New Frontiers

Pongamia

Anyone who is a student of business understands the difference between an efficient and inefficient market. In an efficient market, most of the information has been discovered and equilibrium exists between buyers and seller. Volatility decreases and prices flatten out. The early, smart buyers who spotted the opportunity made the lion’s share of the “easy” money before the rest of the population rushed in and bid up prices. The early buyers often sell to the latter group.

Midwest farmland is a good example. Buyers with foresight who entered 5-10 years ago before farmland investing became the hot asset class have the double-digit total returns to crow about. Occasionally there is a news story about an exorbitant price paid for acreage, and talk of a bubble is in vogue - but those bubble stories are the exceptions. For the most part, prices have been bid up to the point where cap rates have dipped to the 3% range or less on the better farmland. New buyers entering in this area will receive an acceptable cash flow on a solid underlying asset - and that’s fine. They will never get killed on investing like this. No farmland will ever go to zero like the “blue chips” Lehman Brothers or (the old) General Motors did.

Today, investors looking for higher returns are searching for less-than-Class A soils in other states where cap rates can be closer to the upper 4%-to-low-5% range. This is marginally better - and that’s fine too. But for investors looking to allocate part of their portfolio to seek out higher returns in agriculture, there is an interesting opportunity for very strong double digit returns that has grabbed my interest as a farmland broker and investor.

This opportunity spans the long-term themes of fuel, feed, and fertilizer. It also minimizes several of the problematic challenges to modern agricultural operations such as expensive irrigation, and escalating fertilizer and fuel input costs. This opportunity is about growing a hardy, drought resistant pongamia tree for biodiesel. It produces nuts with a high oil content that are crushed for biodiesel. These trees yield a harvest worth many times more than the best row crop and best of all; they can grow on cheap land.

They begin to produce around their nuts around year 4 and level out around year 8-10 and will then produce for over 50 years. The nuts are harvested with mechanized “nut shakers” (as used on almonds or pecans) and then crushed with low-tech crushing machinery (as used for soybeans). At maturity, they should have annual yields well in excess of 400-500 gallons per acre of an oil that is a high of a grade as soybean oil. The tree is a legume so it fixes nitrogen in the soil rather than consuming it. Also, because it is a legume, after crushing, everything left over (seedcake) could be processed as a high-protein animal feed, or a high-nitrogen fertilizer. Pongamia is already certified for carbon credits so one could monetize that number that as well.

The tree is very pest-resistant and the leaves are bitter so cattle and deer avoid them. Once established, the tree has a 30’ tap root so it is not only drought resistant but it does not need all the irrigation costs and issues associated with citrus and other nut crops like almonds or pecans. There is no shortage of information on this tree. Just Google: “pongamia biodiesel”. Most currently, the Asian Development Bank just completed an exhaustive study that spoke glowingly of the economic viability of pongamia as a biofuel.

The other parts of the story are the soils and geography. The (native) tree grows gloriously on marginal land, so it does not necessarily have to compete with arable farmland. It is frost-resistant, but young seedlings are not freeze-proof. Nevertheless, certain practices can minimize the dangers from an unexpected freeze in the tree's early years. In the US, this narrows the field to land along the coastal bend of Texas, the southern half Florida, and Hawaii.

But this is where it gets interesting.

We already know these trees grow in the hot, humid climates in the US. Pongamia trees have been growing in Florida for almost 100 years as ornamentals, but they drove people crazy from all the nuts they dropped! Are there opportunities in Florida? The state has over 400,000 acres of abandoned and diseased citrus acreage that are in search of an alternate crop like pongamia.

Texas land, however, is exceptionally inexpensive if you are going to grow a crop that will cash flow like pongamia. One situation that intrigues me the most is that non-irrigated farmland along the coastal bend of Texas sells for, say, $1900/ac. This is a very rough approximation. In this area it is not uncommon to see non-irrigated corn yields of less than 70 bu - in a good year. And with two anomalous droughts within the last three years, the crops have been a disaster. Milo and cotton have not fared much better. Rice farmers in this area are worried about having their irrigation allotments curtailed in coming years as more and more demands are being put on the river systems. With these soils, yields, and water issues, the coastal bend of Texas is not high on the list of many farmland investors.

Additionally, there are hundreds of thousands of even lower cost acres of decent, marginal, and degraded pasture land throughout this area where pongamia would grow wonderfully. Grazing is not a primary income source for the majority of these acres are owned/retained for the oil and gas mineral rights that lie under the soil (but almost never are sold with the land). Of course, there are no base acres associated with pasture land, but as it affects the business model of growing these trees, it makes little difference. And finally, the Texas coastal bend is blessed with an extensive infrastructure, of rail, highways, ocean ports, and under-utilized biofuel refineries hungry for additional feedstocks.

The opportunity that I see for farmland investors seeking higher – albeit more speculative – returns is to purchase this low cost acreage as they come up for sale and scale in acreage of pongamia trees. What’s the worst-case downside if these trees are a complete bust: An investor still has the value of the land for traditional its traditional agricultural uses. Upside estimates that I have seen in a relatively conservative pro forma analysis estimate over a 30% 8-year IRR on this strategy! Since annual income is sharply higher, the land should appreciate 3x or 4x in a relatively short period of time as cap rates adjust. An investor will have a long-lived tree crop with only a fraction of the annual input costs of row crops, no irrigation worries, and a market with an insatiable appetite for your oil that stretches into the foreseeable future.

Orchard crops have some of the highest returns per acre of any agricultural products because they take longer to establish but their annual output is worth so much more. Check out the prices for citrus or pecan acreage and you will see prices ranging from $7500/acre to over $15,000; tree plantations are some of the highest value agricultural property that exists. This is not a strategy for everyone, but the more research an investor does on the demand side of renewable fuels, the characteristics of these hardy pongamia trees and today’s farmland market, the more attractive this niche will look. Farmers and farmland investors alike both understand that there are risks in growing any crop under the sun. However, of all the investment opportunities have in today’s world, I love the risk/reward profile on this. What are the alternatives out there: CD’s at ½%, long-term bonds at 2.9%, commercial real estate, or a volatile stock market (how has that done for you in the past 10 years?). Since the 2008 market crash, smart money has been migrating to stores of value in hard assets like gold, silver, copper, and other metals that are becoming increasingly rare and dear. And of course as we all know, production agricultural land is one such asset (albeit less liquid) in finite supply that does the other collectables one better - it cash flows through all economic cycles. It produces an annual income. To make double digit returns in agriculture now, an investor has to think out of the box.

Besides agriculture for food, renewable fuels are here are here to stay and will play an increasingly important role in the years ahead. There are federal laws in places that mandate US fuel refiners blend in increasing annual percentages of renewable fuels in each gallon of gas or diesel we buy. To repeat again for effect, this is the LAW; refiners have to obtain renewable fuels to blend. That ethanol blend you put in your car every time you buy gas is there - by law. The Department of Defense also has surprisingly aggressive mandates to purchase renewable fuels and will eagerly enter into long-term contracts to procure supplies.

Terviva BioEnergy LLC is the only company  aware of that is working with pongamia in the US. In 2011 they planted approximately 30,000 trees on plantations in Texas. For more information on this entire subject, we urge you to do your own research or feel free to call here at 877-278-9003, or email us.