ADM's Biodiesel Bet

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With gasoline prices in the stratosphere, industrialized economies' petroleum dependence has been brought into sharp focus. There are plenty of companies out there offering answers to stemming the oil addiction, including Headwaters (NYSE: HW) with its coal-based fuel technology and Energy Conversion Devices (Nasdaq: ENER) with its solar cells. Now, Archer Daniels Midland (NYSE: ADM) is gearing up with its own response to the dilemma. If recent trends hold up, the company's solution should gain traction.

ADM, a major processor of agricultural commodities, announced on Tuesday that it will build its first fully owned biodiesel production facility in the U.S. The site, which will primarily use canola oil as an input, will have the capacity to produce 50 million gallons of biodiesel annually. To put the significance of that new capacity in perspective, it's estimated that just 30 million gallons of biodiesel were sold in the U.S. last year.

Things seem to be aligning, though, to justify growth in biodiesel production. Indeed, usage of the fuel, which is typically blended with conventional "petrodiesel" and operates with conventional diesel engines, has already risen impressively, from just 500,000 gallons in 1999. Admittedly, much of the increased use is probably driven more by government initiatives rather than free-market economics. But the price difference between biodiesel and petrodiesel is not enormous; when oil prices spiked in the wake of Katrina, biodiesel was briefly cheaper than petrodiesel.

Government intervention should play a role in raising biodiesel demand. The energy bill passed in July extended an existing tax incentive for biodiesel. Further, the Environmental Protection Agency will put new rules in place requiring refiners to reduce sulfur content in diesel fuel beginning next year. Biodiesel is nearly sulfur-free, so it might become a standard fuel additive.

Like other alternatives to petroleum, biodiesel is not without its defects. It's still more expensive than conventional fuel, and burning biodiesel releases nitrous oxide, a contributor to smog. But European economies have been safely using huge amounts of biodiesel in their diesel cars and trucks for years. With companies like DaimlerChrysler (NYSE: DCX) and Volkswagen reintroducing diesel cars and trucks into the U.S., more of us could be filling up with biodiesel. And that's good news for ADM.

Get more biodiesel Foolishness here:

• An Alternative Energy Triple Play
• Heads-Up for Headwaters

Fool contributor Brian Gorman is a freelance writer in Chicago. He does not own shares of any companies mentioned in this article