Ethanol's Production Problem

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Since the beginning of the year, ethanol firms and their investors have been climbing all over each other to increase capacity. This year alone, Andersons (Nasdaq: ANDE) has started up two new ethanol facilities with a total capacity of 110 million gallons, while Aventine Renewable (NYSE: AVR) has completed construction of a 57 million-gallon facility. Moreover, US Bioenergy (Nasdaq: USBE) has five new plants with a combined capacity of 450 million gallons presently under development, and Poet Energy (formerly Broin Companies) -- which is already producing 1 billion gallons of ethanol and is the second-largest ethanol producer in America next to Archer Daniels Midland (NYSE: ADM) -- has no fewer than six new 55 million-gallon facilities under construction.

All of this, however, represents just a slice of the action. The venture capital community is throwing money into cellulosic ethanol companies such as Iogen and Cilion like nobody's business. And while it may be a few years before those companies' production comes online, it is difficult to imagine how all of this new supply will not put some significant severe downward pressure on ethanol prices for the foreseeable future.

I suspect that there is still a little money to be made from ethanol, but companies can't just ramp up their production capacity and expect to earn outsized profits. The successful ones will need to continue to find innovative ways to improve efficiencies, reduce energy expenditures, hedge against higher corn prices, and cut down on transportation costs. If I were looking at an investment in this space, I would be concentrating on how the various ethanol companies are addressing these issues and positioning themselves to keep their heads above water in anticipation of the industry's expanded ethanol production.

Interested in other ethanol-related foolishness? Check out:

• Cobs Clobber VeraSun's Profits
• Fueling the Debate: Ethanol vs. Biodiesel

Got an opinion on ethanol stocks? Bring it to CAPS!

Fool contributor Jack Uldrich doesn't own stock in any of the companies mentioned. The Fool has a strict disclosure policy.