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Ethanol train still building momentum?

The ethanol train has been the story of 2006, with huge profits from ethanol
plant processing and tremendous interest from investors in building more plants.
The past year's profit from ethanol extraction might have more than paid for
some plants over the past 12-24 months.

The pace of building has made the
market outlook for the next few years look very bright, as US expansion of corn
acres needed to meet the additional demand is estimated at 5 million acres/year
last year, and for the foreseeable future.

US support of ethanol use is strong, with most politicians unhappy with US
policy in the Middle East and interested in more domestic methods to solve our
dependency on energy. Ethanol has been a natural solution to many problems
including chronic overproduction of grains and a shortage of energy. Most
candidates in the past midterm election campaigned in support of ethanol, and
the current push seems for more support of biofuels, not less, in policy
decisions.

While this seemed almost a perfect situation, the rapid market price rise the
past few months has changed some attitudes, as some pain is being felt by
livestock producers, importers, and biofuels producers with higher prices of
grains. While the higher prices are trying to solve what could become a supply
shortage situation in the future, the situation of attracting acres away from
other food/feed uses into corn is starting to have some repercussions in other
areas. We are starting to hear some grumbling of the results of the adjustment
process as resources are shifted to respond to the market situation. Some US
think tank type groups are starting to question the wisdom of drastic shifts in
resources from food/feed use to energy production.

Markets will work in the long run, but in the short term there are certain
issues that are generated. But in the end, isn't that exactly how markets can
work?

China's announcement this week of placing some limits on the use of corn for
energy was the first official government declaration that shifting lots of
resources to energy production may not be in their best interest.

This could
have far reaching implications for the grain markets. Is this a sign of the
biofuels revolution beginning to end? Or is US policy likely to be the dominant
player in the biofuels revolution? China is the first government to announce
some inclination to limit the use of grains for fuel, while other countries (EU
and US) are pushing hard for biofuels in their official government policy. The
whole premise of the marketplace today is based upon the continued development
of biofuels and the difficulty the marketplace will have to try to meet that
additional demand. This is somewhat different than the Russian Grain buying of
the 70's as this was outside our control, where today the biofuels revolution is
a policy put forth by elected officials in our two regions.

The Chinese
announcement of a potential policy change is the first indication by anyone that
a potential policy change could occur. This could greatly cripple the rally, as
the assumption under current policy is that we will develop a shortage of
food/feed by burning it up in our fuel tanks. So the market is bidding up
prices of grain to solve this potential future problem today.

A significant change in government policy towards biofuels could have far-
reaching implications for the marketplace, as any slowdown in biofuels
development could cause a great change in the psychology of the marketplace. If
we stopped support of biofuels today, the whole makeup of grains would change
from one of shortage to potentially surplus at current prices, so this is a
great risk for the market today. Are we ready to make that change in policy?
The market will be assessing this new factor in the next few weeks.

This may be exactly the linchpin that could end the current grains rally. But
are prices high enough to do that today? Left unchanged, the biofuels
revolution could very well be the multiple year demand that could propel
agriculture to near unprecedented prosperity over the next few years. The fuel
demand is virtually an unlimited market for grains, and one that could have very
beneficial results for US energy policy. It also could drive food/feed prices
back to levels where grain producers are happy to produce without any government
supports whatsoever. This could truly be a golden age for agriculture!

But, a wavering in support for biofuels just when it gets going could be a
disaster to grain markets. Any perceived change in the government policy
towards biofuels will pressure prices, but what it will really take to kill the
market rally will be actual changes in policies or a torrid price drop in energy
prices. Any combination of real changes such as that could have terrible
consequences for grain prices, and in the end might be the only thing that can
end this current bull market.

In the end, perhaps the unparalleled optimism for the use of grains for fuel
will be too optimistic, as we just can't produce enough grain to supply all our
fuel needs at current consumption levels. The rapid pace of development and
construction of ethanol plants perhaps cannot be sustained indefinitely. But, the low grain prices of the past decade also cannot be sustained with the
value of the grains as fuels even better than for food/feed. This push-and-pull
of the marketplace is just now starting to be felt, with the public debate just
beginning.

Perhaps that is the role of the marketplace anyway, to allocate resources to
their best use as valued by all players. We are just now seeing the issues
being discussed more openly, but in the end it might be the marketplace that
settles the matter, not think tanks and pundits.

For now, the bidding wars for these (finally!) valuable resources are heating
up, and the players are all starting to voice their opinions. The marketplace,
as usual, though, is left to solve the problems, and so far it doesn't appear to
have done enough to change US policy towards biofuels, or investors enthusiasm
towards biofuels investments. Until that changes, perhaps the marketplace
hasn't yet accomplished its goal or performed its duty?

The ethanol train has been the story of 2006, with huge profits from ethanol plant processing and tremendous interest from investors in building more plants. The past year's profit from ethanol extraction might have more than paid for some plants over the past 12-24 months.

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