The Bush Administration took a giant leap in the direction of alternative energy during the President's State of the Union Address. His plan to increase ethanol production in an effort to stockpile 35 billion gallons by 2012 sent the alternative fuels market into a frenzy. The price of corn reached new highs, indirectly affecting the U.S.'s Latin neighbors, who remain dependant on corn as a staple crop.
Tortilla prices soared in Mexican markets shortly after Bush delivered his address. A rise in tortilla prices will eventually force the price of food and other commodities higher. Consequently, of course, Mexico's poor, those who account for the majority of the country's population, will suffer the most from the price hike.
Ethanol, harvested from fermenting sugar from corn and other crops, may replace a fossil fuel dependent energy economy. It has been touted as a panacea for the U.S.'s "on again/off again" oil crisis. According to Forbes.com journalist, Jonathan Fahey (in a January 23, 2007 article titled, "Ethanol: Payback Time"), the price of corn is expected to reach $4 a bushel. Corn makes up for 75 percent of the cost it takes to produce ethanol. When you do the math, the average market price for ethanol (net tax) is 2.04 per gallon, 70 cents more than the average price of gasoline.
Moreover, ethanol yields only two-thirds the amount of energy as gasoline. Ethanol users often complain they lose mileage when switching from gas to ethanol. The question is whether the use of ethanol will be economically viable. Will switching to ethanol alleviate the financial pressure caused by U.S. dependence on foreign oil? Will the benefit of relieving our nation's dependence on foreign oil cover the high costs of producing an ethanol substitute? Keep in mind that these costs include an increase in the price of staples and other food commodities as well.
In addition, companies that raise corn fed livestock will suffer from rising prices, thus hiking the price of meat. Other losers will include car owners and taxpayers. I will reveal to you the winners in the February issue of Kenneth Coleman's Investment Tracker newsletter.
The switch to ethanol may not be economically feasible or realistic, and it does not encapsulate America's idea of a "cheap" solution to its growing dependence on foreign oil. In fact, the argument for the use of ethanol is even weaker than its proponents would have you believe. At some point, perhaps as early as 2010, the demand for a crude oil substitute will eventually wane as the price of crude drops dramatically.
Often present throughout history, the law of supply and demand will ease oil prices. According to the American Institute for Economic Research (www.aier.com), "High oil prices beget low oil prices." Is this an inherent contradiction or isn't it?
Not hardly; the laws of supply and demand dictate that the commodity quantity supplied (regardless the type of commodity) expands in response to rising prices. The same goes for oil. The only difference is it takes more time to produce oil. The process of exploration, discovery, and extraction is extremely time-consuming. It takes an average of two to four years to find and develop oil reserves.
2004 bared witness to a massive explosion in the price of crude (from $30 per barrel to a record nominal price of $79 this last summer). Consequently, global exploration and development is currently surging following a 20-year slump. Over time, increased activity in this sector will most likely increase the pressure of supply and demand on oil prices, which is exactly what happened in the 1970s. Initially, the price of oil soared to unprecedented highs. Then, following massive exploration, the price per barrel of crude plunged below $12 a barrel.
Those investors heavily invested in the alternative energy sector were wiped out, while many of the companies they were invested in were forced into bankruptcy. The lesson here is that alternative energy cannot exist in a free market crude oil cycle without the support of Congress. Government subsidies for alternative energy quickly evaporate once conventional energy prices return to low levels.
However, this time could be different. With the help of Congress and several major corporate players, alternative energy may be here to stay. The issue will be extremely covert throughout the 2008 presidential election year because the real reason for subsidizing ethanol at $4 per gallon at the pump will never be discussed. I will explain more on this subject in the upcoming issue. Meanwhile, it may be wise to begin considering alternative energy investments. You may want to look at companies like Archer Daniels Midland, Vera Sun Energy, and Pacific Ethanol. Stay Tuned!
