Ethanol: Behind the Buzz

Money in Market Mechanics

Anytime a new international commodity market develops, chances are there is money to be made investing in its mechanics. In this instance, the promising opportunities seem to lie not in market-making itself, but in delivering market orders.

Although ethanol trading will generate real profits, it may be difficult to find a pure-play investment to capture them. Ethanol is likely to be traded on the same big exchanges through the same market-makers and be the subject of the same types of derivative financial instruments and ancillary services as other commodities. Consequently, trading-related returns will be buried deep in market-makers' profit and loss statements, dwarfed by the mix of other investment activities.

While there may not be good opportunities in trading orders, there should be in delivering them. The development of a commodity ethanol market should increase both gross production and international trading. Whereas today most ethanol is consumed domestically, ethanol commodity markets will connect efficient South American producers with energy-hungry Asian economies.

Physically delivering these large quantities of ethanol around the world will require development of new transport infrastructure. Specifically, market growth is creating investment opportunities in short-railroad construction, pipeline construction, and railcar and trucking manufacturing. In late February, Brazil's state-run oil firm Petrobras, Japan's Mitsui & Co. and a Brazilian construction firm signed a memorandum of intent to study the construction of a pipeline in Brazil used to help export ethanol to Japan.