Rick Wilson, CEO of Cobalt Technologies, opened a tiny vial of clear liquid, and a slightly sweet, alcohol scent wafted forth. It didn't smell even remotely like jet fuel, which it was.

Wilson opened another small vial of straw-colored liquid. This one had a "nose" of pine pitch. When it burns, this biodiesel fuel does not even remotely resemble the noxious black smoke that belches from semi trucks and buses, Wilson said.

"It's the future of the smells of fuels," he said.

Cobalt Technologies of Mountain View is one of a handful of Silicon Valley companies carving out a niche in the alternative-fuels race.

The industry might have been dismissed as alchemy in the 1960s, when oil was cheap and plentiful and a gallon of regular gasoline cost 31 cents. But with rising gas prices and concerns about Middle East instability, biofuel is poised to offer at least a partial solution to the energy problem, industry leaders said.

Bay Area companies are developing a new generation of biologically based fuels along with the infrastructure to deliver them to the gas tank.

Commercial production of some fuels could start in the next few years, industry leaders said.

But they also cautioned that biofuels won't be a panacea. It will take all manner of alternatives to match oil demands, they said.

The industry also faces many challenges: scaling up and finding enough land and/or renewable resources to produce the "feedstocks" needed to create the fuel; finding a high enough price point to attract investors yet not so high as to render the fuel price noncompetitive.

And while Silicon Valley might be the place where the innovation takes place, keeping the industry here amid the high costs of housing and lifestyle could also be a challenge, Wilson said.

Cobalt and others are hedging their bets. In addition to fuels, companies are also developing other products, such as biochemicals. Those products have higher price points that could create economic stability for the companies long before any big investments in biofuel production take place, Wilson said.

"This is a little company. Why take a molecule and turn it into $2 for fuels when you can turn it into a $5 chemical?" he said.

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Cobalt has chosen to launch into biofuels through the high-end market. Aviation fuel brings a higher price upward of $123 a barrel, according to the International Air Transportation Association. Cobalt plans to build an intermediate-sized, 470,000-gallon biofuel production plant, he said.

The company has partnered with the U.S. Navy at China Lake, Calif., to test its biojet fuel in aircraft. Biofuel could offer supply security for the military; production plants could be located at bases, he said.

Cobalt takes wood materials and turns them into an alcohol-based fuel called butanol or butyl-alcohol.

First, the mass of plants is treated to make its sugars digestible by bacteria. The digestible material then goes through fermentation, and the byproduct is an alcohol-based fuel.

In Cobalt's labs, steel tanks fitted with a tangle of tubes, pipes and valves hold the precious liquid made from digested plant mass, called lignocellulose, and sugars that microbes have broken down.

Wilson calls butanol "the magic molecule." It is used in everything from cosmetics to paint coatings, and it can be blended into gasoline to make a "flex fuel," he said.

As a fuel source, bio-based butanol biobutanol offers an energy density (i.e., amount of stored energy per volume) that is similar to petroleum-based aviation fuel. But it also produces 70 to 80 percent less pollution than petroleum-based jet fuel, Wilson said.

Wilson isn't envisioning biobutanol as a gasoline substitute any time soon.

"I question if there's going to be a biogasoline," he said, citing challenges to the chemistry, but points to jet fuel and biodiesel.

Biodiesel, another of his company's products, can directly fuel existing diesel engines with no modifications, he said.

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Another biofuel that industry professionals say shows promise is known as cellulosic ethanol, or ethanol produced from non-food plant materials.

Palo Alto's Genencor has developed microbes to aid in making ethanol (an alcohol that is found in alcoholic beverages) from plant materials such as corn stalks, rice-plant stems and high-yielding grasses such as switchgrass.

Enzyme production, which is Genencor's focus, could be a $3-billion-a-year industry, Aaron Kelley, biofuels director of business development, said.

Genencor is working with DuPont, a company poised to buy Genencor's parent company. The two companies currently have a partnership to license the ethanol-production process to biorefineries.

In Genencor's immaculate metal-and-glass Page Mill Road research facility, a variety of feedstocks, from rice stalks to grasses to wood, are preprocessed and pretreated with steam and ammonia.

Enzymes in the bacteria saccharify that is, break down the materials into sugars, which are fermented and digested. Ethanol is recovered and dehydrated to create fuel-grade ethanol, according to the company.

