How Ethanol Is Eating Our Lunch

Ethanol is attractive as a solution to high gasoline prices because it promises a free lunch:

• U.S. farmers would grow corn.
• U.S. ethanol companies would turn the corn into ethanol.
• U.S. consumers would go about business as usual.
• And everyone in the U.S. would be less dependent on foreign oil producers.
• But repeat after me: There is no free lunch.

So far, this not-so-free lunch has resulted in higher food prices and rising U.S. dependence on fertilizers produced by, you guessed it, foreign oil and natural gas producers.

The costs are just starting to work their way through the U.S. and global economies. But it's none too early for investors to revise their portfolios to take account of the costs of this free lunch.

On June 4, corn (No. 2 yellow, central Illinois) sold for $3.77 a bushel. A year ago, the price was just $2.25 a bushel. That's a 68% jump in price in a year. (The futures markets say prices will stay here, too, with corn for December delivery selling at $3.83 a bushel on June 4.)

The Price Connection

Soaring demand for corn from ethanol producers isn't the only reason for the price increase, of course. There's rising demand from export markets for corn to use as animal feed and for human consumption. And there's increasing demand for corn sweeteners from the food industry.

But there's no getting around the corn-ethanol price connection. Corn prices are up despite projections of a record 12.5 billion-bushel corn harvest in the U.S. this year -- because ethanol producers will eat up 27% of the U.S. corn crop this year, according to the U.S. Department of Agriculture. Corn consumption by ethanol producers is projected to climb to 3.4 billion bushels in 2007, up from 2.2 billion bushels in 2006, when ethanol producers consumed 20% of the corn crop.