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Every day the U.S. imports more than 13 million barrels of crude oil and related petroleum products. That's equal to more than 567 million gallons of crude per day -- around 60% of the country's energy needs. Even a temporary interruption of that supply can lead to energy shortages and price spikes that have severe, lasting economic impacts. What's worse is that many of those imports come courtesy of politically unstable regions of the world. As my chart below shows, close to 20% of America's crude oil imports come from the Middle East, where oil infrastructure is a constant target for terrorist groups. And another 15% comes from West Africa, including countries like Nigeria where rebel groups have been implicated in the kidnapping of several foreign oil workers. In short: America's imported oil supply is far from secure.
And the nation pays dearly for that lack of security in the form of higher oil prices. As just about every consumer already knows, crude has been hovering well above $70 per barrel in recent months despite large inventories of oil in storage. In fact, more than 35% of the U.S. trade deficit is directly due to imported crude oil; Americans spend a whopping $800 million on imported oil per day. And every time there's a terror attack or negative geopolitical development, oil prices spike. Few would argue that there's a significant political risk premium built into oil prices. The Domestic Energy Source
America Has Been Waiting For That's exactly the promise held out by ethanol and other so-called biofuels. The term biofuel refers to any energy source that's derived from agricultural products or organic matter. Far and away the most common biofuel in the U.S. is ethanol -- a type of alcohol distilled mainly from corn. The U.S. is one of the world's largest producers and exporters of corn; most of the nation's ethanol is produced directly from corn grown right in the heartland of the U.S. Midwest. Therefore, ethanol is totally free of political risk. Right now, there are two main uses for ethanol. First and foremost, ethanol is a common blending agent -- refineries mix ethanol with conventionally produced gasoline to produce a blended fuel. Every car sold in the U.S. is capable of burning up to 10% ethanol, and most are capable of burning fuels with mixtures of as high as 15%. In fact, ethanol is already blended with conventional gasoline in most parts of the country -- you have probably already filled up with the corn-derived fuel without even knowing it. Even better, ethanol's use as a blending agent is growing quickly due to a series of environmental regulations. In 1990, the Clean Air Act went into effect. This legislation limited the amount of carbon monoxide and unburned hydrocarbons (basically gasoline that didn't ignite properly) that could be released from passenger cars. Readers who live in or near certain metropolitan areas are likely familiar with air quality tests that must be performed on their cars every few years to test for the presence of such pollutants. Much of this is a result of clean air legislation. One way to lower the carbon monoxide content of automotive exhaust is to oxygenate fuel -- basically add a chemical that increases the oxygen in fuel when it's burned. Back in the early 1990's, the oxidizer of choice became a chemical called methyl tertiary butyl ether -- commonly known as MTBE. MTBE effectively oxidizes fuel and is inexpensive to produce. But in the years after 1990, MTBE was found to have some unfortunate side effects. Specifically, MTBE bonds easily and readily with water -- when it leaks from fuel tanks it often finds its way into the groundwater supply. And secondly, MTBE is thought to cause cancer -- at least 28 States have listed the additive as a carcinogen. That's where ethanol comes in. As an effective oxidizer, it's the only widely available alternative to MTBE. Earlier this year, U.S. refiners switched from using MTBE to using ethanol as an oxygenating blendstock; the government is phasing out the use of MTBE. Demand Far Outstrips Supply To meet demand for ethanol, the nation's ethanol producers are building out their capacity to produce the fuel; with prices at current levels, producing ethanol from corn is highly profitable. Meanwhile, a host of new producers are entering the fray, frantically building new facilities just to keep pace with booming demand. This industry clearly has years of growth ahead of it. But that's only one use for ethanol. While normal cars can burn fuels with as much as 10% to 15% ethanol, specially modified cars known as flex-fuel vehicles are capable of burning gasoline much richer in ethanol. In fact, a blend of fuel known as E85 -- 85% ethanol and 15% gasoline -- is already