We've been talking about cellulosic ethanol as a way of investing in renewable fuels for over a year now.

By now, anyone who follows the ethanol industry even semi-closely knows that cellulosic ethanol is the future of renewable transportation fuels.

But for all the talk and ballyhoo, a commercial plant has yet to be opened here in the U.S., though there are at least two under construction. Many claim to be the first, but here's what I found.

The first was announced in November 2006, is being built by the Broin Companies in Iowa, and will produce 125-million gallons per year (GPY) from corn fiber and corn stover.

The second (which is the one usually cited as first) was announced in July 2007, is being built by Range Fuels in Georgia, and will ultimately produce 100-million GPY from wood and wood waste.

Those are commercial scale plants. There are already numerous pilot and demonstration plants in place and producing cellulosic ethanol, but scaling up has proven to be an issue.

Renewable Fuels: What in the Cell is the Hold Up?

Ok, I'm going to give a semester-long science lesson in just a few minutes, so bear with me. It is vital to understand the scientific fundamentals of the renewable fuel industry before we get to the investment angles.

In order to produce cellulosic ethanol, the cellulose must first be extracted from the feedstock. This has proven exceedingly difficult because the carbohydrate polymers (cellulose and hemicellulose) are firmly bound to the lignin, which is a complex compound, mostly derived from wood, and a vital part of plants' cell walls.

This can be done one of two ways.

In the first method, called cellulolysis, the feedstock is first pretreated to separate the cellulose from the lignin.

The cellulose molecules, which are long chains of sugar molecules, are then broken down into individual sugars. This is done with either a chemical acid reaction or an enzymatic reaction.

The chemical process, used by Bluefire Ethanol (OTCBB: BFRE), attacks the cellulose with acid in the presence of heat and pressure. The reaction produces individual sugar molecules, which can then be neutralized and fermented into ethanol.

The other option uses Mother Nature as its driving force. It uses bacterial enzymes, like the ones in the stomachs of ruminants. These specialized enzymes break the cellulose down into individual glucose molecules, which are then fermented into ethanol.

This has become the heart of the cellulosic ethanol industry: engineering the best enzymes to break down the cellulose into usable sugar.

It all comes down to which company can get the most usable sugars from its feedstocks. And the race is still wide open.

Here's the problem: the traditional fermentation process uses standard baker's yeast, which produces ethanol from hexoses, a 6-carbon sugar. But because of the complexities of the carbohydrates in cellulosic feedstocks, many of the sugars derived are 5-carbon sugars, which are harder to break down and ferment.

In fact, up to 30% of the total fermentable sugars derived from corn stover are 5-carbon sugars. And that's much more than optimal.

So it's vital to find enzymes and yeast that can digest and ferment both types of sugars to make the process more efficient and economical. Whichever company does that wins - plain and simple.

Investing in Cellulosic Ethanol Companies

Well, we already know that Bluefire (OTCBB: BFRE) is one of the only games in town on the chemical process side. That stock has been volatile lately, only popping on good news or the rare occasion that a grant is accepted. If you can handle the risk, don't pay more than $3.00 for this stock.

On the enzymatic side, there are numerous players, both in enzyme manufacturing and ethanol production:

• Verenium (NASDAQ: VRNM) looks to be one of the early winners there. They had a nice pop back in July after a joint announcement with BP (NYSE: BP), but have since sold off. Again, if you can handle the risk, under $2.00 is buying territory for that company.
• If you trade internationally, you'll want to take a look at NOVOZYMES (CPH: NZYM). This Danish company is to the cellulosic ethanol industry what Vestas (CPH: VWS) is to the wind industry. . . a juggernaut.
• Many of the other emerging leaders in cellulosic production (meaning they own the production assets and license the enzymes) are privately held. Those companies include Iogen, Coskata, Range Fuels, POET, Mascoma, ZeaChem, American Energy Enterprises, KL Process Design Group, and SunEthanol.
• If you're interested in a non-pure play, Dupont (NYSE: DD) has established a joint venture with Danisco (CPH: DCO) subsidiary Genencor to invest $210 million over the next three years to commercialize cellulosic ethanol.
• Abengoa (MCE: ABG), a Spanish company, has built a pilot plant in Nebraska and has a $300 million plan to build a commercial facility in Kansas.
• For another risky play, check out Cleantech Biofuels (OTCBB: CLTH), which is working with Hazen Research to start building the precommercial stages of a solid waste-to-ethanol project facility in Golden, Colorado.
• Lastly, SunOpta (NASDAQ: STKL) has been rebounding nicely after some rough times earlier this year. Though a small part of its business, SunOpta provides a pretreatment technology called "steam explosion" that allows cellulose to be more easily converted into sugars. Their process was used in each of the first three demonstration plants worldwide.

Indeed, investing in cellulosic ethanol is a wait-and-see game right now. It's probably worth picking up shares of companies involved on the enzyme side of things before venturing into the producers.

Ultimately, it could be an established corn-based ethanol company like VeraSun or Pacific Ethanol, that licenses enzymes and retools their current facilities, which emerges as the winner.

One thing's for sure. If there is ever solid news from one of these companies, or the investment climate improves, the Alternative Energy Speculator will be all over it. Check it out—the worst you can do is walk away with a free book.

Call it like you see it,

Nick