ETHANOL FUEL MARKETS

Earlier we announced the imminent arrival of a book length report on the explosive market for ethanol fuel and fuel additives. On Tuesday, May 1, the report will be issued by Visant Strategies, www.visantstrategies.com, (631) 893-3028.

The report examines the roots of the current ethanol boom and chronicles the frenzy of plant construction activity currently underway. In it I project a very optimistic growth scenario for the industry with a near doubling of capacity occurring within five years from now and ultimately as much as a ten fold increase overall.

I also examine in detail the relative merits of the various feedstocks for ethanol production as well as all of the major production methods, both established and experimental.

This study is not a hype based forecast nor is it a species of Green advocacy. Instead I have attempted to determine the likeliest outcomes for the ethanol fuel business and the best business opportunities within it. And ethanol is a business, a big business, and one in which there will be winners and losers. The winners will be those who can produce ethanol cheaply and the losers will be those who are not cost competitive. It’s strictly a commodity market.

Right now almost all of the major manufacturers and most of the major investors are betting against new production technologies and new feedstocks. Practically all plants under construction around the world are of more or less traditional design. Only a handful utilize innovative techniques. And little wonder. Almost all plants are constructed by a few large plant engineering firms specializing in this area, and since none has actual experience in building or operating plants based on the newer techniques, their ability to quote projects utilizing such techniques with any degree of precision is rather limited. And since only one cellulosic ethanol plant is in commercial operation, the operational economics of the newer techniques are still mostly conjectural. Would you invest tens of millions of dollars in an unproven technology when failure would mean total loss and no possibility of selling the production equipment for anything other than scrap metal? Of course not, and neither would most equity investors.

So why not trial the new technologies on a smaller scale? That’s precisely what the process innovation companies are trying to do, but you can’t operate the plants profitably since economies of scale are everything in ethanol production irrespective of the processing technology. That best you can do is to establish proof of concept, and most investors want to get in after proof of concept is completed not before.

One other point that I make in the report and is worth repeating here: ethanol has a number of disadvantages as a motor fuel, and is far from a sure bet to replace gasoline. Something to keep in mind amidst all of the hype.

Ethanol Out takes

In the interests of brevity Visant Strategies excised some of the background material from the published text. As a sample of the type of analysis included in the report we’re providing the excised material here free of charge as out-takes.

Some of the material deals with the history of ethanol fuel, which is actually quite lengthy, and an extensive consideration of the Brazilian experiment is provided. We also include sections on ethanol burning engine design, the economics of sugar cane feedstocks, ethanol and peak oil, and production of petroleum-like synfuels which we believe will be the principal rivals of ethanol in the marketplace. We also give an account of the current fuel ethanol investment boom.

Out-take #1 - Speculative Ardor within the Financial Industry

The same institutions that financed the dot com and telecom booms, namely the leading investment banks and venture capital firms, are ardently promoting ethanol today. During the year 2005 approximately a billion dollars of new investment went into ethanol industry in the U.S. alone, while, at the same time, some large established manufactures have resorted to aggressive debt capitalization and new stock issues to finance ambitious new construction projects. To be sure, other areas of new energy technology have also benefited from rising concerns about energy security, but ethanol has received a disproportionate share of investments, and represents the most frenetic market within the alternative energy space today.

The pattern of further capital following the initial keystone investments of financial industry trendsetters is entirely to be expected, especially in what is perceived to be a long term growth industry that yet has excellent prospects for accelerated short and mid term growth. Should then the continuing copious flow of investment be considered a form of irrational exuberance akin to that which afflicted financial markets during the Internet Bubble Era of the late nineties?

We detect a similar lack of due diligence in many of the investments, which is one of the reasons we have undertaken this study. Potential investors and entrepreneurs need to be better informed on underlying technology and market issues and on those attributes of the automotive industry that condition acceptance or rejection of new fuel sources. We also believe that as a consequence of such ignorance the danger of an overheated market in ethanol and ethanol production facilities is real. But in many respects the dynamics of these two markets, that for ethanol fuel and that for new electronic communications technologies, are quite different. The Tech Bubble of the late nineties, which, incidentally, shows signs of reviving today, was concerned with a whole multitude of tenuously related technologies mostly having to do with digital networks of one sort or another. Fuel ethanol, on the other hand, only consists of two markets, motor fuel proper and fuel additives. Both of those are commodity markets, and both should be fairly predictable in terms of their relationship to the growing market for personal transportation and to the growing market for motor fuel to serve that market.

