Ethanol: 2007's worst energy investment

Business Times 20 Nov 07

(NEW YORK) Ethanol, the centrepiece of President George W Bush's plan to wean the US from oil, is the worst energy investment this year.

The corn-based fuel tumbled 57 per cent from last year's record of US$4.33 a gallon and drove crop prices to a 10-year high. Production in the US tripled after Morgan Stanley, hedge fund firm DE Shaw & Co and venture capitalist Vinod Khosla helped finance a building boom.

Even worse for investors and the Bush administration, energy experts contend ethanol isn't reducing oil demand.

Scientists at Cornell University say making the fuel uses more energy than it creates, while the National Research Council warns that ethanol production threatens scarce water supplies.

As oil nears US$100 a barrel, ethanol markets are so depressed that distilleries are shutting from Iowa to Germany. An investor who put US$10 million into ethanol on Dec 31 now has US$7.5 million, a loss of 25 per cent. Florida and Georgia have banned sales during the summer, when the fuel may evaporate and create smog.

'I don't anticipate any sort of immediate rebound,' says Barry Frazier, the 50-year-old president of Center Ethanol LLC in suburban St Louis. 'It's going to take 12 to 24 months before the market is able to absorb the large amount of new capacity.'

The biggest producer, Archer Daniels Midland, may resort to exporting ethanol. Pacific Ethanol, backed by Microsoft Corp co-founder Bill Gates, dropped 63 per cent in New York trading this year as profits collapsed. Record oil prices, which make blending of ethanol with gasoline more profitable for refiners, haven't stemmed the declines.

'Ethanol companies are near break-even at best,' says Ron Oster, a principal at Broadpoint Capital in Albany, New York. 'That's not a good recipe when you have US$100 oil.'

Corn has risen to US$3.795 a bushel on the Chicago Board of Trade from less than US$2.50 in September 2006. Ethanol on the exchange is little changed at US$1.865 a gallon, after falling from a peak of US$4.33 in June 2006.

The Bush energy plan triggered production by mandating increased use of so-called biofuels, such as corn-based ethanol. The administration proposed raising output in the next 10 years to five times the current target amount for 2012.

The US Senate approved the increase and lengthened the time frame to 2022. The federal government has 20 separate laws and incentives to boost ethanol use, and 49 states offer additional subsidies and supports, according to the Energy Department in Washington. Scientists question the wisdom of using ethanol. Stanford University researchers say ethanol, originally added to gasoline in the 1970s to reduce tailpipe emissions, does nothing to improve the environment.

'It takes more energy to produce ethanol than it actually gives off,' says David Pimentel, a Cornell University professor who has studied production of the fuel for two decades. Harvesting, crushing, fermenting and distilling corn requires 29 per cent more energy than ethanol produces, says Pimentel, a professor of ecology and agriculture.

Michael Wang, an environmental engineer at the Argonne National Laboratory outside Chicago, says Prof Pimentel is wrong to include energy spent on making fertilisers and pesticides. Ethanol production results in a 33 per cent gain in combustible energy, Mr Wang says.

US ethanol inventories swelled to a record 10.3 million barrels in August as production jumped 32 per cent from a year earlier and demand growth slowed, the Energy Department said.

Mr Khosla, the Menlo Park, California-based venture capitalist who 25 years ago helped start Sun Microsystems Inc, is undaunted by this year's slump. He founded Range Fuels Inc, which is building a plant in Georgia that will make ethanol from wood chips.

So-called cellulosic ethanol production will create a 'Richter-scale change in the oil industry,' Mr Khosla said, adding the fuel will be cheaper to produce than oil. Range Fuels expects to be profitable at ethanol prices of US$1.25 a gallon, he says, more than 50 cents below the current futures price\. \-- Bloomberg