Is ethanol a good investment?
Monday - 8/20/2012, 10:58am ET
There are many in the U.S government, including President Obama, trying to make Ethanol a substantial energy commodity with little success. There are just too many fundamental problems this energy source is facing that make it a questionable investment. Even the currently high oil prices that result in high gasoline prices aren’t enough to pull Ethanol up. Let’s check the main factors that impede Ethanol from becoming an energy source worth investing.
The Demand
The price of Ethanol is still very low compared with the price of oil (when comparing high Ethanol blend gasoline to low Ethanol blend gasoline). Ethanol is commonly used in many low-level blends to oxygenate the fuel and reduce air pollution. The main advocate for the usage of Ethanol, besides the U.S government, is the environmental groups: this energy source is much cleaner for the environment and produces much less carbon monoxide and carbon dioxide emission than regular gasoline. But is this investment (in terms of ROI and not in environmental returns) worth considering?
According to a recent article, there are some companies, such as Pacific Ethanol, that do explore other ways of producing Ethanol that could reduce its cost and side effects. But as I have pointed out at the beginning of the article the problem of Ethanol isn’t its price – it is currently much lower than gasoline’s price – but its usage.
There is no need to use Ethanol for producing electricity, because the U.S uses natural gas, which is much cleaner than coal, and because natural gas has become very cheap. The main usage of Ethanol remains in the auto industry.
The E10 blend (10% Ethanol, 90% gasoline) is still considered gasoline. There are talks by the EPA to raise this blend to 15% which could raise the demand for Ethanol.
There are many car manufacturers such as Toyota Motor Corporation and Ford Motor Co. that have already voiced their objection to this change. Even if this change will take place it won’t help much for Ethanol investors: this change won’t raise the demand by more than 5%, which isn’t high growth. But it's worth mentioning that these companies are making some progress in manufacturing cars that run on Ethanol: Toyota has recently announced it will launch the first hybrid vehicle that uses ethanol in Brazil; Ford is offering several of its models that run on a gasoline with a high blend of Ethanol.
The big potential growth for Ethanol could occur if the E85 (85% ethanol, 15% gasoline) which currently can only be used in flexible fuel vehicles, will become ubiquitous. For that to occur there has to be significant breakthroughs – i.e. big investments – by automakers in producing a car that will be affordable and reliable. There should also be a change in gasoline stations that will carry this blend in many places. I don’t think companies that own gasoline stations such as Royal Dutch Shell plc will voluntarily make this change considering what’s at stake. Shell is one of the largest oil and gas companies worldwide and one of its core businesses is producing oil.
Currently, there are nearly 8 million flex ible fuel vehicles in the U.S but many drivers don’t even know they can pump E85 into their car.
The Supply
The recent drought in the U.S made everyone nervous as to its effect on Ethanol prices. According to a recent report by the EIA this drought won’t affect much the production of Ethanol. Nonetheless, one of the main problems in investing in this energy source is its reliance on the weather which could affect its production. This means the production comes with high uncertainty that cannot be predicted.
In regards to Ethanol stocks there wasn’t much growth in the past couple of years. This could be due to low growth in production. If this trend will continue and the price won’t rise, it could signal that demand for Ethanol is also stagnating.
The bottom line
There are many who still believe Ethanol will eventually pick up and become much more used than it currently is. This could take a long time. Until there will be a shift in the demand for Ethanol via more cars that can use E85 gasoline and more gas stations with this gasoline, it won’t matter the fluctuations in the price of Ethanol or the increase in gasoline prices. The demand for Ethanol won’t rise enough to make it a reasonable investment.
