The Buzz Around Ethanol

By Gregory S. Davis | February 08, 2006 AAA

Everyone wants to know if alternative fuels such as ethanol can help the United States lessen its dependence on oil, specifically oil from the Middle East which currently represents 20% of U.S. imports. Playing off of the President's State of the Union address where Bush insisted on a 75% reduction in oil dependence by 2025, publicly traded companies related to ethanol production have become targets for investors and sellers alike. There a couple of strategies investors can follow should the ethanol clamoring live up to its hype.

Farmers in corn belt states like Minnesota are getting subsidies towards growing crops to produce corn for ethanol production. Ethanol is typically made by fermenting the sugars in corn grain. Approximately 50% of ethanol plants in the U.S. are owned by small groups of local farmers and investors in cooperative and small business entities. An estimate taken buy the Energy Information Administration (EIA) puts U.S. consumption of oil at 20 million barrels a day with 44% of that total being used for gasoline. Ethanol currently makes up just 3% of the fuel that is consumed in the United States from the 4 billion gallons that are currently produced domestically.

The Tractor Play
As a result of a recently passed energy bill, U.S. ethanol production is slated to increase to 7.5 billion gallons by 2012. In order for more ethanol to be produced more land will have to be plowed, which means the right machines must be in place. Deere & Co (DE), who is one of the largest makers of tractors and harvester is a safe bet to benefit from farmers' needs to ramp up production. Deere & Co closed February 7th at $72.05 just off of a recent 52
week high.

The Automotive Play
The introduction of ethanol-85 (E85) several years ago has allowed General Motors (GM) to sell 1.5 million E85 cars in the U.S.. E85 is a 85% ethanol and 15% gasoline mixture. General Motors (GM) plans to build an additional 400,000 mixed use fuel cars this year while Ford (F) is also set to produce 250,000 fuel flex cars, including a version of its top selling F-150 pickup truck in 2006. Brazil started their move towards using ethanol in 1975 and today they have approximately 5 million flex fuel cars on the road. Brazil's success does point to the possibility of ethanol proliferation inside the U.S.. However, it will take some time for ethanol availability to increase since current estimates put the number of gas stations that carry ethanol somewhere between 550 and 600 out of 170,000 pumps all across the U.S..

The Ethanol Play
The Big Guy: Archer Daniels Midland (ADM). This is a $36 billion company that operates in oilseed processing, corn processing and other agricultural services. Ethanol along with other bioproducts sold by Archer Daniels Midland (ADM) accounted for $2.5 billion or approximately 7% of total net sales in 2005. Archer Daniels closed on February 7th at $29.99.

The Little Guy: Bill Gates investment company, Cascade Investments, put up $84 million to enter the clean energy market place by investing in Pacific Ethanol (PEIX). A press release on November 15, 2005 announced that Cascade Investments purchased more than 5 million shares of Pacific Ethanol (PEIX). In other words, the Fresno, California-based ethanol producer received an $84 million dollar cash infusion. Pacific Ethanol has a goal of building five ethanol plants in the Western United States. The company expects to be able to produce 200 million gallons of ethanol annually. Its first large ethanol production facility is being built in Madera County, California with expected completion during the 4th quarter of 2006. Pacific Ethanol (PEIX) stock hit a 52 week high of $18.83 on Tuesday, Jan 31, just prior to the Bush State of the Union speech. PEIX was an easy target for profit taking as the stock sold off and closed on Feb 7th at $16.00, down 5% for the day.

My Play
For now, the best move may be to wait and see if any of the companies that have been earning the attention of venture capital firms begin to IPO or enter into partnership agreements with more visible firms. Bush's mention of Ethanol has caught everyone's attention, and now as investors we must have the patience to wait for the silence and begin to invest.

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