As tensions in the Middle East, rebounding economic growth and rising demand have all pushed up the cost of a barrel of oil, it's getting more expensive to fill up our tanks. Funds like the PowerShares DB Oil (ARCA:DBO) have rallied over the last few weeks as investors have looked for ways to profit from the tensions and soaring global demand. These escalating petroleum prices have also led to renewed interest in biofuels. However, while traditional corn ethanol has provoked an intense backlash from both policy makers and the public, second-generation biofuels made from plant wastes or non-food crops, are quickly gaining acceptance. For investors, looking towards these cellulosic producers might be the best way to play the up-coming biofuel boom.

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Getting to Commercial Production
The fact that crude oil prices are above $100 a barrel is certainly supporting demand for alternative biofuel sources for cars, trucks and other transportation uses. However, while corn-based ethanol continues to have its detractors, those firms working on using wood scraps, yard trimmings and switch grass are catching their second wind. These cellulosic producers hope to overcome one of corn ethanol's major problems: using food for fuel. Currently around 40% of the U.S. corn crop goes into making ethanol and analysts estimate that ethanol demand pushes up prices by 20% per bushel.

According to the Environmental Protection Agency, the U.S. currently produces no commercial amounts of cellulosic biofuels. However, times may be changing. Several start-ups and advances are currently underway that could turn the tide. Privately held, Virdia recently received about $230 million in loans and tax incentives to build a commercial scale cellulosic biofuel plant in Mississippi. The facility will convert wood chips into sugar that can then be used to produce transportation fuel. Likewise, ethanol giant POET recently broke ground on a new $250 million facility designed to use left-over corn stalks and cobs. Using enzymes, POET plans to produce about 25 million gallons of cellulosic ethanol a year and could be the first commercial plant in the country. Du Pont (NYSE:DD) will break ground on a similar facility later this year.

The long term outlook for advanced biofuels is quite bullish. The 2007 Energy Security and Independence Act mandated the use of 36 billion gallons of biofuels annually by 2022. Of which about 16 billion gallons are to be produced from lighter environmentally foot-printed advanced feed stocks, such as cellulosic ethanol or algae. Globally, biofuel requirements call for at least 72 billion gallons by 2021. However, many of the stocks within the cellulosic sector are trading for their IPO values. This gives investors an opportunity to pick up some bargains in the high tech sector.

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How to Play Cellulosic Superstars
Given the long-term opportunities in the advanced biofuel sector, investors may want to add some exposure. Currently, there is no dedicated biofuels-based exchange traded fund. Broad measures like the Market Vectors Global Alternative Energy ETF (ARCA:GEX) do provide some exposure, but it's negligible. For those wanting cellulosic fuels, direct digging is required.

Partnering with oil giant Total (NYSE:TOT), Gevo (Nasdaq:GEVO) is planning to make another type of post-ethanol fuel: bio-butanol. By retrofitting existing ethanol plants and companies goal is to produce about 2 billion liters of butanol by 2014 annually. Shares of the firm have been steadily rising as announced that the U.S. Patent and Trademark Office would be reexamining a patent of rival BP (NYSE:BP) and DuPont joint venture, Butamax Advanced Biofuels. Also partnering with Total, is genetically engineered yeast fuel maker, Amyris (Nasdaq:AMRS).

Investors may also be interested in Solazyme (Nasdaq:SZYM). The company plans on producing algae based fuel by using a propriety process that speeds up fermentation times and scale. The company has partnered with the U.S. Department of Defense and recently powered a Navy ships voyage. The partnership should continue to bear fruit for the biofuel maker.

The Bottom Line
As oil has risen, biofuels are once again getting some investor attention. However, while corn-based ethanol continues to disappoint, the advanced cellulosic producers are finally turning the corner. For investors, these firms offer the best long term prospects. The previous firms, along with wood waste-based producer KiOR (Nasdaq:KIOR), make ideal choices.

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At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.

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Tickers in this Article: DBO, GEX, TOT, DD, BP, GEVO, KIOR, AMRS, SZYM

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