The Ethanol Conundrum Continues

Oil prices are rising. Unrest in the Middle East has everyone, including the president, looking for alternative fuel sources. Sounds like a perfect storm for the ethanol industry, right?

Sort of, but there are plenty of challenges ahead in turning Midwest farmland into a major source of fuel. As Pacific Ethanol's (Nasdaq: PEIX  ) fourth-quarter loss shows, it isn't moving everyone into profitability. Pacific Ethanol reported a loss of $11.6 million, or $0.14 per share, down from a $245 million loss last year. But this should be a perfect storm that should send Pacific Ethanol's earnings through the roof, or should it?

Food vs. fuel
This has been the battle cry of ethanol opponents since ethanol was invented, but there are market factors at work that will sort this out for us. Assuming food demand is relatively constant, if ethanol demand rises, so does the price of corn, leading to lower margins on ethanol and a higher cost of food. So the average consumer feels a pinch at the grocery store and what looks like a bonanza of good news for ethanol producers ends up being a squeeze on margins.

Even Cosan's (NYSE: CZZ  ) sugar-based ethanol runs into the same food vs. fuel problem, although sugar products are far more efficient at making biofuels.

So when Bloomberg reported this week that the second-largest area of corn planting since World War II wouldn't be enough to meet demand for feed and ethanol, I saw this as bad news for the industry. If supply won't meet demand, higher corn prices will be bad news for ethanol producers' margins.

In the long term, ethanol will encounter these problems over and over again as food demand worldwide increases. I would much rather stick with fertilizer companies that benefit whether agriculture products are turned into food or fuel. Mosaic (NYSE: MOS  ) and PotashCorp (NYSE: POT  ) are two solid picks in this space and provide a much better risk/reward profile than pure ethanol plays.

What's your opinion on the future of ethanol stocks right now? Leave your thoughts in the comments section below and add your favorite pick to My Watchlist to keep up with all of our Foolish analysis on that stock.

Fool contributor Travis Hoium does not have a position in any company mentioned. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.

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Read/Post Comments (2) | Recommend This Article (2)

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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 April 01, 2011, at 10:27 AM, JohnFarage wrote:

    More than 50 percent of corn crop is used as livestock feed; the remainder is processed into a multitude of food and industrial products. The misconception about ethanol is wasting food product on an inefficient process to produce energy. The fact is once ethanol extracted from corn, the remaining is not waste, but high protein byproduct called WDG (Wet Distillers Grains). This byproduct is a desired Livestock and Poultry Feeds.

    Here are some numbers

    2.77 gallons of ethanol per bushel of corn

    One ton of corn = 36 bushels

    One ton of corn produces about 100 gallons of ethanol

    Price of one bushel of corn =$6.93

    Price of one ton of corn = $250

    Price of one ton of Distillers Grains (dry) =$200

    John Farage

  • Report this Comment On April 01, 2011, at 10:33 AM, JohnFarage wrote:

    More than 50 percent of corn crop is used as livestock feed; the remainder is processed into a multitude of food and industrial products. The misconception about ethanol is wasting food product on an inefficient process to produce energy. The fact is once ethanol extracted from corn, the remaining is not waste, but high protein byproduct called WDG (Wet Distillers Grains). This byproduct is a desired Livestock and Poultry Feeds.

    Here are some numbers

    2.77 gallons of ethanol per bushel of corn

    One ton of corn = 36 bushels

    One ton of corn produces about 100 gallons of ethanol

    Price of one bushel of corn =$6.93

    Price of one ton of corn = $250

    Price of one ton of Distillers Grains (dry) =$200

    Price of one ton of WDG (Wet Distillers Grains) =$96

    Therefore; One ton of corn produces 100 gallons of ethanol plus say one ton of WDG,

    One ton of corn =100 gallons @$2.70/g + $96 = $366

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