Ethanol Explosion! How to Invest and Profit from Ethanol
Companies / Investing Jan 08, 2007 - 07:37 AM
Suddenly and silently, the world's demand for ethanol is about to explode, creating a global business that could make early investors wealthy. It's about time! Ever since I first met Elisabeth and began visiting her family's sugar cane farm in Brazil, we've been talking about a future in which millions of cars would run on ethanol.
In fact, her father explained the fundamental principles to my father over 30 years ago: A renewable energy source that's not subject to Arab oil embargoes or Mid-East wars ... cleaner fuel for the world's automobiles ... more jobs ... less pollution.
Now, that future is here:
Every country on the planet wants to see more of its automobiles running on renewable fuels like ethanol. And with 600 million gas- and diesel-burning cars and trucks on the road today, that implies the most massive transformation since the industrial revolution.
Every major government is implementing policies that stimulate ethanol consumption. And with hundreds of billions of public money pouring into research and development, this is not exactly a temporary fling.
Wealthy individuals, large banks, major mutual funds are all looking more seriously at ethanol. And yet, the big flows of investment money into ethanol have barely begun.
Why the Hesitation?
I Count Three Reasons ...
- First, some investors seem to think investing in ethanol is strictly for environmentalists. They don't believe global warming is a man-made phenomenon, and they don't agree that cars should have to shift from gasoline to biofuels. So they don't see much future in ethanol.
Big mistake! The shift to ethanol is not just about burning cleaner fuel. As Elisabeth's father pointed out over three decades ago, ethanol is also about reducing our dependence on petroleum imports ... slashing our vulnerability to wars and revolutions in oil-rich regions of the globe ... and gaining firmer control over our own destiny.
- Second, investors have focused on the fact that gas stations in the U.S. are resisting alternative fuels, making it almost impossible for ethanol to reach American consumers.
But as I'll show you in a moment, the consumption of pure ethanol (the kind that is being resisted in the U.S.) is not the primary source of demand today. Moreover, the U.S. is just one of many growing world markets.
- Third and most recently, some investors have hesitated to move into ethanol because they see petroleum prices coming down. If oil prices don't go up, they figure, ethanol won't make it either.
We disagree. The price for crude oil could fall to $40 per barrel, and it would barely make a dent in a massive global transformation to ethanol that's now under way.
Most important, their hesitation is your opportunity. It has helped bring down the price of some of the leading ethanol stocks. And it has opened a brief time window to jump in.
I'll show you where in a just moment. But first, join me on a brief global tour — so you can see for yourself how broadly based the ethanol revolution has already become.
A New Mega-Industry Is Born
For at least two decades — from the early 1980s to the early 2000s — the ethanol industry was largely stagnant.
Ethanol production in the U.S. and Canada was growing, but only gradually. Brazil's ethanol output was actually sliding. And worldwide output was stagnating.
Then, at the turn of the new millennium, two things happened: The U.S. government and industry began to push ethanol more forcefully. And Brazil, still the world's leading producer despite the earlier decline, took off!
Result: Worldwide ethanol production has nearly doubled in five years ... the surge in volume has triggered the development of new, more efficient technologies ... and a new mega-industry has been born.
Right now, the only country with cars running on pure ethanol is Brazil. But a mix of ethanol and gasoline is used in the U.S., the European Union, Mexico, India, Argentina, Columbia and, now, Japan.
Here's a country-by-country rundown ...
Brazilian Ethanol:
World's Richest Investors
Are Starting to Pile In!
George Soros's Adeco has recently bought a major ethanol plant in Brazil. Bill Gates acquired a share in three new plants in Brazil's western state of Mato Grosso do Sul. Even Google's Larry Page and Sergei Brin have revealed plans to invest in Brazilian ethanol.
International companies are one step ahead of them: Infinity Bio-Energy, which trades on the London exchange, already operates Brazilian ethanol plants valued at $200 million and plans to invest another $500 million in five more plants by year-end. Evergreen, a British group, has recently bought Cridasa, a major ethanol producer in Minas Gerais. And the French group Tereos bought 6% of Brazilian ethanol producer Cosan and owns three plants.
Overall, investments in Brazil's ethanol industry are surging. In 2005, they were about $6 billion, including new plants, acquisitions and expansions. In 2006, they've surged to nearly $10 billion. And by 2010, even if there's a recession in the U.S., they should hit at least $15 billion.
The main attraction: Ethanol is transforming Brazil's economy, and Brazil's ethanol technology is about to transform the world.
The key factor: Innovative ways of lowering the cost of production.
Back in 1980, it cost Brazil's ethanol producers over $2.60 to make just one gallon — not exactly competitive with gasoline!
But now, Brazil is churning out ethanol for a meager 75 cents per gallon. And Brazil's science agencies are funding a raft of new R&D to drive the cost down even further. So even if petroleum and gasoline prices fall further, Brazil's ethanol will remain extremely competitive.
Already, nearly every single car rolling off Brazil's assembly lines has a flex engine capable of burning either ethanol or gasoline. So when we're driving in Brazil, we can fill up with whichever fuel happens to be cheaper. And when our tank is half empty, we can even mix the two fuels at will.
The flex engine has far-reaching implications. And although it's going to take time, ultimately, I see nothing that can stop it from spreading to the world's largest fuel consumers — the U.S., Europe, Japan, China and India.
