Ethanol Article

[FC]

Ethanol: Should You Invest?

 

Our take on the budding ethanol industry.

 

 

 

by Scott Burns | 05-19-06 | 06:00 AM | E-mail Article | Print Article | Permissions/Reprints

 

Investors have been scrambling lately to find the next "new" thing to ride the wave to riches in the energy sector. In this scramble, ethanol has been touted as one alternative fuel that could help rid the U.S. once and for all of its dependence on foreign oil.

 

 

This feverish speculation has helped drive stock prices for companies such as Archer Daniels Midland ADM, Deere DE, and AGCO AG through the roof as of late. Even seed producer Monsanto MON felt the need to remind investors that it has exposure to the ethanol market on a recent call. Given all the attention ethanol is getting in the headlines and in the stock market, we figured that now would be as good a time as any to throw our two cents in on the topic. In short, our position is that while the shift from using methyl tertiary-butyl ether (MTBE) to ethanol as a gas additive will certainly improve near-term ethanol production, there is still much to be done if ethanol is to prove itself a long-term solution.

 

There is no arguing that ethanol consumption in the U.S. will increase. The first driver is petroleum companies' decision to remove MTBE from their gasoline in response to state bans and liability exposure from water-contamination issues. The Energy Information Administration estimates that this will immediately increase our ethanol demand to over 400,000 barrels per day (or 6.1 billion gallons per year). In contrast, the U.S. ethanol industry produced 255,000 barrels per day (or 3.9 billion gallons per year) in 2005.

 

The second driver is the Renewable Fuels Standard (RFS) of the Energy Policy Act of 2005, which requires the production and use of 4 billion gallons of renewable fuels in 2006, increasing to 7.5 billion gallons in 2012. Both ethanol and biodiesel are considered to be renewable fuels, although biodiesel production is minuscule compared to ethanol production. Assuming that the RFS sets the floor for ethanol consumption, we can project that consumption will grow by about 3% to 4%, compounded annually, between 2006 and 2012. And that's on the back of the 60% increase in consumption that we should see in 2006 due to the MTBE phaseout.

 

On a long-term basis, though, the debate regarding the viability of ethanol as a substitute remains unresolved. David Pimentel, a professor at Cornell University's College of Agriculture and Life Sciences, has argued that more energy is used to produce a gallon of ethanol than the energy contained in a gallon of ethanol. Proponents of ethanol would be well advised to consider the entire production cycle and cost of ethanol when considering its economic merits. There is no ignoring the amount of energy implicitly used in planting, irrigating, fertilizing, harvesting, transporting, baking, and distilling any crop to make ethanol. The problem is both cumulative and circular. Cumulative because of all the energy consuming steps and circular because as you increase ethanol production, you increase the use of fossil fuels--especially natural gas--theoretically causing fossil fuel and, thus, ethanol costs to rise.

 

Of course, there have also been many scientific studies arguing that ethanol has a positive net energy balance. Hosein Shapouri, an economist at the U.S. Department of Agriculture, has supported this side of the argument, and scientists have been busy working on improving the efficiency of the process. Additionally, there is merit to the less-tangible value that would be created by weaning America off its foreign energy dependence that could help close the cost gap.

 

We do not yet know who is right on this issue. But it seems to us that the net-energy-balance question will need to be resolved before the U.S. can even consider ethanol as a long-term substitute for petroleum.

 

Once the energy question is resolved, proponents of ethanol can shift their attention to tackling the need for the massive infrastructure spending that will be required to support the shift from gasoline to ethanol. As a starting point to that discussion, we need to look no further than the difficulties the industry is encountering in trying to meet the current MTBE phaseout and the RFS. Ethanol can't be transported or stored along with regular gasoline until the last step in the distribution chain. Plus, ethanol-blended gasoline can't be intermingled with other gasolines during the summer. These extra steps mean extra costs, and consumers can expect to see pump prices rise because of the switch--hardly what one would expect from a substitute that is supposed to lower costs.

 

Beyond the obvious short-term infrastructure issues, to meet our long-term needs, we would need to build a new refining, pipeline, and storage system to get the ethanol from the Midwest to the rest of the country. We basically need to recreate what the oil industry has spent the past 100 years building and perfecting. This is no small challenge and shouldn't be taken lightly. In this challenge, there will undoubtedly be numerous investment opportunities and likely an even greater number of pitfalls that investors could fall into.

 

Still, despite all the challenges surrounding a long-term switch to ethanol, we would be remiss if we failed to acknowledge that there is a very powerful ethanol lobby behind this push. At the end of the day, expanding ethanol's use may be more a matter of political will and special interest influence than anything driven by fundamental economics.

 

So while we remain open to the possibility that ethanol is playing and will play a larger role in the world's increased thirst for fuel, we still think that betting on broad use at this time is pure speculation. One way to cure our skepticism would be for a company like Deere to introduce farm equipment that ran on the 85/15 mix of ethanol and gasoline. We can't think of a better way to jump-start ethanol use than to begin converting the equipment fleet closest to the source. Until that time, we'll leave the speculation to others.

