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Tickers in this Article: ADM, GPRE, PEIX, VLO
As Kermit the Frog once said, "It's not easy being green". That could also be a fitting mantra for the U.S. ethanol industry. The industry was initially stung by the soaring price of corn prices, it's principle feedstock, and then hard hit by the collapse in oil prices, which also took down ethanol prices, by 2008 the industry was a total wreck. Many operators were forced into bankruptcy and a large percentage of the industry's production capacity fell idle. For those companies that survived, shareholders were confronted with share price declines of 90% and over.

IN PICTURES: 20 Tools For Building Up Your Portfolio Ethanol Shares
However, the steady recovery in oil prices to the $80 a barrel level and a drop in corn prices have managed to bring the industry back from the brink, producing some spectacular returns for savvy traders. From their March low levels of just over $1, shares of principle ethanol producer Green Plains Renewable (NASDAQ:GPRE) have soared to more than $13 a share, near doubling in value in just November alone. Smaller producers like Pacific Ethanol (NASDAQ:PEIX) have seen their share price practically triple in the last week, while shares of agri-business giant Archer Daniels Midland (NYSE:ADM) have also steadily increased. (For some ethanol stocks to keep an eye on, refer to Five Ethanol Stocks to Know.)

Government Throws the Industry Another Lifeline
This latest flurry of buying appears to have been fueled by news that the U.S. Environmental Protection Agency (EPA) may be leaning in favor of a decision to lift the blend rate of ethanol in regular gasoline from the current 10% level to 15%. While the final decision won't be revealed until June 2010, pending further tests to determine whether any engine damage can occur as a result of the higher blend mixture, the agency did suggest that vehicles made after 2001 were likely to handle the higher blend product, known as E15. Automakers and vehicle owners have repeatedly claimed that higher ethanol blend levels can do some expensive damage to car engines. Potential compromise solutions to their concerns could include a decision to mandate a combination of low and high blend grades in the marketplace, or gradually increasing the overall blend level over time in one percent increments from the current standard of 10%.

Ethanol Demand Has Topped Out
If some sort of higher blend mandate goes ahead, and its a virtual certainty that it will, it couldn't come at a better time for the industry as the nation's capacity to absorb additional volumes of ethanol appear to have topped out. While ethanol production has been increasing in line with binding renewable fuel mandates passed by Congress in 2007, the recession has taken a big bite out of motor fuel consumption in the U.S. Moreover, the full blend ethanol product, known as E85, is scarcely used outside its Midwest base, and at its current pump price of $2.23 a gallon, E85 is 31 cents per gallon more expensive than regular gasoline, after adjusting for the lower fuel economy inherent in ethanol. Lower overall gasoline consumption and the oversupply situation in ethanol also represent major challenges to top U.S. refiner Valero (NYSE:VLO) who recently entered the ethanol business when it brought the assets of bankrupt ethanol producer VeraSun last March.

The Bottom Line
After mandating the overproduction of ethanol, it's only fitting that the U.S. government now step in and bail out the producers who bought into the government's vision of ethanol as a clean, green fuel that would help the U.S. reduce its reliance on foreign oil. Several years on, the jury is still out on that one. (For more insights into the controversial use of renewable energy sources, read The Biofuels Debate Heats Up.)

But the more relevant issue for investors in this sector is its continuing reliance on government support, be it in the form of a high tariff wall against imported (and much cheaper to produce) foreign ethanol, or artificial demand creation through legislated moves to higher ethanol blend levels for regular gasoline. At some point the training wheels of government support will have to come off, yet the evidence continues to suggest that the relatively costly corn-based U.S. ethanol industry has yet to show that it can reach economic viability without continued assistance from Washington.

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