The presence of competition from other energy sources in the motor fuels market considerably complicates the business of generating projections, however, and, even were this not the case, severe overcapacity would not be inconceivable. The first American petroleum companies, which arose in the Civil War era and immediately thereafter, confronted a considerably less complex market than today’s energy sector, and one whose growth was virtually assured, and yet the majority quickly failed, precipitating relatively enormous losses among investors. Similarly, catrastrophic losses were the rule, not the exception, in the early automobile industry, and to a lesser extent in the railroad industry even though those industries constituted seminal transformational technologies. Even when a need is real, a new industry—and ethanol fuel is fundamentally a new industry—will frequently create an oversupply of its product as an excess of new producers races to meet perceived demand. The problem is compounded in the case of ethanol because new entrants as well as those incumbents who are engaged in re-inventing themselves are not starting on anything approaching an even footing when it comes to new technology. Some few, and they may be very few, command production processes with superior economics, and in a price eroded commodity market they are almost certain to prevail. The others will fail, just as the majority of firms have failed in every other bull technology market.

In the course of this process an undersupply is likely to follow at some point as the failures multiply, which in turn will prompt further gyrations in the market. The extent and severity of those gyrations will be functions of both the urgency of the demand, which is apt to be pronounced, and the difficulty that the ethanol industry has in modulating production to meet surges in demand.

What must be remembered here is that ethanol production is at once a heavy manufacturing industry and an agricultural enterprise and as such cannot easily track sudden convulsive changes in the market. Crops take time to cultivate, and, moreover, the arable land available to serve the ethanol industry is limited, and both factors constrain producers in augmenting production in response to the vicissitudes of increased demand. Simply put, the supply of feedstocks cannot be immediately increased nor can production facilities quickly be built or expanded. And, moreover, since plants are only economical to operate at near peak capacity, excess capacity that persists for any period of time, can bankrupt an enterprise. We explore such issues at length in the body of this study.

Our expectation is that investment will continue to flow into ethanol production based largely upon a growing demand for fuel oxygenates, a demand which is likely to be unmet for some considerable duration as governments throughout the world outlaw competing oxygenates and cast about for substitutes. We are more cautious in advancing scenarios where ethanol assumes dominance as a fuel for spark ignition internal combustion engines. Even in the United States, which constitutes a large and rather densely populated land mass with a super-abundance of feed stocks for producing ethanol, the majority opinion among experts is that the energy requirements for personal transportation are unlikely to be met with ethanol alone even if all nonfossil fuel feedstocks are thoroughly exploited—leaving aside the needs of commercial transport. Only if coal is converted into ethanol could an ethanol regime in personal transportation come into being in the U.S., but we would expect that if coal is extensively utilized for liquid fuel production, synfuels rather than ethanol would account for the bulk of production.

We are in fact rather pessimistic as to the prospects for ethanol assuming a majority status in the very long term. Both liquid synfuels and heavy alcohols have higher values as motor fuels than ethanol and are suited to a greater range of applications such as general aviation and small watercraft. We would add that DME from coal and stranded natural gas, currently a dark horse, exhibits superior economics all around, and appears least objectionable on the basis of greenhouse gas emissions. DME production as an alternative fuel industry may in fact prove to be a more rewarding to current investors than ethanol in the longer term because that industry is in an embryonic state at present and a period of great growth in both production and capital appreciation may lie ahead for early stage companies in this area.

Outake #2 - A Tale of Three Continents, North America, South America, and Europe

As we have seen, interest in ethanol revived in the U.S. in the late nineteen seventies, largely as a consequence of two oil crises during that decade. Serious research on cellulosic ethanol production resumed, and, in the wake of the phase out of leaded gasoline, so-called gasohol consisting of 90% gasoline and 10% ethanol found a market among the owners of high performance sports cars which required high octane fuel to function properly.

The brief ethanol boom of the late seventies and early eighties resulted in a rash of distillery construction in the U.S., often by agricultural cooperatives. Over 170 new facilities were constructed during that period, all but about forty of which ceased production by the end of the decade. It was, unfortunately, yet another manifestation of the usual cycle of boom and bust which has characterized the fuel ethanol industry all through its history, and, arguably still does.

A collapse in world oil prices in the eighties undercut the nascent ethanol revival of the preceding decade, and the almost universal adoption of MTBE as an oxygenate by oil refiners virtually destroyed the market for ethanol as a gasoline additive. Nevertheless, during the latter part of the decade and into the nineties, private research efforts toward developing new production techniques for ethanol intensified, primarily as a part of a larger effort for identifying fuels with lower green house gas emissions profiles in the wake of a spate of scientific publications trumpeting the dangers of global warming. Many of the companies promoting new production techniques today formed during the decade of the nineties.

Brazil’s experience was rather different from that of the United States. Brazil, the leading ethanol producer today with production slightly above that of the United States, also experienced the effects of oil shocks of the nineteen seventies, particularly the first shock which occurred in 1973. Unlike the U.S., Brazil was experiencing a rapid economic expansion at the time, but it suffered from balance of payment problems which ascending oil prices promised to exacerbate. The government, which was then presided over by a military junta, decided that a crash program in ethanol production might yield a solution.

At the time sugar prices were depressed, and cane sugar producers were beginning to face a challenge from manufacturers of high fructose corn syrup. Fuel ethanol looked to be a good secondary market.

