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

Last week I reviewed the ethanol debate in America, in broad terms, courtesy of commentator Ken Root. This week I want to attempt to add more specifics.

Globally, it's Brazil that was the real pioneer in ethanol-based fuel. Back in 1975, the government launched an ethanol initiative in a forced attempt to diversify from gasoline, as well as support the sugar industry (the key ingredient there?corn is for the U.S.), but until recently many have called it pure folly. Remember that for long stretches, gasoline has been so low that it was virtually impossible to make ethanol price competitive. But all the while the government mandated filling stations offer ethanol and it had to be cheaper. Of course this meant the industry was heavily subsidized and it cost the government dearly. Only now is the investment paying off.

[As an aside, Brazil is the world's largest sugar exporter and in addition to being the biggest producer of ethanol, soaring production had held down prices until very recently when sugar futures spiked to the highest levels in a quarter century. In the U.S., though, corn prices have been relatively stable and ethanol is the 3rd-largest use for corn behind livestock feed and exports.]

In the United States, ethanol didn't become a target for production until the Energy Policy Act of 1992, which addressed energy issues such as coal, nuclear power and more "alternative" methods, including ethanol.

"Specifically, the act pinpointed a handful of energy systems that ?could 'help reduce our dependence on imported oil.'" [High Plains Journal] But it stopped short of requiring E85, 85-percent ethanol use. Over time, however, ethanol has taken on a life of its own thanks in no small part to heavy subsidies. And more recently, the 2005 energy bill mandates that ethanol comprise 5% of all gasoline consumption in America by 2012, up from the current 3% level. Of course the President further shined the light on this and other alternative fuels in his State of the Union address last month.

Logistics, though, remain a huge issue when it comes to ethanol and on a number of different fronts. Start off with the reluctance of Detroit to build hybrid vehicles that could run on an ethanol- blended fuel. But while Toyota and Honda have been beating GM and Ford, the latter two have finally stepped up promotion of their so-called "dual fuel" technology, which would accept E85; the mix of 85% ethanol and 15% gasoline.

Of course the consumer, once they buy such a vehicle, needs a place to fuel up and only 500 gas stations, nationwide, currently carry ethanol. The automakers complain that if the government wants to see more E85 use, it's going to have to subsidize the gas stations to get them to offer it. And here you run up against simple supply / demand issues.

For example, the Feb. 15 edition of USA Today talked about the fact that as gasoline prices have been falling recently, at some service stations E85 sells for $2.20 a gallon while more conventional gasoline (even that which contains 10% ethanol, a common substitute for unleaded regular in the Midwest) is $2.05. One fuel company manager offered, "Our customers are saying, 'I'm not going to buy E85, which is better for the environment and the economy, unless it's cheaper.' We're seeing E85 just sit." Needless to say, if the recent slide in oil and gasoline prices continues, the only way to make up for the difference is for the government to subsidize the industry even more heavily.

Part of the price spike for ethanol also has to do with major oil refiners buying the ingredient in bulk; but this is due in part to the majors replacing MTBE, the controversial ingredient that is suspected of causing cancer, with ethanol. As James Healey of USA Today noted, "MTBE isn't officially banned, but oil companies are switching to avoid lawsuits." An analyst with the Oil Price Information Service added, "Gasoline with MTBE in it will become like gasoline with anthrax in it within the next 90 days."

Separately, on the refinery front there are 95 ethanol plants in the U.S., with another 41 under construction, including expansions of existing ones.

But I want to take some time on E85 and the automobile. Ford Motor CEO Bill Ford:

"We already have more than a million FFVs (flexible-fuel vehicles) on the road (and) Ford is working to expand retail ethanol pumps in gas stations around the country. But, we can't meet the infrastructure needs by ourselves."

Overall, there are five times the number of vehicles capable of handling alcohol/gasoline combinations as there are gas/electric hybrids. This figure could rise even more so at a cost of just a few hundred dollars more per vehicle (compared to $thousands for hybrids).

