Ethanol: Behind the Buzz

Advocates trumpet ethanol as green energy. Although corn ethanol's environmental credentials are disputed, replacing oil consumption with sugar or cellulosic ethanol could reduce related greenhouse gas emissions on the order of 80% to 100%. It would also lower tailpipe air pollution as well as contaminants from extraction and refinement. Risks of increased greenhouse gas emissions from production of nitrogen-based fertilizer and accelerated rainforest deforestation complicate the picture, but environmental impact will remain one of ethanol's chief selling points.

This complex and fluid mix of domestic and international politics, evolving technology and agricultural and energy commerce creates uncertainties and investment opportunities.

The Ethanol Investing Opportunity

Ethanol's cheerleaders sometimes sound like they've been drinking from their fuel tanks. Their promises of energy independence, greenhouse gas reduction, strategic security and agricultural growth smack of barroom bluster. Sober analysis reveals a more nuanced picture, but one that does provide real long-term opportunities. Let's examine five: industrial production, technological innovation, regulatory arbitrage, market mechanics and renewable energy funds.

The first investment approach is in ethanol production. The space is attractive because it is more developed than the rest of the ethanol value chain and is easily accessed through public markets. The U.S. market is fairly consolidated with Archer Daniels Midland(ADM Quote) controlling 40%, and the top 10 producers accounting for roughly 70%.

Government subsidies and ethanol mandates virtually guarantee top-line industry growth. Profitability, however, will be driven by the prices of foodstuff inputs and oil. In choosing between producers, investors will therefore want to consider both their relative competitiveness and the extent to which investors want to hedge exposure to oil and foodstuff prices.

To watch Lieberthal and Jim Cramer talk about investment prospects in ethanol, click here.