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The ethanol boom may defy economic logic and could easily drive up food prices. It certainly depends on the generosity of taxpayers, but it makes eminent political sense in Washington, D.C. With a rallying cry of "Money to the Midwest, not the Middle East," politicians say they are addressing our addiction to foreign oil by promoting the use of two crops in abundant supply in the U.S.: corn, which is used to make ethanol, and soybeans, which are used to make biodiesel fuel.
You can invest profitably in biofuel stocks, thanks to those helping hands from Uncle Sam and many state governments. Some of the stocks retreated recently as the price of oil dropped, enhancing their appeal. But before we tell you how to invest, here's a quick primer on this dynamic business.
Energetic gains
The production of U.S. ethanol, nearly all distilled from the starch and sugar in corn, is growing explosively -- four billion gallons last year, five billion this year, six billion next year, according to Matt Hartwig, of the Renewable Fuels Association. Forty percent of the nation's gasoline already contains ethanol, says Hartwig, who thinks the domestic ethanol business can expand to 15 billion gallons by 2015 (current total annual gasoline consumption is 150 billion gallons).
The federal government last year mandated that the oil industry use at least 7.5 billion gallons of biofuels by 2012, a mandate that many analysts think may be raised. Government lavishes a tax credit of 51 cents a gallon on ethanol (and an even more lush $1-per-gallon credit on biodiesel, refined from oil-bearing crops) and shelters the industry with a 54-cent-per-gallon import duty aimed principally at low-cost Brazilian ethanol, which is distilled from sugar cane.
Clean burn
But the main impetus behind the surging demand for ethanol this year has been its role as a replacement for MTBE, a clean-burning, high-octane gasoline additive now believed to be a carcinogen. State after state has banned the additive. Ethanol is the only feasible substitute, and many states are mandating at least 10% ethanol content ("E10" at the pump) in gasoline.
What are the risks of investing in ethanol? A change in government policy is one, but that seems less likely than shifting business economics. Falling oil prices and rising corn prices would squeeze ethanol refiners' profit margins. Demand for ethanol now exceeds supply, but dozens of plants are under construction, and supply could catch up by the end of 2008. For now, the established companies are solidly profitable. Moreover, stock prices of the key players described here are well below recent highs, and price-earnings ratios range from moderate to low.
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