Brazil didn’t get around to launching its ethanol initiative until 1975 after the first oil crisis had already passed, but one should keep in mind that the project was more in the nature of long term energy policy rather than a response to temporary market disturbance, as indeed it had to be given the scope. The government mandated a 20% ethanol to gasoline ratio for motor fuel and set in place an array of subsidies and financial incentives to encourage greatly increased production. In other words a real industrial policy in favor of ethanol was strongly implemented.

Further stimulus was provided by the rapid construction of a comprehensive distribution system. Petroleum production is a state monopoly in Brazil, and gasoline is sold primarily in stations controlled by Petrobas, the state oil company. Petrobas immediately set about making 20% blends available in all of its thousands of stations, and began building 100% ethanol storage and dispensing facilities while simultaneously the government began to press auto makers having factories in Brazil to manufacture vehicles capable of running on pure ethanol.

At the time, we should point out, Brazil was heavily protectionist toward its manufacturing sector, and duties on imported motor vehicles were onerous. Since Brazil’s native automobile industry was small and underdeveloped, the demand for affordable automobiles could only be met by major auto makers from abroad establishing factories specifically to serve the Brazilian market. In this kind of managed economy the government could act forcefully and quickly to set a new energy policy in place and it did so.

Ethanol production increased 500% between 1975 and 1979 when the next oil crisis struck, and then exhibited a further three fold increase from 1979 until 1985. The author recalls visits made to Brazil in 1980 and again in 1985, and the ever present aroma of alcohol on the streets of Rio de Janeiro.

In 1986 the Brazilian ethanol program began to founder. Oil prices plummeted on the world market, and fuel ethanol became a boondoggle in Brazil. By this time the military dictatorship had been succeeded by a democratic republic, and the government was in no position to shore up unpopular programs. The ethanol fuel program quickly began to lose impetus, though, as we’ll see, it was never abandoned.

By the nineteen nineties production of vehicles designed for pure ethanol fuel had ceased but the use of ethanol as an additive continued. And since the ratio of ethanol to gasoline continued to be 20%, plenty of fuel grade ethanol was still being produced. Thus when oil prices ascended again in 2001, Brazil had the infrastructure largely in place to respond. In five years the ratio of fuel ethanol to gasoline increased from 20% to 40%, and flex fuel cars which could run on any combination of gasoline and ethanol and either fuel in pure form became the norm. Today the Brazilian ethanol industry is poised to expand by 100% before the end of this decade.

The Brazilian experience with ethanol fuel is almost universally cited as the singular success story in the alternative fuels business, and alternative fuel advocates in other nations are often enjoined to study the Brazilian experiment if not to emulate the measures taken by the government and industry to put it in place. Clearly the project is succeeding now, but as recently as three years ago it was dismissed as a failure by a number of energy analysts, and had oil prices not remained elevated through the interim, the outcome could well have been different. While we believe that there are lessons to be learned from any large scale, longstanding alternative fuels project, those lessons may be counterintuitive, as we believe they are in the Brazilian example. The topic is taken up at length in the following chapter of this report.

Fuel Ethanol in Europe

All of Europe produces approximately 10% of the ethanol manufactured in either Brazil or the United States. Sugar beets are the most significant feedstock followed by wheat. European production technology has generally not kept pace with that of either the U.S. or Brazil, both of which represent the state of the art in production technology for their respective dominant feedstocks, grain and sugar cane.

Ethanol volumes in Europe will grow over the coming years as ethanol replaces other oxygenates in gasoline, but whether healthy markets will emerge for either pure ethanol fuel or for blends consisting of a high proportion of ethanol remains to be determined. Only in Sweden is there any market for pure or largely ethanol motor fuels, and throughout most of Europe biodiesel is the preferred Green fuel instead, and little wonder since a steadily increasing percentage of automobiles utilize spark ignition engines.

Generally, European nations have shown more interest in synfuels derived from biomass, that is, petroleum analogs, than in ethanol, methanol, or other alcohols, and, with the exception of Abengoa which borrowed its technology from SunOpta, no European firm has undertaken significant research in cellulosic ethanol production methods.

Many European governments maintain the official position that hydrogen will supplant hydrocarbon fuels in the longer term, and although we doubt the feasibility of a hydrogen transition, at least with anything resembling current technologies for hydrogen production and storage, those governments may be slow to put policies and incentives in place that would favor more economically viable alternative motor fuels.

Interest in alternative fuels is probably higher in Europe than elsewhere, and, overall, more research has been done on biofuel production processes than in either East Asia or the United States, but, ironically the prospects for alternatives in Europe including ethanol are more uncertain than elsewhere. Europe’s reigning alternative fuel, namely, biodiesel, is currently produced by costly and unsustainable methods, and the industry based upon it will soon approach a state of crisis if new techniques and production infrastructures are not put in place.

All in all we would not have looked to Europe as the locus for aggressive growth in fuel ethanol, but at the time of publication we have learned that ethanol production in Europe increased more than 70% in calendar 2006.

