Last February, Royal Dutch Shell plc (NYSE:RDS-A) and Brazil’s Cosan Ltd. (NYSE:CZZ) signed an agreement to create a joint venture to distribute and sell cane ethanol in Brazil. The two companies have now ironed out the details and have announced a binding agreement for the $12 billion venture. The deal still requires regulatory approval.

Under the terms disclosed today, Shell will contribute about $1.6 billion in cash, about 2,740 retail outlets and other downstream assets, its 14.7% interest in US biocatalyst firm Codexis, Inc. (NASDAQ:CDXS), and its 50% share interest in Canadian biofuel maker Iogen Energy.

Cosan’s stake in the joint venture includes its 23 cane crushing mills, annual ethanol production capacity of about 2 billion litres, its electricity cogeneration plants, about 1,730 retail sites and other downstream and logistics assets, and debt amounting to about $2.8 billion.

The joint venture, which has no name as yet, will be one of the world’s largest ethanol producers, trailing behind Archer Daniels Midland Co. (NYSE:ADM), which produces about 1.8 billion gallons, and Valero Energy Inc. (NYSE:VLO), which produces about 1.1 billion gallons. Initially the cane ethanol will be sold in Brazil, but the partners plan to “explore business opportunities to produce and sell ethanol and sugar globally.”

Pacific Ethanol, Inc. (PEIX) is acting as though it is the indirect winner here.  Shares are up some 8% today and the average volume of 1.8 million shares has already been hit.

Shell has now made a major commitment to cane ethanol in particular and biofuels in general as perhaps the most viable commercial-scale products to lower carbon emissions from transportation fuels. Cane ethanol is less costly to distill than corn ethanol and the cane stalks themselves can be used to generate electricity in the joint venture’s cogeneration plants. The stalks may also be used to make cellulosic ethanol, provided that technology ever proves commercial viability.

Brazil is a good place for Shell to make this move. Virtually every car sold in the country is flex-fuel capable, meaning it can run on pure gasoline or ethanol blends of up to 85% ethanol. The country does not offer any subsidy to the ethanol industry and a gallon of ethanol is still cheaper than a gallon of gasoline by about a dollar. In the US, corn ethanol gets a $0.45/gallon subsidy and still costs only about a dime less than gasoline.

Shell shares are down slightly this morning and Cosan ADRs are up about 1%.

Paul Ausick

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