Ethanol's future bright even with lower oil price

In an effort to reduce reliance on foreign oil, governors of 37 states — including Washington — asked the federal government on Wednesday for a new rule to mandate use of ethanol — an alcohol distilled from crops that can be burned like gasoline. Currently, automotive-engine warranties limit ethanol use to 10 percent. The rule would call for 25 percent ethanol by 2025.

The governors' timing was not ideal. Crude-oil prices recently fell to $53.76 a barrel. Ethanol is only cheaper to produce than gasoline when oil is between $65 and $70 a barrel. But this break-even point will decrease as more ethanol capacity comes online, which is happening rapidly. Plus, the price of oil may not stay low for long.

With 220 million vehicles on the road today in the U.S. there's already a strong market for ethanol, which has been added to gasoline for years. Washington state is helping to bolster that market; last year, the state Legislature required that by December 2008, all gasoline sold in Washington contain at least 2 percent ethanol.

U.S. producers make about 5.6 billion gallons of ethanol each year. There's a potential market of 14 billion gallons a year nationally, assuming 10 percent ethanol in gasoline. "That's why ethanol prices are currently well above gasoline prices. The demand outstrips supply," says Jacques Rousseau, ethanol analyst at Friedman Billings Ramsey & Co. When engines are made to accommodate more ethanol, the potential market would expand further.

Sugar can yield far more ethanol per acre than corn, but little sugar is grown here. For this reason, the U.S. gives tax breaks to corn-based ethanol producers and slaps a tariff on imported sugar. That has helped ethanol producers and major agribusinesses like Archer Daniels Midland achieve record profits and stock performance in 2006. Ethanol demand has raised prices for corn and led to shortages of less-profitable crops such as barley.

In the future, ethanol will be produced from even cheaper crops such as prairie grasses, and plant wastes such as corn husks and wheat stalks.

"I think domestic producers are in a good position to take advantage of those technologies," Rousseau says. "They're already using the corn, and in five years or so, they can use the whole plant and make even more."