Outake #3 - Ethanol in the Context of Motor Vehicle Design

One of the primary arguments in favor of ethanol fuel is that it will require only minor adaptations in existing power plants on the part of the auto maker. There are no unsolved engineering problems in designing spark ignition engines to operate on ethanol nor in modifying most existing engines to do the same. The main requirements are “hardening” the engine components to endure the mildly corrosive effects of ethanol and eliminating vulnerable metals and plastics and adjusting the spark plug timing to accommodate the different flame propagation characteristics of ethanol vis a vis gasoline. Making a flex fuel can run on ethanol of gasoline is much easier than making one that can promiscuously utilize hydrogen and gasoline. The fact that the Brazilian auto industry was quickly able to convert to the exclusive manufacturing of flex fuel vehicles indicates that no insurmountable problems confront auto makers who would do so elsewhere. And the fact that a certain number of models of flex fuel vehicles are now available in the U.S. confirms that notion.

Still, we believe that most auto makers would prefer not to see ethanol assume pre-eminence as a motor fuel. Ethanol vehicles require considerably larger fuel tanks to achieve the same driving ranges as their gasoline counterparts, and significantly bigger fuel tanks impose design constraints on the product development teams.

Auto makers will accommodate an ethanol transition if it occurs, but they will do nothing to encourage it, we believe.

Brief mention should be made here of the possible roles that ethanol might play in the hydrogen economy and in the fuel cell market. Ethanol can serve as a hydrogen carrier and ethanol may fairly easily reformed to produce hydrogen gas; indeed, a number of ethanol to hydrogen reformers are commercially available today. There is also ongoing research toward the production of direct ethanol fuel cells where the ethanol is the fuel rather than hydrogen derived form ethanol. Making predictions with respect to these poorly established technologies is difficult. Methanol reformers have been far more successful in the marketplace than their ethanol brethren, and natural gas reformers have been more successful still. If low cost ethanol becomes readily available perhaps ethanol reformers will find a mass market, but this is by no means certain. As for direct ethanol fuel cells, there are no commercial examples on the market, and experimental work has not been encouraging. We think that the future of ethanol will remain with internal combustion engines.

Outake #4 - Some Ways of Thinking about Peak Oil

Quite a number of books have been published on the subject of peak oil as well as countless articles in both industry and general interest journals. In a study of this nature it is unfortunately quite impossible to reprise all of the arguments surrounding the issue let alone to state all of the evidence. Instead we must confine ourselves to establishing probabilities and to stating those facts which appear to have the greatest salience as to the ultimate outcome.

Let us begin with a statement of our own informed opinion. We believe that the production of conventional oil is likely to peak somewhere around the end of this decade, give or take two or three years—in other words, very soon. The weight of informed opinion is in agreement with this view and it is in no way unorthodox or radical. It is not universally accepted, however, and the possibility exists that it is wrong. The more optimistic estimates have it that peak oil production lies fifteen to twenty years beyond that point, perhaps as late as 2035, and recently Aramco, the Saudi national oil company, as well as Exxon-Mobil have issued statements to the effect that current consumption levels can be maintained for the rest of the century. Interestingly, the Bush Administration has recently hired Lee Raymond, ex-CEO of Exxon-Mobil, to prepare a report on energy issues, among them peak oil.

In the past such optimistic forecasts were more frequently heard. A few years ago the James Baker Institute at Rice University issued a report predicting production exceeding demand past 2050, and a Pentagon study from the beginning of the decade took a similarly sanguine view. Reports issued by various European economics summits at the beginning of this decade generally echoed such optimism. Recently, however, the number of authorities prepared to suggest that business as usual would prevail until mid-century has declined sharply.

Why should there be such a divergence in expert opinion? Much of the problem lies in the inadequacy of the published evidence on the size of oil reserves throughout the world, and fact that many countries commanding the largest reserves have prevented independent audits by oil consultants, most notably Saudi Arabia which has barred such consultants for decades, and whose oil reserves are the subject of order of magnitude discrepancies in respect to their size in the various estimates posited by petroleum industry insiders.

Current published estimates from reputable sources on the size of conventional oil reserves range from just over one trillion barrels remaining up to 3.5 trillion barrels. If one lacks certain knowledge of the size of remaining resources, then predicting the time when global production begins to decline is extremely difficult, and the range of informed estimates is so large as to put any alternative fuel venture at profound risk.

But, if the task of forecasting declines in production is difficult, it is not entirely impossible.

In the absence of reliable data on the size of current reserves one makes inferences based upon past observations of oil depletion occurring on the local level, and one must resort to mathematical models that have generally proven reliable in the past.

Extrapolations Based upon Oil Discovery Patterns

The data available in the public domain on oil discoveries is much better than that pertaining to reserves, simply because it applies to individual fields and can be tracked historically for accuracy. Discoveries simply cannot be concealed. A relative handful of large petroleum engineering companies bid on providing the infrastructure for oil fields, and their activities become known throughout the industry. While statements concerning the size of any given virgin field can be overstated in the beginning, subsequent production levels provide a check on the initial reporting, and these too are difficult to conceal or falsify. Then too, the number of important of discoveries can scarcely be subject to misreporting. Again, the same bidders will be involved and a large discovery will not go unannounced.

