From the outside, the rustic red-brick mill on a bend in Maine's Penobscot River resembles any other struggling American pulp and paper mill.

But along with its usual business of pulp-making, the century-old mill is doing something unprecedented: Developing technology to produce bio-butanol, a jet fuel, from parts of trees that would otherwise go to waste, one of the world's first to do so.

Production is still two years away, but the reinvention of Maine's Old Town Fuel & Fiber mill is already drawing interest as a potential model for a new wave of biofuel companies that could slash dependence on oil, create jobs and reduce the emissions that lead to global warming.

Loggers, a fading way of life in rugged northern United States and Canada, see the mill as a lifeline for their crippled industry. Environmentalists see it as a test of the Obama administration's push for a big expansion in biofuels.

And chemical and oil companies are waiting to see if the mill can do what none has done before by extracting sugars from wood chips into a biofuel that many regard as more efficient than corn-based ethanol as a possible substitute for gasoline.

There has been a lot of interested parties in what we are doing here, said Old Town's president, Dick Arnold. There have been several oil companies that have been interested in our extract and production of biofuels. There has been a number of chemical companies that have expressed the same desire.

Like its once-mighty peers, Old Maine's mill has suffered in recent years from declining pulp prices and loss of market share to Chinese and Latin American rivals. Georgia-Pacific Llc[KCHINP.UL], the maker of Quilted Northern bathroom tissue, shut it in May 2006, laying off all 400 workers. A group of investors known as Red Shield bought it a few months later.

Red Shield won a $30 million grant from the U.S. Department of Energy to work with the nearby University of Maine on a pilot ethanol production plant, but they ran out of cash and filed for bankruptcy last year, shutting the plant again.

Enter Lynn Tilton, a New York venture capitalist who owns one of the nation's largest helicopter makers. Tilton's Patriarch Partners bought the mill in November, invested about $40 million and shifted its focus to cellulosic bio-butanol.

ALTERNATIVE TO ETHANOL

Tilton can use bio-butanol in her own helicopter and aircraft businesses but is eyeing a potentially huge market after Congress decreed that the United States must use 21 billion gallons of advanced biofuels such as cellulosic ethanols, bio-butanol and green gasoline a year by 2022.

Whether the technology takes off comes down to cost -- and to corn. For much of the last decade, federal officials have touted the potential of corn ethanol as the best substitute for gasoline, but critics question that assumption, noting it corrodes pipelines and raises food prices.

Bio-butanol, a relative of ethanol, is less corrosive and easier to mix with gasoline. Unlike ethanol, it can be transported by pipeline. And its energy content is about 30 percent higher than ethanol's. If regulations allow, it could be pumped into a fuel tank with no changes to a car engine.

Butanol is also sometimes used as a petrochemical in brake fluids, paint thinners and plastics. Its supporters include chemicals maker DuPont Co (DD.N: Quote, Profile, Research, Stock Buzz) and oil giant BP Plc (BP.L: Quote, Profile, Research, Stock Buzz), which have formed a joint venture to make bio-butanol.

It's really comparable to gasoline, said Mark Bunger, a biofuels analyst at Lux Research, a Boston consulting firm specializing in emerging technologies. The issue has been that ethanol is easier to make, it's just not easier to use. Butanol doesn't have those same restrictions.

For a lot of chemical reasons, it's a good alternative. If you're a venture capital company and you said you are going to be making ethanol, I would say, 'Do you have another idea?'. But if they are really focusing on butanol, that is a smart move.

He cautioned, however, that it remains unclear if bio-butanol can compete on cost with oil or substitutes like ethanol without government subsidies. A lot more research and technical development is needed to make it cost competitive.

OBAMA FACTOR

Other companies are trying, such as startups Tetravitae Bioscience in Chicago and Cobalt Biofuels in Mountain View, California. But Old Town is the first to do so with a fully functioning timber mill that already generates cash flow by selling traditional pulp to paper companies.

Bio-butanol will be derived from wood that would have gone to waste in pulp production, or have been left on the forest floor as unusable by loggers.

I wouldn't go deep into a hole without the ability to generate cash flow on what we do now, Tilton said. That is the beauty of this. We are not building a start up facility to create ethanol where you are out $300 million before you start creating any kind of cash flow.

Already the plant has put in place a system for extracting sugars from the wood and expect by year end to start construction of a biorefinery to turn it into butanol. She expects the mill will need another $75 million to meet its target of producing butanol in two years.

Some of that will come from the Department of Energy and some we will invest. And how that return on investment will be garnered will be deeply dependent on government demands, pricing for the product as well as our ability to take this technology and roll it out across other platforms.

A big factor, she said, is the Obama administration's push for renewable energy through tax breaks, loan guarantees and millions of dollars in grants, with more support expected in upcoming energy bills.

If one believed that ultimately this would peter out and green energy would become less of a focus going forward, this would be a very risky investment because truthfully pricing will be dependent on supply and demand. If it is not forced as a mandate, then I think the pricing won't be there, she said.

To that end, the mill is on track, said Arnold. Two towering vessels, each 100-feet (30-metres) high, extract sugar from wood chips that will eventually make butanol, while also maintaining the traditional process of extracting fiber from wood to create sheets of dried pulp to sell.

That $30 million award from the government will help us finance the building of the balance of the biorefinery, he said. We believe that in the next two years we will have an operating biorefinery at the mill.

Initial volumes will be small, about 1.5 million gallons of bio-butanol a year produced from 80 dry tons of wood. But we believe this technology can be replicated. And there are a lot of assets out there in terms of pulp and paper mills that are suffering that could be used for expansion, Arnold said.

(Editing by Cynthia Osterman)

Canada Energy