This is a catastrophe unfolding in slow motion right before our eyes. The tealeaves are in place and the consequences can be readily deduced. We all understand our dependence on fossil fuels and its suppliers require we do everything to ameliorate future problems before they emerge. But Corn based ethanol is not a solution, and because of the billions of dollars already expended (and in the pipeline) and the political constituency set to benefit from this government inspired solution, the price toll and mis allocation of investment will not be stopped now, but will be allowed to mushroom into a far far larger problem.
It is a short to intermediate term opportunity for investors, and the victims (what else when politicians are at the wheel) will be the public at large. Lets take a look.
As I mentioned, we all need to address the problems of greenhouse emissions, energy production, and its efficient use. I support this with all my heart and head. But Corn based ethanol produces no benefit for anyone but the politicians and their campaign committee supporters. The ethanol industry, the politicians and the “misinformed and mislead” in the public support it with all their hearts. It is a freight train of unintended consequences headed directly at you.
But it is not just the agricultural community that is affected, Live stock producers are reducing future herds because of high feed costs (protecting their current profit margins), rushing existing livestock to market pushing prices temporarily lower before they whipsaw much higher when the public demands their be beef, chicken and pork in the grocery stores. People will not stop eating meat and grain stuffs so we can save the country from its energy consumption problems.
This industry would never have been born if an honest cost and benefit analysis had been conducted. There is no net gain from the ethanol industry. NONE. It arguably uses more energy to produce then it creates to be consumed. That is the bottom line. For every gallon of ethanol produced you might and I say might get 1.1 unit of energy for 1 unit of energy used to produce it.
Dennis Gartman of the www.thegartmanletter.com sums it up quite nicely “Simply put, and rounding to the nearest numbers for the sake of simplicity, we note that in producing 10 gallons of ethanol we need to expend the rough equivalent of 7 gallons of gasoline. That on the surface would be a fine swap. The problem is that those same 10 gallons of ethanol produce 85,000 BTUs of energy, while the 7 gallons of gasoline produce 125,000 BTUs! Thus the 10 gallons of ethanol contain the same energy output/equivalent of 6.75 gallons of gasoline.” OUCH.
On top of this every gallon produced in the US is subsidized by 50 cents on the gallon by the taxpayers and energy consuming public. The very people this industry was created to benefit. This is one of the very very bad consequences of this. The price of corn has doubled; as corn has become more scarce, live stock producers have switched to wheat. The price of wheat has skyrocketed. Wheat is in extremely short supply as production worldwide has declined for 6 years in a row and demand has continued to grow. There is no extra wheat in storage or in the fields to meet the extra demand as livestock producers switch to wheat. Soybeans supplies are ample, but livestock can’t eat beans as a substitute for wheat or corn except on a very limited basis. And in order to price in the incentive for farmers to plant enough beans to avoiding creating a shortage in the future, the price of Soybeans have risen 50%, as we go to press the European Union is mandating biofuel use rise to 20% of energy consumption, setting the stage for the coming soybean shortages. And example of the inflation directly ahead was detailed by Keith Collins, chief economist of the US department of Agriculture, who told the 1800 attendees at the USDA annual conference that the net returns for each acre of corn (maize) would rise to $334 from last years return of $125. In response there was a sharp gasp of breath, followed by a celebratory cheers as farmers started to count their potential windfalls. This sets the stage for even more recklessness and poor decision-making. And anecdotal evidence/news reports that the reckless drive to cash in is rolling across the country. The amount of new corn acres looks set to rise far far further than predicted just a month ago.
Grain supplies worldwide are at 50 year lows in terms of inventory. In the big picture there is no corn or wheat to meet today’s food demand, let alone the skyrocketing new demand by the ethanol plants. Do you realize how the prices of many items are going to be affected by this? The price distortions and inflationary effects that is rolling into the prices of other everyday items from cereal, bread, pasta, meat, just to name a few. You can’t understand the tsunami echoing into supermarkets around the world by the shortages of corn and wheat, this uneconomic enterprise is creating. Think about the billions of dollars being invested in the Midwest to produce this product that costs more than it produces. Many of these enterprises are owned by the local farmers and once again they will temporarily benefit from the boom in agriculture prices, but when the economics turn against them they will be left holding the bag. Or the taxpayer will!! Probably both.