So what does the historical data tell us? Both the number and size of discoveries have been declining steadily since the late nineteen sixties, exhibiting precisely the predicted bell shaped curve that theory suggests. The shape of the curve itself tells us approximately the length of time between the peak of production and the peak of discovery—forty years, more or less. That number indicates that the global peak is imminent, since just under forty years now separate us from the peak of discovery in the late sixties.

What evidence do we have that this curve will actually obtain for the global petroleum industry?

Apart from the fact that we are now a good ways down the right side of the curve, itself a strong indication that the trend will continue inexorably, the same curve has manifested itself from region to region, with most oil producing nations already on the downward slope in production. Only the largest Middle Eastern producers, Saudi Arabia, Iraq, and Iran, appear to have swing capacity, that is, the ability to throttle up production to meet increasing demand. True, such producers command a disproportionate share of the world’s conventional oil, probably over 50%, but still the curve has held true so universally in the past that it is difficult to believe that it will not recur on the macro scale.

Another disquieting bit of information is the fact that the peak of oil production on a global per capita basis was passed long ago, indeed back in the year 1979. This indicates that production cannot possibly track demand as new nations become industrialized and their citizens demand personal transportation—unless of course tremendous new oil resources are discovered and are rapidly exploited.

Of course the question naturally arises as to why political figures and media pundits would be so seemingly unconcerned if all this were indeed the case. And, undeniably, peak oil is not a frequent topic of discussion in either the mainstream press or the political arena. True, there is a lot of bloviating in the U.S. about dependence upon Middle Eastern oil and the security problems arising from that unhappy state of affairs, but discussions of peak oil, while not entirely absent from the mass media, are still uncommon, and, when they occur, they are seldom in depth. And when the subject is broached in a political context, it is usually followed by a policy initiative declaring a mandate for full energy independence in twenty years, a goal that is almost impossible to achieve under any realistic fuel substitution scenario.

While we are disinclined to speculate on the motives of politicians at any length, a couple of explanations as to their apparent indifference suggest themselves.

Many political figures expect to have concluded their political careers by the time that oil shortages assume any urgency while others may believe that their command over public opinion is such that they can assuage the anxieties of the electorate indefinitely or divert attention to various “hot button” issues involving social mores. In any case, promoting expensive and controversial programs for lessening dependence on petroleum is politically hazardous at present for obvious reasons. What if one is premature? Look what happened to advocates of alternative fuels in the early eighties. Plunging oil prices made fools of them.

The other rationales for doing nothing are essentially historical in nature. One such rationale points to the past successes of industrial societies in generating ever greater amounts of energy at ever lower prices while demonstrating the consistent mistakes of the natural resources doomsayers. Technology leaders, especially the United States, will beat the odds and produce ever more cheap energy simply because they always have, or so this line of reasoning goes. So too, crop yields will steadily increase, and the earth will support billions more people at undreamt of levels of prosperity.

A similar argument has it that if a scarcity of oil manifests itself, that will result in price elevations which in turn will spur a search for new deposits. Technological advances will enable energy concerns to unearth new resources which in turn will increase supply and precipitate price declines.

A corollary of this viewpoint is that private investment will easily accommodate the required changes, and, that being the case, political inaction is not only permissible it is advisable.

A good summary of this overall perspective is provided by The Bottomless Well, a recent publication by Peter Huber and Mark P. Mills of the Wall Street Journal. Huber and Mills, incidentally, don’t deny the imminence of peak oil, but they tend to discount its importance. Other energy sources, they assume, will simply fill the gap, a notion that might give comfort to ethanol producers.

We happen to subscribe to the notion that technological innovation will play a major role in managing any energy transition in the future, but otherwise we see little to indicate the inevitability of a smooth and seamless transition.

The real problem is in bringing alternative fuel resources such as ethanol online at a sufficiently rapid pace as to counteract the anticipated decline in conventional fuel production.

There are at least three reasons to expect that alternative fuel production cannot and will not ramp up quickly enough to offset a diminution in the production of conventional petroleum. The first has to do with the absence of any well developed production chain for any alternative fuel whose cost effectiveness vis a vis conventional petroleum has been conclusively demonstrated. That makes investors hesitate. The second has to do with the sheer cost of new fuel production facilities. Any plant of appreciable capacity, that is, in excess of 100 million gallons per year, is likely to cost hundreds of millions if not billions of dollars to construct and to require years to complete. Many alternative fuel projects under construction today are pre-commercial, and those few that are in full production cannot possibly make a difference in overall fuel production patterns. Nor are there anywhere near the number of new facilities in the planning stage to achieve significant production volumes in the mid term.

