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Should You Invest in Ethanol?

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Despite President Barack Obama's best efforts to the contrary, ethanol isn't a very popular energy source. It's generally cheaper than gasoline, but the advantages mostly end there. It burns cleaner than regular gasoline, but the total environmental impact is about as bad, considering the energy-intensive process of creating it. It has problems traveling through existing gas pipelines, so it has to be shipped by truck, further negating some of the environmental benefits. The most damning issue with ethanol is that it serves as a bridge between fuel for people and fuel for machines.

About 40% of the corn crop in the United States will be used for ethanol production this year, up from just 8% a decade ago. The actual crop has not risen nearly enough to absorb that much extra demand, leading to a doubling of the price of corn. And because the price of corn is so high, farmers are incentivized to plant more of it than they ordinarily would, crowding out other crops such as soy, which has also doubled  in price as supplies become constrained. To a lesser extent, the increased demand for corn has also contributed to the rising price of inputs such as fertilizer and farmland, as well as products that must cope with rising corn prices, such as livestock.

Problems at the pump
Despite all that, ethanol companies have one major thing going for them -- ethanol-blending mandates. E10, a blend of 10% ethanol and 90% gasoline, is generally the maximum blend allowed by the EPA and is mandated in only a handful of states. However, more than 90% of the gasoline sold in the U.S. is a blend of some kind, and the EPA is considering raising the limit to 15% ethanol (E15). In theory, that could mean far more ethanol sold.

But that's just in theory. Twelve different automakers have come out against the proposal, including heavyweights Ford (NYSE: F  ) , Honda, and Toyota Motors, saying that cars get fewer miles per gallon with ethanol-blended fuel, and a higher blend may even damage engines and void warrantees. Meanwhile, the American Petroleum Institute -- which admittedly has an interest in keeping blending low -- also made a statement recently saying that half the gas stations in the U.S. are not equipped to handle E15, and that E15 at those locations could damage equipment and pose a threat to the local environment.

A stream of difficulties
As for ethanol companies themselves, they have done poorly. By 2009, about 9% of all ethanol plants had filed for bankruptcy, including high-profile cases such as VeraSun and Pacific Ethanol, which emerged from a Chapter 11 restructuring in 2010 but has continued to struggle. The loss of so many companies hasn't separated the wheat from the chaff, however, as many have simply restructured, like Pacific Ethanol, or been purchased by survivors, as Green Plains Renewable Energy (NYSE: GPRE  ) did with some of VeraSun's plants.

Even diversified companies have suffered. Grain king Archer Daniels Midland (NYSE: ADM  ) recently reported earnings, and while it may have crushed estimates, it revealed a steep drop in profits, due largely to its ethanol operations. Ethanol profits dropped to $37 million in the most recent quarter, down from $121 million last year. Oil company Valero (NYSE: VLO  ) comes at ethanol from the other direction, but suffered a similar downturn, reporting a drop in ethanol profits from $44 million to just $9 million. The Andersons (Nasdaq: ANDE  ) was the worst off, reporting Monday that ethanol profits had dropped from $3.6 million to just $0.1 million, barely avoiding a loss, and adding fodder to my underperform thesis for the company.

The Foolish bottom line
Obama is pushing hard for more ethanol use, and some companies, such as Pacific Ethanol, are exploring production with other inputs such as algae, wood, and grass. These other forms may be more economical and have fewer negative side effects. Unfortunately, they are a long way from the mass production corn ethanol enjoys. Ethanol isn't going away anytime soon, but don't be surprised if the companies that produce it do.

Don't let ethanol's troubles scare you away from energy investing, though. Three of The Motley Fool's top Rising Stars have put together a free new report with their top three stocks for $100 oil. Enjoy, and Fool on!

Fool contributor Jacob Roche holds no position in any of the stocks mentioned. Check out his Motley Fool CAPS profile or follow his articles using Twitter or RSS. The Motley Fool owns shares of Ford Motor. Motley Fool newsletter services have recommended buying shares of Ford Motor. Motley Fool newsletter services have recommended creating a synthetic long position in Ford Motor. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (3) | Recommend This Article (8)

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 May 08, 2012, at 2:44 PM, rebozo2 wrote:

    I've always felt that ethanol was a 'feel good' subsidy to make green and agricultural folks happier, and as many have pointed out, the cost of producing it (both financially and fuel consumption wise) doesn't really justify it's use. Besides that, I need an additive so my lawn mower won't clog up! The improving mileage in automobiles and trucks could outweigh the supposed benefits of ethanol though I haven't run the numbers. I think it's time to admit ethanol isn't the solution we'd hoped it would be and end the requirement it be added to gasoline.

  • Report this Comment On May 10, 2012, at 1:25 PM, CelaneseTCX wrote:

    As countries evaluate their supply options to meet the growing global demand for liquid fuel, Celanese believes they will need to balance four priorities: 1) Safe and clean fuel blend stocks 2) cost 3) energy security and 4) global environmental impact. Ethanol produced using Celanese TCX Technology is the best fuel choice among all other alternatives when balancing these considerations. Ethanol has already gained acceptance in most global markets as a high-octane, non-toxic biodegradable fuel. However, traditional ethanol production processes (ie: fermentation) are not economically viable and are limited as they compete for arable land (ie: food and feed supplies) and typically require government mandates or subsidies. Celanese's breakthrough TCX ethanol allows for a commercially viable, low-cost route to ethanol produced from locally available, abundant natural gas or coal resources that does not use arable land or require government support. TCX ethanol is a long-term, responsible option for helping to meet future personal transportation fuel demand.

  • Report this Comment On September 28, 2014, at 5:02 PM, TrentNY wrote:

    I hope people don't believe the rhetoric against ethanol. The simple truth is if you change certain engine dynamics ethanol fuel gets better gas mileage than gasoline.

    Indy Racing League tech director said cars can get better mileage on E100 than gasoline; engine optimization is the issue.

    In Indiana, Indy Racing Leauge Senior Technician Director Les McTaggert told Hoosier Ag Today that with modifications to compression, and the elimination of unneeded horsepower, cars would achieve the same of better mileage on E100, saying that loss in mileage experienced by customers of E85 stems from the fact that "the engine is principally designed to run on hydro carbon fuels. You change certain dynamics of the engine to optimize it to run on an alcohol fuel and get better gas mileage."

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