Ethanol has found some powerful and vocal friends in recent months. President Bush highlighted the alternative fuel in his State of the Union address last month, when he cited the need to reduce the nation's oil addiction. Meanwhile, domestic automakers General Motors (NYSE: GM) and Ford (NYSE: F) have become major ethanol boosters as they seek to bolster their green credentials relative to hybrid-vehicle leaders Toyota (NYSE: TM) and Honda (NYSE: HMC).
This is all music to the ears of Archer Daniels Midland (NYSE: ADM), the country's largest ethanol producer. Now there's evidence that the agribusiness giant is convinced that rising demand for the fuel is here to stay. ADM recently revealed plans to increase its capital investment from $700 million in fiscal 2006, which ends in June, to $1.1 billion in 2007 and again to $1.2 billion in 2008. Part of the spending will go to increase ethanol production by 500 million gallons by 2009, a jump of about 42% from the current production of 1.2 billion gallons.
In the near term, there is little doubt that ADM will be a major beneficiary from ethanol enthusiasm, but its aggressive plans for ethanol should be viewed with some caution. The political winds are definitely blowing in ethanol's favor right now. The federal government subsidizes production and provides tax breaks. What's more, six states have passed laws requiring ethanol-blended gasoline, and nine states are considering similar legislation, according to the Associated Press.
Not surprisingly, rising demand and government incentives are fueling a lot of investment in ethanol production, not only from giants like ADM, but also from a host of small refiners. But as ethanol production grows, so, presumably, will the federal subsidy bill. And as that bill becomes onerous, it's more likely that a future Congress and/or White House facing massive deficits will be tempted to make cuts. If that happens, ethanol could suddenly become a lot more expensive and a lot less attractive to consumers at the pump. And then, presto -- there's an ethanol glut.
Admittedly, the subsidies might never face the ax. Further, ADM and other ethanol outfits could find ways to produce ethanol so that it's more price-competitive with gasoline. Nevertheless, investors should note that ADM's ethanol strategy is currently built on favorable political winds, and those winds have been known to change direction.
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Fool contributor Brian Gorman is a freelance writer in Chicago. He does not own shares of any companies mentioned in this article.
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