Monday, September 10, 2007

Ethanol Diversification

The lead story of today's Wall Street Journal concerns the efforts of international commodity firms, including US companies such as ADM, Cargill and Bunge, to break into the Brazilian sugar cane ethanol market. On one level, this reflects the growing globalization of the ethanol business, as more countries look for alternatives to petroleum products. Deeper strategic issues are at work, as well, involving the need for these companies to reduce their dependence on high-cost supplies of corn ethanol, in anticipation of new competition from cellulosic ethanol within a few years. Brazil's potential as a low-cost supplier of ethanol has been recognized for along time; what's new is the apparent international bidding war to participate in this bounty.

Last week I ran across an academic paper arguing that the energy balance of ethanol was irrelevant. Aside from the errors in the author's conclusions about oil displacement, his suggestion of framing the balance in economic, rather than energy terms has merit. He argued that the market values different forms of energy differently. While that is certainly correct, it underlines the challenges facing a fuel requiring energy inputs that nearly equal its ultimate delivered energy content; corn ethanol can never be as cheap as ethanol from sources requiring fewer costly inputs. That's the essence of the appeal of ethanol derived from sugar cane grown in the tropics, instead of corn from the northern temperate zone. It's also the promise represented by cellulosic ethanol, which will be produced from agricultural waste and non-food crops requiring minimal fertilizer.

So if the bulk of your company's energy portfolio is tied up in something that, in spite of federal and state subsidies and a mandatory renewable fuel standard, looks like the high-cost supply in the long term, what do you do? You seek to diversify, of course. It's a little early to buy into cellulosic ethanol, because there are so many competing technologies and no industrial -scale facilities, yet. But cane ethanol is here, now, and it's been industrial-scale in Brazil for decades. The biggest risk is paying too much for the assets.

At the same time, US corn growers ought to be watching these moves closely. They should regard cane ethanol as a tough competitor, even if they succeed at preserving both the domestic ethanol blenders' credit and the tariff on imported ethanol. While pending Congressional energy legislation may expand their future market significantly, rising corn prices and the advent of cellulosic ethanol are putting the big ethanol firms under a lot of pressure to diversify and reduce costs, at the same time that the competition between food and fuel uses of corn is becoming more apparent. A future drop in oil prices would compound these problems.

The Journal does a good job on most of these issues, but their effort to put Brazilian ethanol in perspective is off by a wide margin. They compare its 9.5 billion gallon per year (BGY) potential output to crude oil from the Alaskan North Slope (ANS.) That doesn't even work using current ANS production, on the back end of its long, steady decline. 9.5 BGY equates to about 435,000 barrels per day (bdp) of oil, after adjusting for ethanol's lower volumetric energy content. That's nothing to sneeze at, but if the Journal's readers construed it as comparing favorably to the North Slope in its prime, they'd be sadly mistaken. ANS production peaked at over 2 million barrels per day in 1988 and yielded more than 1 million bpd for 26 consecutive years, starting in 1978. It still delivers roughly 800,000 bpd, or about 15% of total US crude oil production.

Even if Brazilian ethanol isn't quite another North Slope or North Sea, energy-wise, it will be an important part of a global energy market in which renewable fuels from many sources play an increasingly important role. And as the market for ethanol and other biofuels globalizes, the domestic market will shift, too. The ethanol commodity firms appear to see that, and the corn-belt states and their farmers should, too. The ethanol business is about to change, and not all the changes will be positive for corn.

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