Market Analysis

Hyped Up on Hooch

Nearly three quarters of a century after the end of Prohibition, bootleggers are making a comeback. This time, though, they're turning that corn hooch into fuel, not moonshine.

Nearly three quarters of a century after the end of Prohibition, bootleggers are making a comeback. This time, though, they're turning that corn hooch into fuel, not moonshine.

Think about today's world—there's nary a product, corporation, or ad campaign that doesn't loudly proclaim the greenness of its creator. And ethanol is one of the biggest means to that end, offering enormous potential for a greener world according to alternative energy proponents. Corn, it seems, has unintentionally regained its sex appeal. But a little sobriety is needed here. The ethanol craze is a classic case of politics overruling rational science and economics.

What's behind the recent surge in corn popularity? Ethanol gained steam with President George Bush's Advanced Energy Initiative, introduced in his 2006 State of the Union Address. His stated goal is to replace 15% of projected gasoline use with ethanol and other fuels by 2017. With that in mind, Congress gave the ethanol industry a shot in the arm, extending tax credits for farmers and the 54 cent-per-gallon tariff on imported ethanol while requiring that 7.5 billion gallons of the nation's fuel come from biodiesel by 2012. Recent proposals in the Senate have taken it even further—36 billion gallons of the stuff by 2022.

These are admirable goals. The reality is corn ethanol isn't quite ready for the big stage yet, neither economically or environmentally. The subsidies and political handouts probably have something to do with the fact that America's top 10 corn-growing states hold almost 40% of the Electoral College votes.

Many academic studies point to the energy balance of corn ethanol being a loser's game today. That is, figures suggest corn ethanol requires just as much if not more carbon-emitting fossil fuel than it creates.

But let's say that ratio is greatly improved in the future through technological advances (a completely logical and likely assumption). It would still barely make a dent in our energy needs. According to National Geographic, if the entire US corn and soybean crops were turned into biofuels, it would replace just 12% of US gasoline and a meager 6% of US diesel (not to mention dramatically increasing the price of Corn Flakes). There's a good reason growing fuel isn't quite the energy panacea it's being promoted as—at least not yet.

Whatever the viability of ethanol as an alternative energy source in the future, its popularity illustrates the unintended economic and market implications of political meddling. The ethanol boom has already pushed corn prices to levels not seen in decades. The last time corn traded consistently in the $4 a bushel range was 1995, a time former President Bill Clinton called the "worst drought in 100 years"—a legitimate supply-side shock to corn prices.

All of this has spurred US farmers into dramatically boosting their production. About a fifth of the crop will be converted into ethanol, more than double the amount five years ago. The economic ramifications from artificially tinkering with demand have not yet been fully realized but could have large scale ramifications.

A better way to handle the alternative energy riddle: Drop trade restrictions and let the markets have at it. Brazilian sugarcane ethanol, for example, holds up much better as a viable alternative. Its energy balance is one unit input of fossil fuel for eight units of sugarcane ethanol. And the economics make sense. In Brazil, a gallon of gasoline cost $4.91, while the energy equivalent in sugarcane ethanol is $3.88. That's why almost all of Brazil's cars run on the stuff. Problem is, there is the aforementioned tariff on Brazilian ethanol thanks to the protectionists in Congress, keeping the playing field unfairly tilted towards less efficient solutions.

Ultimately, if ethanol, or some alternative, solves the "sustainable" energy puzzle, the market will be the first to know. Political pandering and silly subsidizing will merely create inefficiencies and delay potentially meaningful breakthroughs. It's sexy to be green right now—look no further than Oscar winner and Nobel laureate, Al Gore. It will make some quite rich, and corporations will ride the positive public relations as long as they can. But given the way politicians are distilling energy policy, be wary of the potential economic hangover. Grain alcohol can be strong stuff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.