Even before that technological shift takes place, Brazil's shipments of ethanol to overseas markets are surging. Late last year, it jumped 91 percent to 144 million gallons from 76 million gallons a year earlier. Plus, Brazil is negotiating with Japan, China, India and the EU to export still more. Even Brazil's ethanol exports to the U.S. are growing despite a huge, 50-cent-plus tariff per gallon.
U.S. Ethanol Industry Starting to Ramp Up
As you well know, in the realm of petroleum and gasoline, production in the U.S. has been stagnant, with virtually no new refineries built in the U.S. since 1976.
Not so in the ethanol industry! Even while America's oil refineries were aging, over 100 new ethanol production facilities have been built in the United States.
And that was mostly before August 8, 2005, when President Bush signed the Energy Policy Act — a renewable fuels standard that should double the use of ethanol and biodiesel by 2012.
Indeed, even the normally cautious U.S. Department of Energy predicts that ethanol could put a 30% dent in America's gasoline consumption by 2030.
But those projections are probably low, especially after the Democratic takeover of Congress this week, which opens the door to a bigger-than-expected push for ethanol.
House Speaker Nancy Pelosi has proposed a doubling of the amount of ethanol required by law to be blended into gasoline by 2012.
Collin Peterson of Minnesota, who has just taken over the House Agriculture Committee, says he will also be more aggressive in seeking ethanol subsidies.
And other House Democrats say they plan to establish a dedicated fund to promote renewable energy and conservation, with a lot of the money going into research for making ethanol from sources other than corn.
Japan: Ethanol Sleeper Wakes Up
Until recently, Japan was the world's largest sleeping giant with respect to biofuels. Now it's wide awake and leaping forward.
Prime Minister Shinzo Abe plans to increase consumption of biofuel for transportation to 3.15 million barrels by the end of 2010. He will boost the ethanol content of regular gasoline to as much as 10 percent. And as a result, Japan's purchases of ethanol will rise to as much as 44 million barrels per year.
Nippon Oil and other Japanese refiners have set their goals even higher. They want to replace 20 percent of Japan's gasoline and diesel consumption with biofuels.
That's why we've seen so many Nippon Oil executives in Brazil in the last couple of years. And that's why they've created Brazil Japan Ethanol Corp., a joint venture with Petrobras, Brazil's only major ethanol exporter. The company will start shipping ethanol to Japan in 2010, aiming for 37.7 million barrels by 2012 — not only for consumption in Japan, but also using Japan as an ethanol sales hub in Asia.
Meanwhile ...
Australia has had voluntary goals in place to blend up to 10% ethanol by 2010. But now it looks like it could meet its target one or two years ahead of schedule.
Canada has provided tax benefits for ethanol since 1992, while various Canadian provinces have similar mandates.
Argentina requires use of 5% ethanol blends over the next five years.
India mandates 5% ethanol in all gasoline.
Indonesia aims for 10% biofuel use.
And this is just the beginning.
New Companies Jumping Into The Ethanol Industry
A few small companies are coming up quickly ...
VeraSun Energy Corp. , a small startup in South Dakota, has quickly emerged as America's second largest ethanol manufacturer.
Pacific Ethanol of Fresno, California went public in 2005, making headlines with an $84 million investment from Bill Gates. The company plans to build five plants in the state by mid-2008 and has raised a total of $111 million.
Aventine Renewable Energy Holdings , now the nation's fourth largest, is also ramping up.
And Denver-based BioFuel is building two ethanol distilleries and plans three more, each of which will be able to produce 115 million gallons of the grain-based fuel a year.
But despite all these plans, U.S. investors are still leery, especially with the lack of ethanol at gas stations. That's one reason Global Ethanol Holdings , an Australian producer of sugar-based fuel, scrapped its IPO last year.
And it's also why it may be too soon to jump into small U.S.-based companies.
Instead, I see two better vehicles for U.S. investors interested in ethanol:
Vehicle #1. Archer Daniels Midland
Archer Daniels Midland is pumping out more than a billion gallons of ethanol per year. As such, it's the agricultural giant whose future growth is more tied to ethanol than probably any other major company in the U.S.
Ethanol does not account for more than 5 percent of the company's $36 billion in annual sales. But it's generating almost a quarter of the operating profit. Plus, the company is expanding ethanol production by 50 percent, or 500 million new gallons of annual production capacity.
CEO Patricia Woertz sees the company as uniquely positioned at the intersection of the world's increasing demands for both food and fuel.
We agree.
And although the stock is still in a primary, long-term uptrend, it's down substantially from the peak it made in May, opening a window for new investors to get in.
Vehicle #2 The Leading Brazil ETF
Brazil's ethanol industry is helping to strengthen Brazil's economy in more ways than one — with more export revenues, more fuel-efficient cars, and more local jobs.
Moreover, by cutting new natural resource mega-deals with countries like China, Japan and India, Brazil's newly re-elected president is gearing up for another growth spurt in Brazil's economy, even without an ethanol boom.
Brazil's stock market is already anticipating this trend. That's why the iShares MCSI Brazil Index (EWZ) recently challenged the highs it made last year, and after a mild correction last week, could easily exceed them.
My view: Even though ethanol is just one component of Brazil's overall success, EWZ is a worthy vehicle.
Elisabeth's older sister Christina, who now runs the family's sugar cane plantation in Brazil, summed it up nicely when she represented ethanol farmers at the United Nations last year:
“As fossil fuels become economically, environmentally, and politically unsustainable, agroenergy is today's future. Farmers can play a critical role in planning for — and meeting — the call for renewable energy and, hence, energy security needs.”
For the world, it's a solution.
For investors, it's an opportunity.
Good luck and God bless!
Martin
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