Ethanol stalls out for investors

The Baltimore Sun

CHICAGO -- Ethanol, the centerpiece of President Bush's plan to wean the U.S. from oil, is 2007's worst energy investment.

The corn-based fuel tumbled 57 percent from last year's record of $4.33 a gallon and drove crop prices to a 10-year high. Production in the United States tripled after Morgan Stanley, hedge fund firm D.E. 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.

While oil nears $100 a barrel, ethanol markets are so depressed that distilleries are shutting from Iowa to Germany. An investor who put $10 million into ethanol Dec. 31 now has $7.5 million, a loss of 25 percent. 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 Co., may resort to exporting ethanol. Pacific Ethanol Inc., backed by Microsoft Corp. co-founder Bill Gates, dropped 63 percent 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 Inc. in Albany, N.Y. "That's not a good recipe when you have $100 oil."

Corn has risen to about $3.80 a bushel on the Chicago Board of Trade from less than $2.50 in September 2006. Ethanol on the exchange is little changed at about $1.87 a gallon, after falling from a peak of $4.33 in June 2006.

The Bush energy plan triggered production by requiring increased use of 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 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.

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.

Ethanol is a form of alcohol that is created by distilling starches from corn, sugar, wheat and other crops. Harvesting, crushing, fermenting and distilling corn requires 29 percent more energy than ethanol produces, says Pimentel, a professor of ecology and agriculture.

But Michael Wang, an engineer at the Argonne National Laboratory outside Chicago, says Pimentel is wrong to include energy spent on making fertilizers and pesticides. Ethanol production results in a 33 percent gain in combustible energy, Wang says.

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

At least six new ethanol plants were canceled after prices tumbled to a 28-month low in September. One was by VeraSun Energy Corp. in Reynolds, Ind., dubbed "BioTown U.S.A." two years ago by Gov. Mitch Daniels.

Even with distilleries being canceled, so many new mills are under construction that annual U.S. output may reach 11.3 billion gallons by the end of next year says Eitan Bernstein, an analyst at Friedman Billings Ramsey & Co. in Arlington, Va.

Leaders in the House and Senate are negotiating on whether a final energy bill should include a Senate plan to increase the renewable-fuels requirement to 36 billion gallons a year, more than five times the amount produced now.

"Long-term prospects for the industry depend very much on whether a new energy bill requires higher blending targets," says Christoph Berg, managing director at commodities researcher F.O. Licht in Hamburg, Germany.

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