The Great Ethanol Debate

You can't carry on a debate about the economy these days without two nagging points coming up: The price of oil is on a tear, and inflation remains a serious threat.

Of course, the increase in the price of oil is a telling sign of an inconvenient truth (no Al Gore cliche intended): Oil is finite; our appetite for it is not.

So when ethanol was introduced as a viable alternative, it wasn't any surprise that hallelujahs made their way around the country. Finally, we can free ourselves from the Middle East's abundance of black gold. Instead, we can use our heartland's trademark: corn.

If only ...
As the popularity of ethanol grew, the price of its main input, corn, mushroomed, doubling in price in just the past year. Farmers took advantage of the new price, clearing fields used to grow other crops to make room for -- you guessed it -- corn.

That price disruption has an ugly effect. The price of soybeans has climbed more than 20% to date. Wheat has more than doubled in the past six months. Some of the increase in commodities is from lower interest rates and speculators looking for an inflation hedge, but a good chunk of the runup stems from good ol' fashioned supply-and-demand imbalances caused by the ethanol crush.

Ironically, ethanol is hardly an energy savior. A study conducted by Cornell University and UC Berkeley found that corn-based ethanol required 29% more fossil fuel to produce than it provided in benefits, although it is worth noting that similar studies have shown contrary results. To grow corn, you still need tractors and fertilizer stuck in the petroleum age. Not efficiency at its finest. Why, then, is ethanol production so popular?

Insert anxious politicians here
Our buddies in Washington take a portion of the claim. The federal government has mandated that by 2022, 36 billion gallons of biofuel enter the marketplace. For perspective, last year we produced 7 billion. The heightened demand could result in big profits for ethanol producers such as Archer Daniels Midland (NYSE: ADM  ) , Pacific Ethanol (Nasdaq: PEIX  ) , and Bunge (NYSE: BG  ) , particularly given the industry's massive subsidies, but might not turn out so hot for other sections of the global economy.

The rising prices of corn and wheat mean higher prices for animal feed, which increase the price of beef, which increases the price of milk, which increases the prices at Starbucks (Nasdaq: SBUX  ) ... and you get the idea. The rising price of one commodity spreads to other realms of the economy. Ethanol's outsized demand for corn does just that.

Don't add injury to insult
Before I continue, I'll clarify one point: Ethanol production isn't solely responsible for inflation worries. Many factors play a role in those. But let's face it, the economy needs all the help it can get. Federal Reserve Bank of Dallas President Richard Fischer recently noted that the Fed will battle inflation before it can tackle keeping the economy from recession. With so much effort going into ethanol for embarrassingly inefficient energy returns, why shoot ourselves in the foot to begin with?

And with banks such as Citigroup (NYSE: C  ) and Bank of America (NYSE: BAC  ) hanging on by their fingernails, the last thing we need is higher interest rates to fight inflation that in hindsight could have been easily prevented.

Or think about this: The United Nations estimates 852 million people worldwide don't get enough food to sustain a healthy life. To be sure, war, politics, weather, and location play a huge role, but having the price of food commodities surging to historic highs can only make this far worse.

That puts us between a rock and a hard place. With oil at historic highs and global demand galloping forward, the petroleum party won't last forever. But the consequences of corn-based ethanol don't forecast a rosy horizon. So what route are we to take?

Well, according to fellow Fool Toby Shute, lard and algae, of all things, could play a part. Alternative energy is vital and its development must be given priority. But jumping at every opportunity, as some have jumped at ethanol, is a short-sighted way to go. With every benefit comes a marginal cost, and ethanol's net result doesn't even add up to corn flakes.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 01, 2008, at 11:10 PM, fearnowr wrote:

    Morgan,

    I come from an ag. background and this is the problem that I see with your artical. Too many people aren't aware of the by product of the ethanol process. It is called distillers grains and it is used for animal and human food and many other extracts. It is actually easier to process into other products. Most people do not know this. I do know that it is not ever discussed in the news. The high price for corn is not because of the ethanol. My request for you is to look at distillers grains and see for yourself what it is used for and what the amount of this is put into the food chain. It is too bad that a some of our leaders are not making this clear.(USDA)

    Thanks,

    Bob

    P.S. Please let me know what you find.

  • Report this Comment On September 09, 2009, at 2:40 PM, pahedrick wrote:

    Some other questions to ask yourself, How much does it cost the U.S to support jehadist each year?, How many farmers are going bankrupt each year that could use the ethanol business paying them and supporting thier families?, How many times has an ethanol spill endangered the environment and wildlife vs oil spills?, Which of the two burns cleaner?, and How many times have farmers declaired jehad on anyone?. To cure some ignorance, I burned an ounce of gasoline in a stainless still bowl and an ounce of ethanol in another stainless steel bowl. I had to put out the gasoline with an extinguisher and the bowl was black and nasty, while I could put the ethanol out with a spray bottle of water and it was nice and clean and cool to the touch. Maybe that would save on our global warming if we were to run all cars on ethanol alone and the money stays in the U.S. How much energy and money does it take to produce one gal. of gasoline, and transport it around the world?

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