But I found the following of interest in an article for The American Enterprise (March 2006) by Dr. Robert Zubin. In addressing the non-availability of high-alcohol fuel mixes at the pump and the fact gas stations don't want to dedicate space to a fuel mix used only by 1 percent of all cars:

"This chicken-and-egg problem can be readily resolved by legislation. One major country has already done so. In 2003, Brazilian lawmakers mandated a transition to FFVs, with some tax incentives included to move things along. As a result, the Brazilian divisions of Fiat, Volkswagen, Ford, Renault, and GM all came out with ethanol FFV models in 2004, which took 60 percent of the country's new vehicle sales that year. By 2007, 80 percent of all new vehicles sold in Brazil are expected to be FFVs, producing significant fuel savings to consumers, a boost to local agriculture, and a massive benefit to the country's foreign trade balance.

"To date, all FFVs have been either methanol/gasoline designs or ethanol/gasoline designs. Combined methanol/ethanol/gasoline FFVs have not yet been produced. Their development poses only modest challenges, however. The question is, which alcohol would be the best one upon which to base our future alcohol-fuel economy?

"Methanol is cheaper than ethanol. It can also be made from a broader variety of biomass material, as well as from coal and natural gas. And methanol is the safest motor fuel, because it is much less flammable than gasoline (a fact that has led to its adoption by car racing leagues).

"On the other hand, ethanol is less chemically toxic than methanol, and it carries more energy per gallon. Ethanol contains about 75 percent of the energy of gasoline per gallon, compared to 67 percent for methanol. Both thus achieve fewer miles per gallon than gasoline, but about as many miles per dollar at current prices, and probably many more miles per dollar at future prices.

"Methanol is more corrosive than ethanol. This can be dealt with by using appropriate materials in the automobile fuel system. A fuel system made acceptable for methanol use will also be fine for ethanol or pure gasoline.

"Both ethanol and methanol are water soluble and biodegradable in the environment. The consequences of a spill of either would be much less than that of petroleum products. If the Exxon Valdez had been carrying either of these fuels instead of oil, the environmental impact caused by its demise would have been negligible."

But there are other issues to consider. Dr. Zubin continues:

"The United States uses 380 million gallons of gasoline a day. If we were to replace that entirely with ethanol we would have to harvest approximately four times as much agricultural output as we currently grow for food production. Now it is true that we don't need to replace all of our gasoline, at least not in the short term. Replacing half would make us substantially energy independent. Furthermore, future processes might eventually wring out higher ethanol yields per acre. Surplus ethanol from Brazil or other tropical nations could also be imported. Nonetheless, relying on ethanol alone would require putting under fresh cultivation an amount of land greater than what we now use for food production. This would cause many strains."

So the solution is a broader use of methanol. And for this coal is particularly important. Zubin notes:

"The United States could power its entire economy on coal for centuries, and large reserves also exist in allied countries. Current coal prices stand in the range of three cents a kilogram, much cheaper than agricultural products, so methanol can be made from coal at low cost."

And there is this added geopolitical benefit. Dr. Zubin:

"Even with methanol in the mix, the shifting of the world from a petroleum to an alcohol standard would remain a great boon to farmers. Third World farmers as much as American growers would enjoy the benefits - not only from a vastly increased market for their products, but also from the collapse of petroleum prices (which currently threaten crushing fertilizer and tractor fuel prices). This adds a strong humanitarian case for the transition to flexible fuels."

It's all kind of exciting, I think you'd agree, but it takes real political leadership. Dr. Zubin concludes:

"Our nation's founders stipulated that the purpose of our government is to provide for our defense, promote our welfare, and secure the blessings of liberty to ourselves and our posterity. In our current economic and military dilemma, decisive action for energy independence is one of the most dramatic steps we could take to achieve those ends. Congress should immediately require that all future vehicles sold in the U.S.A. be flexible- fueled, thereby launching us into an alcohol-energy future that holds promise like few other options within our grasp."

Sources:

David Luhnow and Patrick Barta / Wall Street Journal
Andrew Johnson Jr. / Barron's
Jeff Caldwell / High Plains Journal
Dr. Robert Zubin / The American Enterprise
James R. Healey / USA Today

Wall Street History returns next week.

Brian Trumbore

BUYandHOLD does not recommend any securities. The securities mentioned above are being used for illustrative and informational purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy.