Ethanol: Behind the Buzz

Although pure-play ethanol producers such as Verasun Energy(VSE Quote) and Aventine Renewable Energy(AVR Quote) stand to profit handsomely if oil prices rise and corn prices fall, they will bear the full brunt of an oil price decline, as they did in 2006 when the stocks fell nearly 50% after oil retreated from its summer high. By contrast, large agribusiness producers enjoy a natural hedge and can look to their food, feed and industrial products to cushion the impact of falling oil prices. Domestically, ADM's market-leader position in ethanol production, product diversification and developed infrastructure make it an attractive ethanol bet.

Another interesting opportunity may lie abroad in Brazil's largest ethanol and sugar producer, Cosan, which trades under the ticker CSAN3 on the Brazilian Bovespa exchange.

Brazil enjoys the world's lowest production cost for sugar and its exports account for well over one-third of globally traded volume -- market share that is likely to increase in the wake of a recent WTO ruling reducing exports of highly subsidized EU sugar. Ethanol demand should grow even more quickly. Analysts predict that Brazil's domestic demand could nearly double from today's 13 billion liters to 22 billion liters by 2012, driven by the increased penetration of flex-fuel and ethanol vehicles, and energy-hungry Asian economies stand ready to buy up excess supply.

With the high production flexibility between sugar and ethanol, Cosan should be able to move nimbly between the products in response to fluctuating prices. Moreover, Cosan's scale gives it access to cheaper credit and greater bargaining power with suppliers relative to its domestic competitors, advantages that should help it to expand quickly through acquisition in Brazil's fragmented sugar production market.