Solazyme Looks Promising On Growing Supply And Demand

With a recent string of accomplished records coming out of advanced biofuel-maker Solazyme (SZYM), investors following the San Francisco-based company are sure to be pleased with the deepening relationships that are being formed with partner organizations. As a green renewable oil company, Solazyme is arguably the most prominent leader in the field of algae-derived oils. Its products can perform in a wide range of purposes that span from use as the base material for heart-healthy foods, the manufacturing of innovative cosmetics, and even the flying of military aircraft.

Now coming up on one year since its initial public offering, Solazyme's progress in building relationships has been trackable by the headlines the company has been making. As the budding company begins to expand its relationships and put steel into the ground to build up its production capacity to a commercial scale, such ongoing news should offer encouragement to investors. For each progressive test that serves as validation of the company's products, there is growing demand that the supply capacity will one day address. Some of the progressive events were as follows:

• In June 2011, Solazyme was the first company to have its algal-based jet fuel flown on a military aircraft as the U.S. Navy flew a MH-60S Seahawk helicopter test flight. The refining partner was Honeywell UOP (HON) which has been working with the company since 2009.
• In November 2011, the U.S Navy launched its largest alternative fuel test to date with a 20,000 gallon test of Solazyme's algae-based fuel into a destroyer ship named the Paul H. Foster. The destroyer sailed on a 20-hour trip alongside the California coast.
• In December 2011, the U.S. Navy set the fastest speed record achieved to date by a Navy surface craft while using a biofuel blend as LCAC 91 reached a speed of 50 knots on Solazyme's 50/50 biofuel and petroleum fuel blend.
• Last week on January 23, the company announced the successful 1-month testing of its 100% algal fuel aboard a Maersk Line container ship more than 300-meters long, a test sponsored by the U.S. Navy. With a 6,500 nautical mile journey from Northern Europe to India, the ship burned about 30 tons of Solazyme's renewable fuel.

For those seeing the pattern, the deepening relationship with the U.S. Navy, amongst others, is beginning to show off its real potential. On December 5, 2011, the Navy announced an order for 450,000 gallons of biofuel, the largest order to date for $12 million. In this awarded contract, Solazyme partnered with Dynamic Fuels, a joint venture between Syntroleum (SYNM) and Tyson (TSN). Solazyme will be responsible for 100,000 gallons of jet biofuel.

Future rewards appear promising, as a looming investment of $510 million by the U.S. Department of Energy and Agriculture, and the U.S. Navy dangles above the heads of advanced biofuel makers. The investment by the three agencies will help spur the construction of U.S. plants to produce biofuels that can be used with existing infrastructure. With growing relations with the U.S. Navy, Solazyme appears well-positioned to receive some of these funds. This is even more likely as one of the requisites of the award is that companies provide half the capital along with the government, a task made most feasible by companies that have recently had an IPO to raise capital.

But even as Solazyme deepens its relationship with the U.S. Navy, the private community has not failed to take note of Solazyme's growing success. United Continental Holdings (UAL) recently flew the first U.S. domestic commercial jet to run on biofuel using Solazyme's blend back in November 2011. United Continental subsequently released an announcement stating its willingness to buy 20 million gallons per year from Solazyme. Chevron (CVX) continues to be a funding partner with Solazyme stretching back to 2008. In 2010, Solazyme also initiated its ongoing working relations with Ecopetrol (EC). Additionally, Bunge (BG) and private company Roquette Frères have both signed agreements that allow for the construction of joint venture production facilities. Roquette is even footing the entire bill for the construction and working capital necessary for the 50,000 metric ton facility made for Solazyme-Roquette Nutritionals, the joint venture between the two companies. This site is expected to yield 55 million liters of renewable oils annually.

And in this task of building up production capacity lies the key to the widespread adoption of the company's products. Solazyme has repeatedly cited its expectations that it can yield gross margins of 30-60% for its fuels segment once operating on a commercial scale. In its other initial markets for food, chemicals, and cosmetics, margins appear to be even more generous.

When compared against the price of oil, Solazyme expects to create tailored oil barrels valued at $200-600/barrel once operating at a commercial scale. Such numbers serve as an attractive value proposition that contrasts against fears of an unsustainable industy were oil prices to fall. A large part of this gaping number lies in the often overlooked concept that a barrel of petroleum consists of many parts of varying value. There are valuable cuts of that barrel that include portions used for plasticizers, lubricants, and diesel, and there are less valuable portions used for asphalt, tar, and etc. What Solazyme is able to uniquely do through its bioengineering process is to create barrels of tailored oil that yield more than 80% of the most valuable cuts of a typical barrel of oil.

With such developing relationships with key partners that can take the company to the next level, Solazyme's promising technology appears poised for widespread adoption in the coming years. The company appears more than capable to compete alongside its industry peers. And as the company focuses on ramping up its production capacity, it already has initial agreements in place to tentatively hit 90% of its goal to create 550,000 metric tons of manufacturing capability by 2015. It would seem that investors with a long-term outlook on their shoulders would fair well in keeping this particular renewable oils company on their active radars.

Disclosure: I am long SZYM, BG.