How ethanol bites you in the wallet
It may help at the gas pump, but the ripples emanating from the
ethanol boom are higher prices for corn, fertilizer and the food on
your table. Investors, adjust your portfolios.
http://articles.moneycentral.msn.com/Investing/JubaksJournal/HowEthanolBitesYouInTheWallet.aspx

By Jim Jubak

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.

How ethanol bites you in the wallet
It may help at the gas pump, but the ripples emanating from the
ethanol boom are higher prices for corn, fertilizer and the food on
your table. Investors, adjust your portfolios.http://articles.moneycentral.msn.com/Investing/JubaksJournal/HowEthan...

By Jim Jubak

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 67%
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 corn-ethanol 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 United States 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.

Supplies would be even tighter if high corn prices hadn't deterred
some buyers. Corn exports, the U.S. Department of Agriculture says,
are expected to drop by 10% in 2007. And corn purchases for animal
feed will drop 3%.

The soybean and grain markets

The high price of corn has had a ripple effect on the price of other
farm commodities, too. With corn so profitable to plant, farmers have
shifted acreage from soybeans, for example, to corn. In 2007, the
acreage planted in corn will grow by 16% from 2006, while the acreage
planted in soybeans will fall by 11%. So it's not especially
surprising that the price of a bushel of soybeans was up 36% as of
June 4 from a year earlier. (Corn isn't just displacing food crops,
either. In the southern U.S., the acreage planted in cotton is down
20% in 2007 as farmers switched to planting corn.)

And the ripples haven't stopped with the grain markets. The U.S. food
industry is largely built on corn. It feeds the chickens, pigs and
cows that wind up on our dinner tables. It's the source of the
sweeteners in everything from soda to cookies to bread. And it's
processed into starch for use in candies, soups, cake mixes, baked
goods and, in the general economy, into plastic, paper, adhesives and
textiles.

Food prices on the rise

So if the price of corn is up, you'd expect the price of everything to
be up. And so it is. If you grilled steak on this past Memorial Day,
it cost 5.5% more than a year ago, according to the U.S. Labor
Department. Think you can escape by barbecuing chicken? Forget it.
Whole chickens cost 7.7% more than they did in May 2006. Milk and
cheese are up, too, since corn makes up the bulk of a dairy cow's
diet. Milk prices are up about 3% from a year ago, or about 10 cents a
gallon, according to the U.S. Department of Agriculture. But higher
costs could push up the price of a gallon of milk by an additional 40
cents in the next few months to a national average of $3.78 a gallon.

And those annual rates of increase understate the spike in prices so
far in 2007. In the first quarter of 2007, raw milk prices were up
23%, for example.

OPEC is threatening to cut investment in production and drive up the
price of oil if industrialized economies don't stop investing in
biofuels. MSN Money's Jim Jubak says it's nothing more than an empty
threat -- and that investors should call OPEC's bluff.

And so far in 2007, food inflation in the United States is running at
an annual rate of 6.7%. If that rate holds for the entire year, that
would be the fastest rate of increase in food prices since 1980.

Continued: Price inflation abroad

Price inflation abroad

The effects of higher corn prices don't stop at the U.S. border. In
fact, higher prices are hurting consumers in poorer countries more
than more affluent consumers in the United States. Food price
inflation is running higher in developing economies than in the United
States, and in those countries food takes up a bigger part of the
family budget. Food-price inflation was running at 6.2% in China in
the first quarter of 2007 and 11% in India, for example. In the United
States, food makes up only about 15% of the shopping basket that the
U.S. Commerce Department uses to calculate the Consumer Price Index.
In Thailand, food makes up 35% of that basket. In the Philippines,
it's 50%.