And, as for the third reason, that is rooted in the basic behavior of politicians and political bodies. No one wishes to undertake costly palliatives for a problem that may not manifest itself until far into the future.

The problem with extractive industries like oil is that one can draw down one’s resources very quickly and easily up to a point and then suddenly the economics of recovery become distinctly less favorable. And if that industry involves an absolutely vital resource without well established substitutes, then the economic consequences may be dire.

A particular problem in dealing with the consequences of peak oil is a lack of apt and instructive historical analogies. Certainly societies have faced critical material scarcities in the past, but in most cases those were pre-industrial societies with limited coping mechanisms; more recent analogies largely consist of artificial and transient war time scarcities. And, incidentally, the full mobilization of industrial nations in the total wars of the twentieth century did result in impressive feats of invention and production for the purpose of replacing embargoed necessities. Germany produced enormous amounts of synthesized ammonia for explosives in the First World War and ethanol for motor fuel during the same conflict. The Luftwaffe ran largely on synthetic aviation fuel during the Second World War, while millions of motor vehicles throughout Europe utilized producer gas generated from wood chips. And in the U.S. during the same world conflict butyl rubber replaced natural rubber and later became the preferred substitute.

The question is whether a peace time society can respond with equal alacrity and effectiveness in changing its energy regime. That remains to be seen.

There is also the question of whether the peak of production can be maintained for any considerable duration before the inevitable decline sets in—in other words, is a high plateau at all possible? Probably not, but enhanced oil recovery techniques could perhaps extend the peak for some period of time.

A related question is how rapid a decline one might expect subsequently. The most optimistic estimate is about 2% per annum while the most pessimistic is double that. If world population and vehicle ownership were static, perhaps such a droop would not be catastrophic in its effects, but with much of the developing world clamoring to become motorized, and with agriculture consuming ever greater amounts of fossil fuels in the form of fertilizer, one cannot view the situation with complete equanimity.

Most economic projections we’ve seen on oil consumption in the decades to come assume that if oil continues to be available to meet demand that total consumption will rise anywhere from fifty to seventy percent over the course of the next 30 years. The question then arises, what if it’s not available? Obviously, absent alternatives, growth in transportation markets is choked, and a bidding war ensues among nations and indeed among individuals for remaining resources. Those with the greater financial means inevitably win such a bidding war.

Most economists who’ve speculated on the topic believe that any decline in production, however slight, would result in very steep price increases, and we have seen forecasts as high as $200 a barrel following hard on the heels of a clear and permanent decline in production. The National Energy Commission maintains that a 4% global shortfall, which could occur in as little as one year after the peak of production, might result in a 177% increase in the price of crude. Since every $50 increase in the price of a barrel of oil results in roughly one dollar more per gallon at the pump, $5 a gallon gasoline is not inconceivable in the U.S. sometime in the next decade.

We would conclude by noting that the Energy Information Agency has forecast continued high oil prices over the course of the next seven to ten years even should a clear peaking in production should not occur. Such elevated price levels will continue to stimulate the alternative fuels market and will be beneficial for ethanol producers.

Outake #5 - Sugarcane

More ethanol is produced from sugarcane than from any other source, and we believe that there is a good possibility that the dominance of cane will continue. Sugar cane offers two sizable advantages as a feedstock—immense yields of up to 90 tons per acre, and a simple production process that eliminates the initial fermentation stage associated with starchy feedstocks. Up-to-date Brazillian manufacturing techniques as well as selective breeding of the cane itself allow for parity pricing with gasoline at current world petroleum prices, and a factor of two cost advantage over European sugar producers, but whether those production process can be significantly improved upon remains to be seen. In any case, the most efficient Brazilian ethanol producers have brought total production costs down as low as fifteen cents per liter.

Many current efforts in selective breeding are directed toward producing cold resistant strains which will thrive in warm temperate zone regions, but the basic physiology of the plant would seem to preclude cultivation in any area subject to frosts. To date cultivation in warm Gulf Coast areas within the Continental United States has proven rather disappointing in respect to the size of the yields.

Brazil is the world leader in cane derived ethanol, both in terms of production volumes and in the technologies for the processing of cane into ethanol, but considerable interest has arisen in both India and South China in the cultivation of sugarcane on a massive scale for ethanol fuel production. Both countries are already major producers of ethanol from cane, and could easily expand their capacities for both sugar cane cultivation and for processing the cane to produce ethanol. Should the demand for ethanol continue to soar, it is entirely likely that other tropical and subtropical nations will expand the land under cultivation for sugar cane and add distilling capacity. Sugar refineries in tropical northern Australia are already entering the fuel business in some numbers and interest is high in many other tropical nations.

Because of the success that Brazil has enjoyed in manufacturing low cost ethanol from sugar cane, many industry observers assume that sugar cane is the feedstock of choice, given the opportunity to cultivate it, and that companies capable of raising the crop enjoy an inherent advantage in the economics of production.