Those are the bones of cellulosic ethanol production, but the company has gone through several iterations of enzyme technology to get costs down. Accellerase Duet, its latest product, unlocks the energy stored in the plant materials more thoroughly and affordably and can digest many different kinds of feedstocks, Kelley said.

"Each time, we've lowered the cost by one half," Kelley said.

Kelley sees cellulosic ethanol as eventually becoming competitive with gasoline and starch-based ethanol, which comes from corn and sugar cane. As the technology becomes more efficient, cellulosic ethanol could go as low as $2.50 a gallon, he said.

"The price of corn is going crazy now. Biomass (from the other sources such as grasses and wood) is expected to be cheaper," he said.

Today's price for biomass can be $50 to $100 per ton, compared with $160 per ton for corn. Eventually, the prices are expected to be half of corn, he said.

One drawback to ethanol is that its energy density is about 70 to 80 percent of gasoline's. Vehicles get fewer miles per gallon, he said. But higher oil prices will still make ethanol competitive; and some automakers are working on more efficient engines that recover the lost energy, Kelley said.

Cellulosic ethanol is also "cleaner." It produces 80 to 90 percent less carbon dioxide than gas and oil, he said.

Using materials that are essentially thought of as somebody else's trash and situating biorefineries near fields and plants where solid waste, paper mills and lumber mills are located could also cut costs, including transportation, he said.

Ironically, the country could have been decades ahead in cellulosic technology and perhaps biofuel production if it weren't for cheap oil, according to Kelley.

"The foundations for cellulosic processes started in the 1970s after the oil embargo. The oil prices came down and then research was shelved for 20 years," he said.

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Vinod Khosla, a Menlo Park venture capitalist and well-known investor in biofuels, wrote in a Jan. 19 post on the Greentech Media website that "cellulosic and sugar-derived fuels offer one of the lowest risk advances to quickly and affordably achieve low-cost transportation."

The driver for biofuels production was the U.S. Energy Policy Act of 2005 Renewable Fuel Standard, which required increasing volumes of ethanol and biodiesel to be blended with fuel between 2006 and 2012.

The Energy Independence and Security Act of 2007 required 9 billion gallons of renewable fuel use in 2008, increasing to 36 billion gallons by 2022.

The new standard caps starch-based ethanol production at 15 billion gallons by 2015 about 13 billion gallons are currently being produced, according to the American Coalition for Ethanol.

By 2022, 21 billion of the 36 billion gallons must be derived from biofuel such as cellulosic and non-corn-based ethanol.

"That's a very, very big number," Kelley said.

Ironically, the low price that would make biofuels competitive with oil and desirable for consumers could turn off some investors, Wilson said.

David Horning, an analyst for Palo Alto Investors, a stock-investment firm, said that he has not invested in biofuels, even though "it's a space I follow. There have been some IPOs in the last six months."

Palo Alto Investors has backed only one green-fuel-related company with venture capital: Fisker Automotive, a plug-in hybrid automaker in Anaheim, Calif., he said. (Fisker is planning on moving to Palo Alto this fall.)

Horning is still concerned about the ability to scale up to commercial production and the return on the capital of expansion.

"I'm a little less bullish than other investors out there. ... The operating losses are very, very large. I don't know how quickly they'll be able to come down the cost curve. Biorefineries are very expensive plants. The costs are well north of $6 to $8 a gallon to build," he said.

Wilson said the money to scale up must come from many sources, and venture capital can't do it all. It will take partnerships with business and government.

Some tax credits and federal financing are helping.

A special depreciation allowance allows a 50 percent depreciation deduction of a new cellulosic ethanol plant in the year it is put in service. Any enzymatic cellulosic plant acquired after Dec. 20, 2006, and operational before Jan.1, 2013, qualifies. The provision is effective through Dec. 31, 2012.

The Department of Energy announced it would give $80 million in 2010 for numerous biofuel projects and plant development, including through its Biomass Program.

In January, the U.S. Department of Agriculture and the Department of Energy announced $646 million in advanced-biofuels loan guarantees to four companies.

Horning said the transition will take a long time, and it won't be on the scale that Silicon Valley is used to.

"People tend to make connections with tech. The timescale for tech is in months. But the energy-tech time scale is in years and decades," he said.

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