Top Five Ethanol Picks

Among the pure-play ethanol producers, Aventine Renewable Energy boasts the second-largest production train below VeraSun. Its $490 million market cap also puts it No. 2 to VeraSun ($1.2 billion) in terms of valuation.

Like VeraSun, Aventine can use economies of scale to squeeze out competitors, and its relatively strong balance sheet could allow it to go shopping for existing refineries.

Aventine has also done something unusual by creating a distribution network that transports its competitors' ethanol. This network of railcars and ethanol terminals provides Aventine with a relatively reliable cash-flow stream separate from its own ethanol sales.

Regardless of this effort, Morningstar analyst Michael Tian recently wrote in a report that he doesn't think Aventine "has sufficiently differentiated itself from other ethanol producers."

In short, if you have to pick one name, VeraSun might be the better option.

Geographic Distinction

Finally, there's Pacific Ethanol(PEIX).

Most ethanol producers are located in the Midwest. Transporting that ethanol to blending stations that are typically along the coasts can be expensive. Pacific Ethanol is taking an alternate route, building small plants on the West Coast with better access to its customers.

The company will sell its distillers grain byproduct like most ethanol producers. Distillers grain usually must be dried to extend its shelf life, and drying the grain requires natural gas. Pacific Ethanol can bypass this process by building plants near cattle yards. This allows it to deliver its distillers grain wet, saving the company money on its energy bill.

Pacific Ethanol also has a very ambitious construction plan which would boost its production capacity from 60 million gallons in 2008 to about 400 million gallons at the end of 2010. But the cost of building plants has risen dramatically in the past year, and Tian thinks that this schedule could be too ambitious.

As infrastructure for the distribution of ethanol spreads across the country, Pacific Ethanol's protected market in the Northwest will be opened up to competition, and it will ultimately have to produce ethanol as cost-efficiently as its peers. For now, though, it has geography working in its favor.

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