We believe, however, that such assumptions represent a gross oversimplification of a complex energy policy pertaining to a single nation and a fundamental misreading of the evidence.

Sugar Cane – Natural History and the Economics of Cultivation

Sugarcane is a type of grass that is native to Southeast Asia. It has been cultivated for over 2,000 years, and there is evidence that ethanol was being distilled from cane juice in the early Christian era in India. Incidentally, the distillation of ethanol seems to have been independently invented by the civilized Amerindians of Peru and Bolivia hundreds if not thousands of years ago—an interesting example of parallel technological innovation.

Sugarcane is a perennial, and the plant can survive for several years. The plants can be harvested repeatedly without reseeding.

Sugarcane has a fairly restricted geographic range, thriving in regions of consistently warm weather and abundant rainfall. Sugarcane is not restricted to the tropics per se, but will not survive at high latitudes and cannot endure hard frosts. Southern Louisiana is the most northerly area in the U.S. where cane is cultivated, the other growing regions being located in south Florida, southeast Texas, Hawaii, and Puerto Rico. Attempts to raise sugar cane in Southern California have been unsuccessful to date, but efforts have resumed in the Imperial Valley with special cold resistant strains. Currently less than 30 sugar mills are operating on U.S. territories, and none is serving the ethanol fuel industry.

In marginal areas such as the Gulf States, growing seasons for cane may be only three to six months. In contrast, favorable tropical regimes may have nine month growing seasons. Special cold resistant strains are advisable in areas north of the Tropic of Cancer. During the cooler months, the plants become essentially dormant. Full maturation to the point where the plant may be harvested normally takes approximately eighteen months.

Once mature, sugar must be processed very quickly in order to extract the greatest quantity of sucrose. Sugar juice expressed from the plant is normally fermented immediately, with distillation following directly. Sugar mills necessarily must be located very close to the source of sugar cane.

Because of the long time span between harvests, and the near impossibility of storing either the cut cane or the extracted juice, the milling, fermentation, and distillation facilities remain idle much of the time, which represents a very poor utilization factor and which also necessitates a casual work force. In favorable tropical regimes plants may operate up to nine months per year, but in the American South plants they only operate three to six months out of the year.

In Brazil neither of these factors has proven highly problematic; the mills themselves have been subsidized directly or indirectly, and the vast number of underemployed rural poor makes Brazil a buyer’s market for employers. Nevertheless, in a more developed nation the underutilization of capital resources might prove troubling. One solution might be to design the mills to accommodate other sugar feedstocks such as sorghum and sugar beet molasses, a measure which would ensure protracted if not year round operation.

Sugarcane grows to considerable height, and very large yields are possible on fertile, well watered soil. Brazilian plantations regularly top 90 tons per acre, and Hawaiian growers derive as much as 80 tons of cane per acre per year from their fields, though much lower yields are the norm elsewhere in the world. North American growers, for example, average a little over 30 tons per acre per year.

To the uninitiated such tonnages suggest that cane will yield a superabundance of ethanol, but the matter is not nearly so simple as appearances might suggest. True, a cane field, best case, may produce twenty times as much biomass as a corn field, but whereas corn consists of 70% starch, the ultimate precursor of ethanol in grain feedstocks, cane has less than 15% sugar content, and only the sugar may be converted into alcohol since cane lacks any significant quantity of starchy matter. Typically cane fields do yield somewhat more ethanol per acre than corn fields, but the disparity is not enormous.

In Brazil sugar cane has been subject to much selective breeding and genetic modification and yields have doubled in a period of thirty years. In the U.S., however, yields have remained fairly static.

Cane juice itself requires only a single stage of fermentation to produce ethanol in contrast to starchy grains which necessitate two stages of fermentation, one to convert the starches into glucose, and a second to produce ethanol from glucose. The actual production of ethanol from cane juice requires only about 50% of the energy input as does production from grain since the grain must be cooked prior to the commencement of fermentation. Extraction of sugar juice from cane is an energy and capital intensive process, however, and involves crushing the cane with heavy machinery. Experimental techniques involving reverse osmosis can considerably improve the economics of sugar extraction, but they have not been adopted anywhere as yet.

As with most other biofuels, the biggest cost factor in ethanol production tends to be the feedstock, and with sugar fetching prices that are multiples of those for corn starch, sugar isn’t competitive as a fuel feedstock in North America. In Brazil, which suffered from overproduction of sugar in the seventies when the government launched the ethanol fuel program, government planners took an approach that was vaguely analogous to the U.S. farm subsidies. It simply established de fact limitations on the amount of cane that could be allocated for food production and set aside the rest for fuel ethanol at guaranteed prices. To be sure, those prices were a good deal lower than the market highs for refined sugar, but they were guaranteed and farmers value stability. Moreover, the government put in place generous subsidies for plant construction and for putting new land under cultivation. Cane cultivation went from being the kind high risk, single crop agricultural enterprise of the kind that has typified ex-colonial nations throughout the tropics to being a stable business with predictable returns on investment.