The decision to promote corn-based ethanol as part of our national
energy policy (if you can call it that) has imposed other costs on the
economy, as well. Since ethanol is too corrosive to ship through
existing pipelines, it has to be delivered from refinery to consumer
by truck or rail. It's also necessary to ship corn to the ethanol
refinery and, then to ship what remains after the starch has been
extracted from the corn kernel to disposal sites or back to farms for
use as feed. All of that extra hauling has put more pressure on U.S.
rail lines that are already struggling with too much traffic running
on too many single-tracked lines.

Where's the fertilizer?

And that 16% increase in the acreage planted to corn has also produced
a big surge in U.S. fertilizer demand -- as much as an extra 1 million
metric tons this year. (The shift from soybeans to corn also increases
demand for fertilizer, since soybeans can fix nitrogen from the
atmosphere and require less nitrogen fertilizer than corn.)

The supply to meet that extra demand won't come cheap, since
nitrogen-based fertilizer prices are near record highs. Prices are
projected to average $365 a metric ton in 2007, up from $270 a ton in
2006, an increase of 35%.

Much of that fertilizer will be imported, too. It takes natural gas to
produce nitrogen fertilizers. High natural-gas prices have driven most
U.S. producers out of the business, leaving nitrogen fertilizer
production to countries such as Trinidad and Tobago, Russia and,
surprise, Saudi Arabia. The U.S. Geological Survey calculates that in
2005 the United States imported 21% of the urea it turns into nitrogen
fertilizer from Saudi Arabia and Qatar.

A game plan for investors

So where does this all leave investors?

Buying the shares of farm-equipment makers, such as Deere (DE, news,
msgs), since whatever its net effect on the economy as a whole,
ethanol is clearly good for farm incomes.
Buying the shares of fertilizer makers such as Potash Corporation of
Saskatchewan (POT, news, msgs) and Yara International (YARIY, news,
msgs).

Buying the shares of agricultural commodity traders such as Archer
Daniels Midland (ADM, news, msgs) that have the ability to arbitrage
prices between commodities and geographies.
Selling the shares of food-processing companies, such as Kellogg (K,
news, msgs), Nestle (NSRGY, news, msgs), Hershey (HSY, news, msgs) and
PepsiCo (PEP, news, msgs), that are getting squeezed by rising
commodity prices for key ingredients such as corn, corn sweetener,
milk and cheese. And staying neutral on ethanol producers themselves.
Government subsidies for ethanol production have brought too many
companies too quickly into the industry. A consolidation, fueled by
high corn prices and bottlenecks in the distribution system that make
it hard to get ethanol to market in many areas of the country, has
just started.

And the technology questions still remain to be answered.

Brace yourself

Can the corn-based ethanol industry find a way to solve its corn-price
problem by turning more of what remains after ethanol production into
animal feed? (Currently, that "waste product," DDGS, or distillers
dried grain with solubles, has too much oil to be easily digested by
many farm animals.)

Will the technology for making ethanol from plant cellulose, such as
the switchgrass so often mentioned by President Bush, evolve from test
project to commercial viability any time soon?

Corn-based ethanol yields only marginally more energy (optimistically)
than it consumes in production, and it requires so much corn that
reaching the administration's lofty production goals is unlikely. Yet
despite all its faults, corn-based ethanol is here to stay, at least
for the next five years or so. The political logrolling that passes
for energy policy in Washington -- you vote subsidies for ethanol,
I'll vote subsidies for "clean" coal -- just about guarantees that.

So you might as well prepare your portfolio for the consequences.

--
There may come a time when the CO2 police will wander the earth telling
the poor and the dispossed how many dung chips they can put on their
cook fires. -- Captain Compassion.

Wherever I go it will be well with me, for it was well with me here, not
on account of the place, but of my judgments which I shall carry away
with me, for no one can deprive me of these; on the contrary, they alone
are my property, and cannot be taken away, and to possess them suffices
me wherever I am or whatever I do. -- EPICTETUS

Celibacy in healthy human beings is a form of
insanity. -- Captain Compassion

"Civilization is the interval between Ice Ages." -- Will Durant.

Joseph R. Darancette
dar...@NOSPAMcharter.net