Ethanol: Behind the Buzz

From the White House to Wall Street, ethanol has moved to the heart of national debate about energy, security and the environment.

Its champions promise that it will win energy independence for the U.S.; aid its farmers; weaken hostile oil-subsidized regimes in Tehran, Caracas and Moscow; and better the environment. But the skeptics see little more than a massive agricultural subsidy dressed in patriotic and green rhetoric.

In March, President Bush traveled to Brazil to sign a landmark agreement encouraging ethanol innovation and trade, and then to Detroit to press the CEOs of General Motors(GM), Ford(F) and DaimlerChrysler(DCX) to produce ethanol "flex-fuel" vehicles.

The truth, unsurprisingly, is more complex and creates an array of investment opportunities.

Defining the Product

Ethanol fuel is identical to the alcohol in your merlot or martini. It is less potent than gasoline, providing 75% less energy per gallon, and is commonly blended with gasoline for retail sale. Although conventional auto engines can utilize low-ethanol fuel concentrations without alteration, greater concentrations -- such as the "E85" 85% ethanol standard in the U.S. -- require "flex-fuel" engine modification.

Production is booming. Global output of ethanol more than doubled between 2000 and 2005. It comprises the bulk of the worldwide biofuel market, which is forecast to grow to $80.9 billion by 2016 from $20.5 billion in 2006. The U.S. and Brazil dominate, dividing more than 70% of the ethanol market evenly between them, with the European Union and South and Central America capturing most of the remainder.

Much like liquor, ethanol can be distilled from different ingredients through various methods. Three ingredients dominate the industry: sugar, corn and cellulose. Although they produce identical final products, each raises different technological, commercial and political issues.