Best Stocks to Make Money Off Ethanol

Ethanol, to be sure, is here to stay.

But if you look at the falling stock prices of companies that produce it below, you might be tempted to view it as "demon ethanol." Unfortunately, some very common myths about ethanol may keep you from investing in these stocks now that the prices have been beaten down.

Why should investors take another look at the ethanol concept?

Here are some ideas for investors in high-growth stocks to consider:

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The new law creates a big ethanol and biofuels market opportunity.

The Energy Independence and Security Act signed last December mandated fuel economy, development of biofuels and energy efficiency. This law set a goal of 36 billion gallons of alternative fuels (largely ethanol) by 2020. It is widely recognized that the maximum production of ethanol from corn starch is only 15 billion gallons a year, implying a mandated production shortfall of some 21 billion gallons a year.

Two large companies produce nearly half of the ethanol fuel in this country, and the whole industry capacity would have to go up sixfold to meet the mandate.

Think about this a minute. At the current average pump price of $2.77 a gallon of blended E85 ethanol, President Bush and Congress created a market with an annual revenue potential of more than $100 billion a year. This is big business.

Investors initially reacted very positively to this news last November, driving the ethanol stock prices up 40% to 60% in 30 days. Then the next reality set in.

But the new mandate also creates a supply gap.

Ethanol is a great opportunity, but it is not without its challenges.

The federal mandate cannot be reached solely using U.S. corn-based ethanol alone. According to some studies and projections, even if we planted all our farm land with corn, we could not meet the goal without major changes.

We will need new technologies for production.

Fortunately, ethanol can be produced from nonfood crops, such as switch grass and straw. However, these approaches can not yet compete in the marketplace, and they are unlikely to do so in the near future.

We will need more alternative-fuel cars.

All major American auto makers offer models called Flexible Fuel Vehicles, or FFVs, that can actually run on E85, E-10 Unleaded, ordinary unleaded gasoline -- or any combination thereof. The computerized fuel system automatically adjusts for the level of ethanol in the fuel. In other words, FFV owners do not have to fill up with E85 all the time.

We will need more distribution.

Today there are 1423 public gas stations that dispense E85 fuel, and the number increases every day. But vendors of E85 still make up less than 1% of the total gas stations in the country. Go to the National Ethanol Vehicle Coalition Web site to find a station near you.

We will need more imports.

The U.S. currently fills the supply gap by importing lower-price sugarcane ethanol from Brazil, which is subject to a much-debated 54-cent per-gallon import tariff. There is a growing global market for ethanol fuel, and Brazilian producers are aggressively working to increase their ethanol production capacity from 5 billion to 7 billion gallons of fuel alcohol a year by 2010.

We will need luck.

If ethanol fuel production depends on farm crop harvests, then weather will become an even more important and uncontrollable factor in our economy.

Speculation has driven up production costs. The ethanol supply issue has had a very negative effect on corn prices and, indirectly, food inflation. At current September futures prices of $6.24 per bushel, some ethanol producers cannot turn a marginal profit. They will need to dip into their capital to fund needed growth.

Investors are less enthusiastic about ethanol now and are staying away from startups. Just last month, Ethanex Energy filed for bankruptcy as it was unable to get a new capital infusion. The weaker capital market for ethanol stocks has been signaling a consolidation was needed after a dot-com style craze period.