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Economics: Going Green
New York: February 05, 2007
By John R. Stephenson

"Faced with this emergency, now is not the time for half measures. It is the time for a revolution, in the true sense of the term."

--French President - Jacque Chirac - February 2, 2007

What a difference a year or two makes! Last year, the Republicans were firmly in control of Congress and the environment was on the back burner. Big oil and the war in Iraq were the major issues. But all of that was before crude oil bounced off $78/barrel, hurricane Katrina ripped through New Orleans and Al Gore shot to prominence with An Inconvenient Truth, a movie about climate change. Today, every politician on the planet is talking green and the environment is solidly at the forefront of discussions.

Politicians, long noted for their intransigence on environmental issues, have realized that this issue is hot. Big oil never had a better friend in the White House than George Bush, but even he felt the need to discuss "the serious challenges of global climate change" in his most recent state-of-the-union address. As a result, America now has an aggressive target of reducing gasoline consumption some 20% by 2017. To dial-in on this reduction, America will have to become increasingly dependent on corn-based ethanol. This is certainly welcome news for the American corn farmer.

For politicians, going green is a natural. Five of the warmest years ever recorded in the history of the planet have occurred in the last six years. To the average person, the inescapable reality that the planet is warmer today than when they were kids has finally taken root. As well, the strong advocacy of the environmental movement, the effects of hurricane Katrina on the gulf coast as well as other incidents of freakish weather has the public clamoring for action.

But this time around, the public has a surprising advocate for change — big business. Faced with the prospect of a patchwork quilt of state regulations on the environment, big business is looking to the feds for direction on the environment. As well, business is sensing that environmental technologies could be a new source of profit. For politicians, the motivations are different. They can be seen to be the good guys with this issue, but another equally important political motivation is national security. By developing alternative fuels, America can reduce its oil dependence which is increasingly reliant on unstable and, in some cases, hostile regions of the world.

This burgeoning enthusiasm for the environment has created a bull market for alternative energy solutions. According to New Energy Finance, Americans invested some $30 billion in the alternative energy sector in 2006 alone. One of the prime beneficiaries of this movement is the demand for ethanol, a fuel additive. In the U.S., ethanol is made from corn. Ethanol acts as a fuel replacement or gasoline extender by reducing the carbon monoxide that is produced when it is mixed and burned with regular gasoline. In other parts of the world, ethanol (or grain alcohol) is made from barley, wheat, sugar cane (Brazil), sugar beet (France), barley, potatoes or cassava.

Figure 1: Ethanol Demand is Projected to Grow!

The strong interest in ethanol as a potential solution to the world's energy crisis has led to a bull market in corn and grains of all types. Food stocks around the world are at thirty year lows as production shifts from food for consumption (by people and animals) to food for fuel. With government mandates becoming ever more stringent on emissions, a bizarre dynamic may be established where food is grown not for consumption, but rather for fuel. This could eventually result in a global situation where rich countries are pitted against poor countries in a struggle for scarce resources. Within countries, the drive for increased biofuels (such as ethanol) are increasing the cost of food, making it more difficult to feed the urban poor. Making matters worse, is that politicians, rather than economists or business people, are establishing the guidelines for emissions. To date, it remains to be seen if North Americans will have enough rural land to grow sufficient corn to meet the new environmental guidelines. Dow Chemical's CEO recently stated: "We don't have enough land in America to produce corn-based ethanol and feed the people". The situation looks dire.

Figure 2: Brazil and the United States are the World's Largest Ethanol Producers

It is not just biofuels such as ethanol that have been on the rise of late, in much of the world, alternative fuels called biodiesel fuels have been all the rage. In the European Union, biodiesel is very popular, particularly in Germany, France and Italy. Much less toxic than petroleum diesel, these biodiesel fuels are produced by combining vegetable-based oils (soy and palm oil are the most common) with alcohol and a catalyst to form a fuel. For countries such as Indonesia and Malaysia (with 84% of the global production of palm oil), this boom in biodiesel fuels has been a godsend.

Nowhere is the political heft of this rising environmental movement more obvious than in the United States where, in the last month alone, the United States overtook Brazil as the leading producer of ethanol worldwide. Unlike the U.S., Brazil has been in the game for a long time with sugar cane based ethanol production dating back to the 1970s. The result of this aggressive investment in alternative energy is that today, Brazil is 100% energy independent, with ethanol accounting for 40% of the fuel Brazilians use in their cars. Sugar cane makes a much more suitable ethanol feedstock than corn resulting in a 50% reduction in processing costs. But corn is what we have a lot of in America — not sugar cane. In this crazy new world that is greening quickly, it is the political imperative rather than the economic one that is winning out.

In states such as California, the going green message has been the rage for quite some time. In 2006, the state passed its Global Warming Solutions Act, a law that requires greenhouse gas emissions to be rolled back to their 1990 levels by 2020 — a very ambitious target. Already, the first salvo of the war on emissions has begun with Governor Schwarzenegger issuing a regulation earlier this month, which obligates the producers of gasoline and other fuels to cut the carbon dioxide emissions from their products by 10% by 2020. For utilities and other electricity generators in California, the message is the same, generate 20% of the power they sell from sources such as windmills and biomass by 2010 and 33% by 2020. The state's initiative to increase solar power ("million solar roofs") scheme has been gaining traction among consumers with the state planning to pump some $3 billion over the next decade into the initiative.

Figure 3: The Left Leaning States Are the Most Environmentally Friendly

But in the rush to go green, one key question has remained unanswered — is it even economical? For some, the answer is a clear no . Some economists who have studied the economics of ethanol have come away disappointed. The reason is that the energy inputs required to produce ethanol are greater than the energy that can be produced from ethanol. According to a 2005 study conducted by Cornell and the University of California, Berkley it took 29% more fossil fuel to turn corn into ethanol than the fuel produced.

While this may cause many to pause, the political imperative has just become too great for politicians to ignore. With a stroke of a pen, politicians around the globe are creating whole new industries dedicated to producing alternative forms of energy for human consumption. The results so far are clear, higher commodity prices for corn, soybean and palm oil in the future.

One way for investors to play the rising tide of the environmental movement (short of buying farmland in Iowa) is to take positions in the companies that produce fertilizer and the rail companies that transport these commodities. For farmers, the dual purpose for some of their cash crops (food or fuel) seems to be ample incentive to increase production to the extent that they can. Fertilizing the land seems to be the logical choice for farmers since it doubles production over organic (one reason organic produce costs so much) at a time when farm economics can be maximized. For investors, the railroads that service farm country and the fertilizer companies that increase crop production seem the most logical way to play the bull market in agriculture.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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