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Investing in ethanol is popular, but volatile due to factors such as corn prices and government subsidies. Lack of data on ethanol demand and fluctuating oil prices also contribute to uncertainty and potential removal from portfolios during tough economic times.
Investing in ethanol has seen remarkable popularity as a way to invest in non-oil based alternative energy. These investments, while attractive due to their novelty, can be highly volatile due to a number of factors. Most of the ethanol produced in the United States comes from corn, so the price of ethanol manufacturing is highly dependent on the price of corn. The price of oil also influences ethanol prices, since ethanol appears more attractive as an alternative energy source when the price of oil is relatively high.
The industry that creates ethanol from US corn is relatively new. An unproven industry making a new product, however intriguing, will usually be subject to market concerns. Such was the case with the company VeraSun. After closing a futures contract for corn for just under $7 US dollars (USD) per bushel, the market price of corn fell to less than $5 USD per bushel. VeraSun announced that because of this, they would experience an operating loss of up to $103 million dollars in that quarter. While this is a significant loss, the market reacted in a huge way, driving VeraSun’s stock price down 73% in one day.
The volatility of corn prices is not the only problem for ethanol investments. Many ethanol producers are helped by government subsidies and laws, such as those that require the blending of ethanol with retail gasoline. However, this federal backing is not as secure from an investment perspective as market-based consumer demand is. Nor does it necessarily indicate a profitable future for the ethanol industry.
Investment markets can feel the uncertainty that is present when companies or products are insulated from the usual economic laws of supply and demand. Investments in ethanol, then, suffer from this latent uncertainty in the form of volatility. Additionally, due to the lack of hard, real-world data regarding ethanol demand, ethanol investments may be among the first to be removed from a financial portfolio when tough economic times hit.
Oil and gasoline prices have seen unprecedented volatility in the 2000s, most notably in 2008, when there was a rapid rise in the price of oil and gas, followed by an even faster decline. This is an important point to consider because when oil and gasoline are relatively cheap, ethanol investments look less attractive by comparison. For example, if a petroleum-based fuel is cheaper than its ethanol counterpart, most consumers will choose the less expensive option, thereby reducing the demand for ethanol and the profitability of ethanol investments. The corollary is also true: high gas prices tend to bode well for ethanol investments, but rapid price changes contribute greatly to the volatility of such investments.
Smart Asset.
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