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Ethanol Craze?

Agriculture.com Staff 09/08/2006 @ 12:38pm

The old saying goes something like "too much of a good thing and eventually pay the price." That might be the case in the ethanol industry.

One perspective suggests that the recent good fortunes that have been experienced by ethanol companies should have the industry concerned that too much of a good thing, profits for ethanol plants, eventually leads to over-expansion and a problem for all of the ethanol industry.

Exceptionally cheap cash corn prices (due to large crop the past two years) and a spike in ethanol prices (due primarily to the mandating of an ethanol mix in gas formula for consumers) has been the ideal situation for those already in the ethanol business.

Investors, as well as builders of plants, have benefited more than most anyone could anticipate. However, in the long run, history has proven over and over again that industries such as the ethanol craze eventually come back in line with more of the basic laws of economics. Why? It is a matter of simple supply and demand.

When profits are high and eyes are glassed over with no end in sight as to how long cash will flow into the trough, investors step up to the plate in order to get their share. Eventually though, it comes to an end. Our concern for those investing in future ethanol plants is that one of two likely scenarios will occur.

In the long haul, enough ethanol plants will be built to meet demand. At some point, there is a diminishing return and an ethanol plant or plants will be built that are unprofitable. Secondly, we have concerns that energy prices, while staying in the upper 60s or lower 70s for crude oil price, could crash in future years. Just as any market that rallies, at times prices go down.

Recently, we've heard a number of energy analysts suggest that energy markets are not likely to go down, but continue to go upward. Our question is this: Where were these people three years ago when energy prices were half of what they are now? Suddenly, they've come out of the woodwork after the rally and tell us that energy prices are going to stay high. Bottom line: no one knows.

Lastly, the big push for ethanol profits the last year and a half have come primarily from dirt-cheap corn. What happens the year when timely rains don't fall and corn production goes from a reliable 11 or 12 billion bushels down to 9 or 10 billion or less? Theoretically, the market runs out of corn. That won't happen due to a rationing effect in which prices skyrocket. If ethanol plants aren't well-positioned or hedged, there will be a serious bloodletting in which investors will wish they'd never considered the idea of investing in ethanol.

Bottom line, the industry is hot now because it is new, exciting, and profitable. As the market gives, it can take. Be prepared and careful for anything in the future. Remember the tech stock craze!

If you have any questions or comments or would like more detailed strategies for your situation, please contact Top Farmer at 1-800-TOP-FARM, ext. 129.

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