These plants will be bought out of bankruptcy when celulose/switchgrass technologies are developed that allow a profit to be made, and energy production and consumption are a net benefit. The economics, energy yields and environmental benefits of cellulose/switchgrass are outstanding and when the technology is perfected the economics of corn-based ethanol will absolutely collapse. Till then we will see an inflationary spiral with no benefit to anyone but small group of those in the industry who are being subsidized by the government and the farmers of the grains themselves. Corn based ethanol is not an economic, energy yielding or environmentally beneficial enterprise. When this new cellulose/switchgrass technology is available you will have a crash in the price of food and agricultural commodities. From overproduction! Destroying the people who misallocated capital to “Invest” in the advertised as booming and viable industry. The “little guy” and the “fools” that rushed in based on the headlines and promises of sugarplums by politicians trying to buy votes or repay industrial campaign supporters.
During the last 4 years of worldwide economic growth demand worldwide has skyrocketed for Grains and meats as the emerging and developed world alike increase their consumption. Worldwide demand for these things are at record levels while worldwide inventories are at historical lows.
What if there are Crop problems? Chinese sees the problems emerging and has stopped all new ethanol plants, as they have no extra corn in the bins. (Chinese politicians do not need to worry about reelection, they have their eyes firmly on orderly growth and sustainability, conversely US and European politicians devise political solutions to problem rather than practical solutions) Wheat production last year in Australia suffered a crop failure, as did the Ukraine, as did India, now all have export bans in place. Prices are skyrocketing for basic food stuffs (corn, wheat, meat, etc.) in these countries. You can read the reports daily in international business publications such as the financial times and Wall Street Journal. If the US even sneezes during the coming growing season international trade in grains will be at a standstill as governments scramble to secure food for their populations. There is no margin for error. NONE!
Add to this the huge numbers of new corn ethanol plants coming on line on a weekly and monthly basis in the United States and Europe, all on the buy side of corn, creating new demand that really can’t be met. And as the prices rise the economics of their businesses get worse and worse. Every rise in the price of the corn punishing their slim to none profitability, creating additional demand for more and more taxpayer funded subsidies. So the public will pay three times, once at the checkout counter at the grocery store, once at the gas pump as the 50 cent subsidy is passed right through to them at the pump, and then at tax time when the money has to be collected to fund and subsidize this atrocity.
Now President Bush is in Brazil signing a joint initiative to expand the ethanol industry across the world, pitting these efficient, economically and environmentally viable sugar based ethanol producers against the disaster that is the current US corn ethanol industry. As Holman Jenkins posits in the today’s WSJ; “How many of the 111 U.S. ethanol refineries already in operation depend on tax handouts, mandates and import tariffs to keep themselves profitable? Probably all of them. How many of the 78 on the drawing board would be uncompetitive at world prices? Probably most. And many of these are being built with federal or state grants, only enlarging the coalition for protectionism.” Thanks Holman. Europe is busily building the same boondoggles modeled on US initiatives to what else? Benefit the powerful farming and alternative fuels industry there.
These issues are plainly seen, but US and European politicians are busily putting the pedal to the metal in expanding this industry and looming government created disaster, what are they thinking? Are they thinking at all? No. I saw an interview with Senator Charles Grassley of Iowa, and he bemoaned the Brazilian ethanol industry and pooh poohed President Bush’s initiative in South America saying we need to encourage more growth in our domestic ethanol industry. Lets see? Sugar based ethanol has all the hall marks of good business, energy yields are high, the environmental gains are good, and it is very profitable in all aspects, as opposed to the US ethanol industry which has no benefit to anyone but his small Midwest constituency. Who will be slaughtered on the altar of his hubris? Charles coincidentally sits on the tax committee, so much the better for a Senator who wish is to steal from the public at large and transfer the money to his own supporters. Charles presents himself as a thoughtful and intelligent person, but close inspection of his positions on taxes and agriculture know this man is either an amiable dunce or a very evil man.
If the United States or Europe have “any” crop problems this season it will create a “WORLDWIDE” panic. And a skyrocketing in all food prices directly or indirectly through out the world. As governments fight over the food required to feed themselves. As Americans we have had decades of low food prices, as America has been the breadbasket of the world. A source of cheap and abundant grains and meats (we are major exporters of meats), thereby driving food prices lower for everyone worldwide.
But now that has changed, we are going to be the cause of a calamity worldwide caused by this little US government inspired boondoggle (little in that the total amount of money generated is of the US ethanol industry is about 6 billion dollars in a 50 trillion dollar economy). There will be 10’s if not 100’s of billions of dollars in costs related to this stupidity. All to create no Benefit to any participant. But the people in the ethanol industry who bought off the politicians through campaign contributions and foolish farm state politicians who can’t see past the next election cycle. MARK MY WORDS DOWN. It will ultimately be a headline disaster, both on the upside and the ensuing collapse. But if you are smart can make a lot of money during the trip…
by Ty Andros
Managed Futures & Alternative Investment Specialist
233 West Jackson Blvd. Ste. 725
Chicago, IL 60606