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Last Spring, ethanol became a buzzword for a public weary of gasoline price spikes and worried about climate change. The corn-based fuel drew the attention of politicians, Wall Street, and environmentalists. Flashy corporate ad campaigns and widely promoted initial public offerings signaled that the industry had reached a new level of acceptance.
But with the hype fading into memory, and more favorable conditions for gasoline supplies and prices, the bloom may be off the stalk. Now that it has the public's ear, ethanol has yet to convince skeptics—many of whom criticize government support for the industry and its suppliers in the agricultural field— that it will play a key part in America's energy future. And Wall Street doesn't appear fully convinced either.
Since President George W. Bush signed the energy policy act in August, 2005, the ethanol industry couldn't have scripted a better run. In the spring, many oil refiners replaced the polluting gasoline additive methyl tertiary-butyl ether (MTBE) with ethanol. As refiners adjusted to the change, rising ethanol prices helped usher in an unsustainable "period of 'nirvana'" for the industry, according to a recent report from A.G. Edwards. Profits climbed, and in June, ethanol outfits VeraSun Energy (VSE) and Aventine Renewable Energy (AVR) went public. Hawkeye Holdings, another ethanol IPO, is pending.
There are still disagreements over the extent of ethanol's environmental benefits. Industrial corn growing consumes enormous amounts of land and fertilizer, and it can increase ground-level ozone. Nonetheless, compared with gasoline, ethanol use reduces carbon-dioxide emissions. And the yield per bushel of corn has mitigated some concerns about its toll on the land. More importantly, the fuel has ridden political support for an alternative—any alternative—to petroleum imported from hostile regimes.
PUMPING PROFITS. At this point, ethanol isn't about to supplant gasoline as America's fuel, but industry boosters describe it as a David to Big Oil's Goliath. In this case, they say the underdog offers a clean burning domestic-sourced gasoline additive that creates rural jobs.
It’s an offer that appears to promise something for everyone, but the government support that ethanol receives infuriates free-marketeers. Jerry Taylor, a senior fellow at the Cato Institute, wrote in an e-mail that ethanol's supporters use "populist sleight-of-hand" to support their position. Opponents must find the subsidies especially galling when ethanol is making money.
VeraSun, the second largest U.S. producer, reported a net income of $19.55 million for the quarter ended June 30, on sales of 57.1 million gallons. This represented an income increase of more than sevenfold over first-quarter results, though sales volume squeaked up only about 5%. Along the same lines, diversified agriculture giant Archer Daniels Midland credited ethanol prices with a disproportionate contribution to its record fiscal year earnings (see BusinessWeek.com, 8/2/06, "Ethanol Fuels ADM's Performance").
TAX ADVANTAGE. But as a commodity-based product, ethanol prices can be wildly volatile, and it's unlikely to consistently deliver big profits. Investors may want to bet that ethanol will thrive with the support of government, but Wall Street remains wary. Both VeraSun and Aventine are trading well below their IPO prices.
The controversial supports for ethanol include a mandate that in 2012, 7.5 billion gallons of ethanol must be mixed into gas, guaranteeing a market for the fuel. In addition, refiners receive a per-gallon tax credit for the ethanol they buy. Many refiners "would rather not use it and not have the tax credit," says Bob Slaughter, president of the National Petrochemical & Refiners Assn. Among its disadvantages, he says: Ethanol can be difficult to transport and the mandated use raises the price.
Brian Jennings, executive vice-president of the American Coalition for Ethanol, says the tax credit ensures "that our product will be purchased by our competitor [the oil industry]," since refiners are aware that "every gallon of ethanol introduced into the fuel supply displaces a gallon of gasoline."
Jennings points out that the oil industry also receives government subsidies and that there is a "de facto mandate" for drivers to buy gasoline. "I think it's appropriate for the government to foster an alternative," especially one with ethanol's potential benefits, he says.
NO SAVINGS. But don't expect ethanol, which accounts for less than 5% of the U.S. fuel supply, to wean the nation off oil. Nor does it facilitate consumer choice. By and large, it's added to gasoline on a state-by-state basis. The few pumps offering e85, fuel made of 85% ethanol, are concentrated in the Midwest. And only specially equipped flex-fuel cars can burn the stuff. According to Jennings, around 1% of the 5 billion gallons of ethanol produced in the U.S. this year will go into e85.
"When crude oil prices are $70 [a barrel], consumers are interested in an alternative," says Bill Honnef, a senior vice-president with VeraSun, which sells ethanol and a branded e85 fuel. Unfortunately, e85 isn't necessarily cheaper than gasoline. For the time being, the cost per gallon is typically less than gasoline, Honnef says, but e85 packs less energy by volume than gas, forcing drivers to make more stops.
Nonetheless e85 is an important component of ethanol's marketing. VeraSun has partnerships with Ford Motor (F) and General Motors (GM) to promote its use, as the carmakers seek to show off their green credentials.
IMPORT TARIFF. Despite the swell in support, Jerry Taylor of Cato says, "If it weren't for heavy government preference towards ethanol, there wouldn't be an ethanol industry." Nonetheless, ethanol's supporters are unapologetic. "Maybe we'll develop the industry to a point where it doesn't require as much public support," says Jennings. In the meantime, he backs increasing government mandated ethanol purchases to keep up with expected production.
Another potential source of ethanol is Brazil, which produces the fuel from sugar cane. With ethanol playing a crucial role in that country's gas supply, Brazil isn't seen as being able to export large quantities to the U.S. in the near future. Nor does it have much incentive to grow more: The U.S. ethanol industry supports an existing tax and tariff on most ethanol imported from Brazil, a position that makes it hard not to see the government's support as directed more toward the U.S. industry than toward the fuel itself.
Looking forward, ethanol could improve its lack of capitalist cred. Vinod Khosla, a venture capitalist and Silicon Valley eminence, is among the more prominent advocates of cellulosic ethanol, which is mashed out of plant waste (see BusinessWeek.com, 5/19/06, "Khosla's East Coast Ethanol Play"). It boasts all of ethanol's potential advantages, but could possibly be produced on a much larger scale than its corn-fed cousin (see BusinessWeek.com, 5/19/06, "Ethanol: Myths and Realities"). It's not yet cheap enough to be commercially viable and probably won’t be until sometime in the 2010s. But cellulosic ethanol, along with other alt-fuel technologies on the radar, could shake things up in the cornfield.
Halperin is a reporter for BusinessWeek.com in New York
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