Another factor that has conduced to the favorable economics of ethanol production in Brazil is the fact that most ethanol is produced from molasses, not from raw sugar or sugar juice. In most sugar refineries molasses constitutes about half of the output and is normally seen as low value co-product. While a few individuals do enjoy molasses as a sweetener, that market is small, and molasses is typically added to animal feed and sold at low prices relative to refined sugar. The economics of producing ethanol from molasses are quite good, and if the sugar mill owner confronts a vast market for ethanol supported by the government, then it is more profitable by far to make ethanol from molasses than to sell it for hog feed. The mill owner can continue to sell refined sugar to confectioners while at the same time enjoying a profitable new market in fuel ethanol.

Of course at some point—and that point is not far off—the economics will change. If more ethanol is demanded by the market or by government mandate, then more of the cane will have to be devoted to ethanol production and profitable sales of refined sugar might have to be foregone. If ethanol prices rise sufficiently, that may not be a problem, except that when the whole crop rather than a co-product is devoted to ethanol production, cane may no longer be competitive with corn.

One other advantage that sugar has enjoyed in Brazil is that to date it has not competed with food crops for land. That could change in the future, but for the time being Brazil is on track to increase ethanol exports by some 50%.

Another Sugar Boom?

Sugar cane, to an extraordinary degree, has been associated with highly speculative investment and wild cycles of boom and bust. Arguably the world’s first cash crop, sugar cane was imported from India by Arabs in the late Middle Ages and raised on large slave plantations on the island of Cyprus. When Spain and Portugal overran the Atlantic islands of Madeira and the Canaries in the fifteenth century they sought to emulate the Arabs and to take advantage of the more favorable subtropical climates and rich volcanic soils of the newly claimed territories. With the conquest of the Americas shortly thereafter and the virtual depopulation of large parts of two continents, the Hispanic nations suddenly found themselves with immense resources of suitable land, and they henceforth commenced sugar cultivation on an enormous scale, utilizing techniques already perfected on the Atlantic islands. They were followed in time by French, English, and Dutch interlopers.

The freebooting planters who built the sugar plantations throughout the Caribbean and the Atlantic Coast of South America were scarcely farmers in the usual sense. Sugar was a luxury, not a staple, and was thought to have all manner of medicinal properties. It was also a highly suitable feedstock for beverage alcohol. Unlike subsistence farming, cane cultivation was highly capital intensive, requiring armies of slaves and expensive industrial machinery for juice extraction, fermentation, and distillation, and so well endowed adventurers or adept borrowers were the norm among planters—in other words, the planter was essentially an entrepreneur rather than a stolid, landed gentleman farmer. Incidentally, the infamous speculative episodes involving the Bank of Scotland and the South Sea Bubble at the beginning of the eighteenth century were both in large measure financing projects intended to extend cane cultivation in the tropics.

Now we’re seeing the cycle repeat itself. India, southern China, and various nations in Southeast Asia are contemplating greatly extended cane cultivation to meet an anticipated demand for fuel ethanol. Australia, already a major cane producer, is looking at the fuel ethanol business as well.

Most of theses nations share with Brazil a ready supply of low wage labor and a favorable climate for cane, but otherwise they may have difficulty in replicating Brazil’s success. Brazil in the seventies, while plagued with corruption and what now appear to be misguided protectionist economic policies, already possessed a sizable industrial base, the largest in Latin America by far. It also possessed a significant market for automobiles, and the ethanol program was set up primarily to meet the needs of the Brazilian motorist in the face of uncertain oil prices. Brazil’s comprehensive planning and long term commitment to ethanol made for success, and in fact Brazil was employing measures that took sugar cane out of the boom and bust cycle in which it had been trapped for centuries. Those who would enter the ethanol business now with a rash of new sugar mills appear to have a very different perspective, however. They’re counting on a return to boom times and on turning a quick buck—the same expectations harbored by growers ever since sugar became a cash crop during the Age of Exploration.

Unlike Brazil, the new coterie of aspirants may not be able to depend upon lavish government subsidies. Fuel ethanol is merely one new economy industry among many vying for cash in the rapidly industrializing nations of Southeast Asia, and one has to ask can it compete with microchips for investment capital? Furthermore, cane may be competing with food in environments already suffering from past episodes of speculative cash crops and plant monocultures, including rubber, coffee, and palm.

One could conceive that one crop economies could become the norm in many tropical countries if ethanol or other fuel alcohols establish themselves as the dominant energy sources for personal transportation, and one could also expect that the same adverse economic and environmental effects as occurred in the past might recur. An ethanol nation could quite possibly better fit the model of the banana republic than of the oil emirate, although neither model seems to bode well for the long term prosperity of the nation embracing it.

In any case, we believe that nations already boasting sizable sugar industries, such as India and the Philippines, would be more likely to establish fuel ethanol businesses in the mid term and would be more likely to succeed than countries or enterprises lacking significant experience.