because this coastal property is not being used for other crops. It is currently sitting idle in most cases.

To date, Stratos has invested about $22 million in development costs. 

The company has acquired an older sugar cane processing plant. You see it pictured on the left. It is being relocated and retrofitted, and should begin processing sugar cane into ethanol sometime in mid 2009. Pictured on the right is an artist rendering depicting the transformation SRNW plans for the existing plant and surrounding land.

The company also has plans to build a second, much larger distillation facility. It will require an investment of $100 million. SRNW has a commitment for 70% of the capital in the form of debt, and is working to raise the other 30% in the form of an equity investment.
 

The Long Range Plan

By 2010, SRNW plans to have the production capability to deliver about 45 million gallons of Ethanol. At current prices, this would convert to $76.5 million in annual revenues.

Their production facilities will be located a mere 40 kilometers from the Northern Port city of Eten. A German tanker company operates at the port with 80 facilities world wide. The German company has offered to build storage tanks in return for a long term contract to deliver ethanol at about $.05 per gallon.

When the second and larger production facility comes online, SRNW anticipates a quick ramp up to 90 million gallons in annual production. At today's prices, this would translate into $153 million in revenues. The company's cost would be about $90 million including cost and shipping- leaving a net profit of $63 million. 

I believe it is more likely fuel costs will be higher than today's prices in two years, but who can say for sure.

Peru currently has three major competitive advantages over Brazil- its neighbor to the east. First, ethanol can be produced for less money. Secondly, Peru has a shipping advantage. Tankers off load at the port of Eten, and often go out empty. This allows for inexpensive shipping costs. It's a straight shot north to the California ports of San Diego and LA.

Third, and perhaps most importantly, Peru has a free trade agreement with the United States. As things stand today, Peruvian ethanol would not be subject to the burden of a $.51 per gallon tariff, as is the case with Brazilian ethanol.
 

Conclusion

In Part I of this series on Ethanol I explained why the US corn based ethanol is a failed model. In Part II, we examined how the ethanol program has worked for 20 years in Brazil. These editions brought lots of controversy- I received a lot of emails on both sides of the issue. 

In Part III, I'm sharing an idea which represents an opportunity to invest in a new Ethanol frontier. It's a very long term idea, and it's in a zero revenue company today, so it's highly risky. However, the company has invested $22 million in its development, controls one of the largest blocks of agricultural land in Peru, and owns in a distillation facility.

Working against us is the head winds in the overall markets. Investors are sidelined today, panting from the massive destruction of wealth we have lived through since early September. It takes a lot of courage to be willing to invest, but of course that's the point in time the most wealth is also created. 

As of the end of September, SRNW had about $2.6 million in cash. This money can last the company well into 2009 as they have a reasonably low burn rate. They plan to raise about $6 million more in capital to commence operations by the third quarter, as disclosed in their recent 10Q filing. They have already raised $22 million with some well financed VC funds, so another traunch is likely even in this environment. 

There are about 60 million shares I&O. This idea is in keeping with my theme for the future- global investments in emerging markets. I'm focusing on companies with a Clean Tech theme and revolutionary ideas. This will be the next frontier of big returns in growth.

The chart suggests one should not pay more than $.80 to $.85 for the stock.  Also, in light of the deleveraging going on in world wide markets, I would suggest taking a small position to start with if you like the idea. You have over six months to accumulate the stock before operations begin, and any number of forces could offer a more favorable level down the road. As you can see from the chart, there hasn't been much recognition for the stock. However, in the last couple of days, there have been some interesting volume surges.

I believe a year from now this company will be recognized by the global clean tech community as a real pioneer in its field. It has many competitive advantages- they are the first in the market, will have lower costs, no tariffs for exports to the US, and easy shipping facilities. 

In the current environment, I am thinking long term on all my ideas. You have to. You have real value here with the land holdings and their plant. In 2009 when operations commence, look for much higher levels on this stock. If you have a feel for the future of 

For more information, visit their web site- there's a short video clip that will give you some understanding of the company. Go to http://www.stratosrenewables.com/home.php. 

There is a more comprehensive video presentation being completed. It should be available sometime next week. It will put you right on the site, and introduce you to a world class management team.

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