Let's Get Real About Ethanol

It's been a somewhat tough slog for the ethanol crew lately, but the federal government, in the form of the overzealous Environmental Protection Agency, is on the case.

Makers of the corn-based product have been struggling with a combination of opposition to the increased use of their product and price volatility in their primary raw material and energy fuels. You of course know about ethanol, the compound made from the sugars that exist in some crops, such as corn, sugar beets, and sugar cane. For several years now, ethanol has been added to the blends refined by Tesoro (NYSE: TSO  ) , Chevron (NYSE: CVX  ) , and others to typically constitute about 10% of the gasoline purchased at the pump.

Let's just order up a bigger serving
Ethanol is supposed to aid in our effort to achieve energy independence, while simultaneously reducing automotive emissions. But now, using my kids' logic that, if a bowl of ice cream is good, 10 gallons should be lots better, the EPA has jacked up the requirements for the blending of ethanol to absurd levels. That, despite a host of difficulties resulting from anything beyond minimal use of the additive.

It was back in 2005 that Congress created the Renewable Fuel Standard (RFS) as a means of reducing our petroleum usage and, at least in theory, the emissions generated by fossil fuels. The law was signed by President George W. Bush in 2007.

The original targets for ethanol production were reasonable. For instance, the goal for 2012 was 7.5 million gallons, a level compatible with constituting up to 10% of total gasoline output, known in the vernacular as E10. But returning to the ice cream metaphor, no sooner had the president's signature dried on the new ethanol requirement, than interest groups began to lobby the Congress to raise the requirements -- big time. Of late, as in other areas under its auspices, the Obama EPA has been on an ethanol tear.

The drawbacks
The original 2012 objective was jacked up to 15 billion gallons of renewable fuel, and by 2022 we're supposed to find use for a whopping 36 billion gallons of the stuff. That potentially presupposes that E10 will jump to E15 and potentially higher. As a result, the likes of General Motors (NYSE: GM  ) and Ford (NYSE: F  ) -- among others -- are less than pleased. Here's why:

  • Small engines, such as those used in lawnmowers and chainsaws, can be damaged even by E10. But move up to E15, and the prospects for negative consequences for today's automotive power plants increases dramatically.
  • Already ethanol demands are consuming 40% of the U.S. corn crop. It doesn't take an economist to understand the effects: a 400% increase in corn prices in recent years. Those prices expand to cause hikes across the food chain to hog, cattle, and chicken production, and into other corps. But the spillover doesn't stop there, since it spreads to a host of non-agricultural levies as well.
  • While it's purported to be a boon to the environment, its ratcheting up of corn production has put ethanol four-square behind other serious issues. For instance, water levels are dropping in a number of aquifers, including the Ogallala Aquifer, the well-being of which was espoused to be the primary concern behind President Obama's blocking of TransCanada's (NYSE: TRP  ) Keystone XL pipeline proposal.
  • Ethanol requires subsidies and mandates to justify its production in economic quantities. So with U.S. manufacturers already cranking out more of the product than we can use domestically, exporting the surplus effectively means that we're beneficently acting to dampen prices in those countries that buy from us.

There are other key disadvantages to lighting a fuse under ethanol use, including -- importantly -- insufficient energy returns. But by now you get the picture. You also need to know, however, that, as part of the RFS, the EPA has also significantly raised requirements for biodiesel, which is now mandated for 1.28 million gallons next year, a 28% jump from 2012.

Our minds are made up
Last month the agency rejected the pleas of eight governors and almost 200 members of Congress to inject an additive involving "rationality" in its own stance and wave the requirements for the addition of corn-based ethanol in gasoline, following the severe drought -- and consequently puny corn crop -- of the past summer. One response has been a lawsuit from the American Petroleum Institute contesting the biodiesel standards.

As University of Michigan Professor John M. DeCicco said in a Detroit News opinion piece earlier this week:

It's now clear that the expanded RFS targets were a dangerous overreach. Congress should strike its 2007 RFS provisions, reverting to the original and more sensible 7.5 billion gallon goal. Doing so still provides a guaranteed market for truly competitive advances in biofuels and will make more of America's harvest available for traditional food and feed markets.

A Foolish takeaway
What does this mean for Foolish investors? Simply this: As it relates to ethanol, fracking, and other aspects of the U.S. energy picture under its aegis, the Obama EPA clearly is going hog wild. Couple that with geopolitical shakiness in the Middle East, North Africa, South America, and the South China Sea, and it's important that Fools monitor carefully the world of energy. Doing so could affect your portfolio returns meaningfully.

As with other automobile manufacturers, the management at Ford isn't at all happy about runaway ethanol standards. Nevertheless, the company has been performing incredibly well over the past few years -- it's making good vehicles, is consistently profitable, recently reinstated its dividend, and has done a remarkable job paying down its debt. But Ford's stock seems stuck in neutral. Does this create an incredible buying opportunity, or are there hidden risks with the stock that investors need to know about? To answer that, one of our top equity analysts has compiled a premium research report with in-depth analysis on whether Ford is a buy right now, and why. Simply click here to get instant access to this premium report.


Read/Post Comments (5) | Recommend This Article (2)

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 December 28, 2012, at 4:25 PM, farmermike21 wrote:

    Maybe you should take a math lesson from your kids. I am not sure what you are calling recent years, but in the spring of 1995 corn was $5. Today corn is $7 (actually less than 7, but I will give the benefit of rounding up). That is a 40% increase in price, not 400%. Even at $3 corn, which we were at several years ago for a short period of time, it would only be a 133% increase. Would the price of corn be less if we didn't use ethonal for fuel? Sure, but the price of gas would be much higher, and since the cost of our food has more to do with labor and energy prices than it does with the cost of grain, our household budgets would actually be worse off. Also, the subsidies expired on ethonal production.

  • Report this Comment On December 28, 2012, at 6:51 PM, grcor wrote:

    Mr. Smith,

    I am sorry but you do not know much about ethanol and the Renewable Fuel Standard. You make no reference to cellulosic ethanol. It can be made from wood or grasses, but it can also be made from garbage. What does every city in America have? Per capita we probably generate more garbage than anyone else in the world. Think of all the American jobs that would be created, the reduction of money leaving the country to pay for oil, National Security (energy independence), and reducing our carbon footprint.

    If you look at the Renewable Fuel Standard, it says that by year 2022, a total of 21 billion gallons of biofuel needs to be provided by something other than corn. So the requirement to produce more ethanol will NOT increase food costs and NOT reduce the water level in aquifers.

    What we need are move cars and trucks capability of running E85. Brazil has already proven that you can run a nations vehicle fleet on Ethanol.

  • Report this Comment On December 28, 2012, at 10:49 PM, uofa wrote:

    I believe that the auto companies are against E15 because they don't want people putting E15 in older vehicles, and fear consumers will be confused by another selection at the pump. Not because "the prospects for negative consequences for today's automotive power plants increases dramatically." Their concern is that consumers be adequately informed.

  • Report this Comment On December 29, 2012, at 1:18 AM, herky46q wrote:

    ^ That is how I have seen this issue reported. Newer cars can apparently handle a higher mixture of ethanol. It seems like for every pro there is a con with this product.

  • Report this Comment On December 29, 2012, at 9:18 AM, farmermike21 wrote:

    If you remember back when E10 was being proposed, the car companies said the same thing, it will damage the engine. That was totally without merit also. There were some clogged fuel filters because the ethonal cleaned the carbon from the fuel tank and system, but other than that, no complaints.

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