 

 

 

[dave h]

I've taken to using Bio Desiel (a mixture of recycled cooking oils & ethanol) & not only is it slightly cheaper & causes better performance ,it is a great lubricant in the motors I use ! I'm also just started buying Petrol (Gasoline ) that is a 90/10 mixture of petrol & ethanol ! Normally the car that I have that runs on petrol has had to have been run on the most expensive Fuel to obtain a high enough Octane level & then a upper cylinder lubricant had to be added as Leaded fuel is no longer avalible! The Bio petrol is of a high enough Octaine level with straight unleaded to be used & it does not need the additive after filling & so I'm saving a fortune ,with the added bonus of increased power & increased fuel economy Great gear ! But I fear that the oil companies are crying wolf over this one !

As for the debate over the amount of fossil fuel being used to make the ethanol ? the companies who distill it over here ,use the Used suger cane that it is extracted from to fire their boilers to produce both the heat & power required to produce the product .

 

Dave

[fritz]

If they use something other than corn or other grain to make the ethanol, fine.

But if they use grain, it will take feed grain from the producers of livestock and poultry. It will increase the cost of grain.

Helpful to the grain farmer, harmful to the livestock and poultry producer.

 

Remember, there will be a price to pay for this conversion.

 

So, do we make fuel cheaper for the gas guzzling SUV's at the expense of higher prices for meat and poultry?

 

Think about it. But if all you think about is cheaper fuel for the SUV's, think twice.

 

"One way to cure our skepticism would be for a company like Deere to introduce farm equipment that ran on the 85/15 mix of ethanol and gasoline. "

 

That would mean making all the diesel farm tractors obsolete, and going back to the gasoline tractors (which have long faded from the scene) and the reason they faded was because they were weaker, less powerful per gallon of fuel used. Powerful yes, at the cost of more fuel.

 

Much easier to convert internal combustion engines to an alternate than it is to convert a cow or chicken to an alternate.

 

Been there, done that.

 

 

fritz

[FC]

Biodiesel is a fascinating concept.

I imagine it's a lot cheaper to make ethanol from something other than corn, if there are no subsidies.

I must be old Fritz. Grandpa used gasoline powered tractors: 36 Deere, Farmall, and an old Case.

[dave h]

Over here Bio diesil is made from used cooking Oil & the Ethanol is made from either Suger cane or canola (this has been a god send to our suger farmers ! )We run both my work truck & all of ourfarm machinery & Plant on the Bio Diesil now! There is a substantial improvement on the econimy & less wear & tear on all of this Plant ! I have never been able to work out how over here they charge approx 10c per litr more for Diesil than Petrol considering that Diesil is a bi product in the distillling of oil in to fuel ! We do get a hefty rebate due to the volume of fuel we buy but the average motorist still pays top dollar !

 

Dave

[Guest Guest_roscoedoh_*]

You can distill ethanol out of just about anything that contain chlorophyll. That means not only can we use grain, but we can also use tree leaves, pine straw, grass clippings, etc. I can see where there may be a short run price increase in grain prices as we begin to produce more and more ethanol to meet the renewable energy demands, but I can also bet that over time, more and more farmers will return to farming to produce more grains as well. Furthermore, I can foresee the petroleum companies investing more in this technology as time passes.

 

The shift away from petroleum will not happen over night and I would assume that industry will implement the necessary changes at the speed the change over happens. I think we'll be able to manage this transition without too much pain.

[fritz]

"Furthermore, I can foresee the petroleum companies investing more in this technology as time passes. "

 

Well, they damned sure should because didn't the GOP give them huge tax breaks in the last two years? Or have I been out of the country all that time?

 

Better to give the farmers tax breaks when the country needs more grain and feedstock for the process of refining the new fuels. Bring back that old word (so rarely heard today) called parity.

 

I can see new farm programs offered (at taxpayer expense) in order to get farmers to raise more grain. It will be a 180 degree turn from the programs of the past, where the government paid farmers to NOT plant.

 

What goes 'round, comes 'round.

 

fritz

 

 

[roscoedoh]

Fritz,

 

There's ups and downs to everything. I think this is a positive step in the right direction by looking into cleaner burning, renewable fuels. This way, when the middle east runs dry, we won't be caught with our pants quite as far down are legs as we would be if otherwise. Also, I'm hoping that if the government wants to grow more grain, it'll put guys like my ex's father back to work farming profitably. Moreover, if our demand for ethanol becomes as insatiable as our taste for petroluem, I'm sure the rest of the world will begin farming to fill our demand - livestock feed included. As of right now, don't we export more grain than we consume domestically?

[Doble Troble]

Jason, a small, probably annoying clarification; it's not chlorophyll you need for making ethanol, its carbohydrate - sugars that can be consumed by yeast. But you're entirely correct that virtually every organism that contains chlorophyll uses it to synthesize and store carbohydrate that is useful for ethanol fermentation.

 

If it grows, ferment it (this is how our forefathers thought, kind-of puts a new spin on the idea of 'internal combustion')!

[fritz]

"don't we export more grain than we consume domestically?"

 

Sometimes, most of the time, usually, appropriatly.

 

But since Uncle Sam controls our export market, sometimes he has this urge to use our exports of grain to gain points against another country. Or another country refuses to accept our exports. Read the history books on this matter, it has happened before and it will happen again!

 

Unless you have been involved in the business of farming, you cannot understand the power that Uncle Sam has on us. Or the power that other nations have upon us, in the world of "free" trade.

 

If we cannot control our own border between us and Mexico, just how in hell are we supposed to control world trade, (imports, exports)?

 

No, the rest of the world will tell us what they want (from us), and we will probably oblige.

 

"when the middle east runs dry"

 

It will not run dry for the entire world (there is huge quantities of oil there) but it may run dry for the USA.

 

fritz