Ethanol, Part I
Brian Trumbore
President/Editor, StocksandNews.com

"History" might be in the title of this column, but of course I've used it to address issues in the financial world that are drawing intense interest today. Such is the case with "renewables" and "biofuels."

Following are the figures for the energy mix in the United States (12 months ending October 2005), courtesy of Cambridge Energy Research Associates, the Energy Information Administration and the Wall Street Journal.

Petroleum - 40%
Natural Gas - 23
Coal - 23
Nuclear - 8
Renewables - 6

Breaking down the renewables category:

Hydropower - 2.8%
Solid biomass - 2.4
Geothermal - 0.4
Biofuels - 0.3
Wind - 0.1
Solar - 0.1

[Comes out to 6.1% due to rounding]

As you saw the other week, President Bush focused on renewables in his State of the Union address. Many skeptics are saying that we've heard this song before; that when oil prices inevitably decline, and the price at the pump heads back below $2.00, we'll just resume our old habits and the incentives to change them will fade away.

Personally, I disagree. I firmly believe we have turned a corner, though with everything else that has a long timeframe we may not recognize the big changes taking place for a while.

I'll continue to address many of the specifics, particularly on the geopolitical front, in my "Week in Review" column. But for now I want to start with a discussion on biofuels, specifically ethanol, E85 for 85% ethanol-based fuel.

A long simmering debate that has been lying in the background is now on the front pages, owing to issues as diverse as farm subsidies and the cost of sugar, the auto industry, the availability of fuel pumps, and the very sources of energy today.

To start things off, I present a good primer on the ethanol topic from Ken Root.

Many of you know I'm a product of New Jersey and not exactly an expert on farming. But a number of years ago I made the acquaintance of a delightful family that calls the Oklahoma Panhandle home and I've done a little to keep abreast of the issues as their own farm fortunes have grown.

One way to do so has been to subscribe to the High Plains Journal, where Mr. Root writes a terrific weekly column for the publication. He is also farm anchor at WHO Radio in Des Moines, Iowa. Ken has been gracious in allowing me to reprint a piece he did for HPJ this past month.

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Ken Root

"Ethanol's big chance"

Although most of America still thinks ethanol is best served as E3.2 (beer), the potential for E85 (fuel) may be at its highest in 2006. That's because a convergence of ethanol suppliers, facilitators, promoters and users could align this year and government subsidies could ignite real world use. There are also detractors, enhancers and unknowns, but here's how I see the future of high-powered ethanol as automotive fuel in the years ahead.

Suppliers

The U.S. Congress passed an energy bill in 2005 that will offer incentives for production while mandating use of a growing quantity to top out at 7.5 billion gallons per year in 2012. Although total U.S. capacity is far short of this annual number, ethanol refineries are being constructed at a rapid rate that will achieve the capacity far ahead of the mandated use date.

Promoters

Farm state support of ethanol knows no bounds within legislative bodies and farm/agribusiness organizations. This promotion is only slowed by differences between those who wish to mandate its use and those who wish to provide financial incentives to encourage consumption. The Republican leadership of the Iowa legislature is poised to put through bills that will compensate fueling stations for the cost of an E85 compatible storage and pumping system to the tune of $30,000 in tax credits per installation. Estimating the total cost to be $60,000 to $80,000 and adding in federal incentives, the incentives add up to $55,000. Iowa proposes funding 200 new pumps per year for nine years.

Facilitators

Ford and Chevrolet are both building E85 compatible engines and offering them in popular vehicles. Bill Ford could be mistaken for Grandpa Henry in his promotion of ethanol in his cars and trucks. Other automobile manufacturers can't be outdone by a competitor, so look for some ethanol compatible engines at every dealership. Saab has an engine that super- performs on E85. Indianapolis will feature the fuel at the Indy 500 race in May.

Users

The foreign oil-sensitive public is the most likely to purchase an E85 compatible vehicle once they see that there are enough pumps nearby to utilize the American-grown biofuel. The overall public, especially in the major population centers, is still a little uncertain about ethanol in general and E85 in particular, but not as adverse as early users who still hate the stuff that clogged their carburetors. Promotion by government and car companies, with the addition of clearly marked E85 pumps and highway signage, will offer an attractive alternative.

Detractors

The petroleum refiners and retailers still own the gasoline market and their interests are best served by selling their own product. It will be very hard to get major oil companies to install an E85 fueling station under their main canopy or to give it equal promotion with their gasoline grades, even though they may all be spiked with an ethanol blend to raise the octane level. Petroleum retailers are fighting hard to keep ethanol use from being mandated on a state level while pumping everyone for money before they install pumps.

Enhancements

Ethanol plants, in effect, add refining capacity in this country as the fuel only has to be blended with gasoline at a 10- or 85- percent level. This reduces the amount of refined gasoline that has to be imported. Grudgingly, the first new U.S. oil refinery in 30 years is now being built in Arizona. Site selection and construction of petroleum refineries will continue to be an environmental battle.

High gasoline prices will drive alternative fuel use as much as any incentive. E85 has to remain more economical than unleaded in cost per mile to increase use. U.S. presence in the Middle East should keep OPEC nations in control of oil supply and that should keep gasoline above $60 per barrel.

Promotion and awareness of the desirability and availability of bio-fuels has to continue. Trade names and branded products will stick in the public mind better than numbers and generic words.

Unknowns

Profitability of ethanol refineries is still undetermined. Changing technology could make older plants less efficient than others and radical shifts could change the preferred feedstock. Brazil may be able to export ethanol to the U.S. more cheaply than we can produce it. Cuba might become an ethanol producer in the post- Castro era. We are going to have to be hypocritical to keep Central American production out while endorsing CAFTA.

Many investors, including farmers, who own shares in ethanol refineries and other groups are holding meetings and distributing their prospectuses. Some may not have management or a business model that will generate a return for shareholders.

Finally, ethanol is about to go mainstream. It's total impact on U.S. oil usage may be small, but it will be the first step away from petroleum since we fell in love with the automobile a hundred years ago.

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We'll pick up the discussion next week.

Brian Trumbore

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