available at approximately 600 gas stations around the U.S. About 5 million cars in the U.S. are currently capable of burning this fuel, and more models are being added every year. Better yet, E85 generally sells for about a 15% discount to the cost of regular gasoline, providing consumers with a significant incentive to switch to the fuel. Government Incentives Of course, ethanol can never fully replace crude oil or totally break America's dependence on foreign oil. The U.S. consumes some 320 billion gallons of crude oil every year -- even if Congress' mandate is achieved, ethanol would account for just 2.5% of annual demand. Nonetheless, ethanol will certainly play a role in decreasing America's dependence on oil. Right now, E85 is only available in 600 of the nation's 150,000 plus gas stations, but that number is growing every day. If gasoline prices remain at sky-high levels and E85 becomes more widely distributed, then it could well catch on with consumers in a big way. Some lawmakers even envision legislation targeting 60 billion or more gallons of ethanol consumption by 2030 -- an amount that would put a meaningful dent in America's import dependence. To get an idea of the potential, consider the case of Brazil. Brazil produces ethanol from sugar instead of corn; sugar-derived ethanol costs about half as much to produce as corn-derived fuel. In 2005, more than half the cars sold in Brazil were capable of running on any mixture of ethanol and gasoline; these flex-fuel cars can even run on 100% pure ethanol fuel. Brazilian ethanol has proven extraordinarily popular -- ethanol actually accounts for more than half of all fuel burned in passenger cars in that nation.
Growth in Biodiesel So-called biodiesel is produced from rapeseed oil -- an oil better known to most Americans as canola oil. Rapeseed-derived biodiesel is currently being widely used in Western Europe as a blending agent to reduce the sulphur content of traditional diesel. In fact, new E.U. regulations to be phased in over the next few years will all but mandate the elimination of sulphur in diesel. The easiest way to make zero-sulphur fuel is to mix conventional diesel with biodiesel. The existing fleet of diesel passenger cars can handle mixtures of as much as 25% biodiesel. The E.U., like the U.S., is directly mandating and using incentives to encourage greater use of biodiesel. The region is targeting 5.75% biodiesel use by 2010 and as much as 20% by 2020. Currently less than 3% of diesel fuel consumed is biodiesel -- the growth potential here is tremendous. The U.S. too is seeing increased interest in biodiesel production. Soybeans make an even better choice of crop to make the fuel, and America's climate is well-suited for growing beans. In fact, the U.S. is already a leading producer and exporter of soybeans and soybean-derived oils. Even better, diesel engines are roughly 25% more efficient than gasoline engines. While biodiesel is currently very expensive to make, costs are falling as producers garner additional experience with the fuel. How Can Investors Profit
from this Growing Industry? Editor's Note: Throughout the remainder of this article, StreetAuthority.com founder Paul Tracy and his staff provide an in-depth analysis of seven different individual stocks that will give investors exposure to booming growth in the ethanol and biofuel market. To view the remainder of this article, you'll need to subscribe to our premium Market Advisor newsletter. Please visit one of the following links to continue . . . Good investing!
Paul Tracy founded StreetAuthority and became Chief Investment Strategist in 2001. Prior to that he spent several years as Managing Editor at a multi-million dollar financial publishing firm with over 150,000 subscribers. In addition to his role as managing editor and lead financial writer, he was also responsible for equity research and managing a team of seasoned professional financial writers, researchers and market commentators. Paul's previous experience includes a position at Robert W. Baird & Co.'s full-service brokerage operations as well as economic research work on a Money and Banking project funded by the National Bureau of Economic Research. He has also spent time doing outside consulting and research for the University of Virginia, has appeared as a guest expert on several prominent financial radio shows, and has been a featured speaker at various investment conferences across the U.S. Paul graduated with a B.S.
in Finance and Management from the McIntire School of Commerce at the
University of Virginia.
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Bottom
line: ethanol demand is growing quickly and the government is actively
pushing the fuel. The Energy Information Administration (EIA), a unit of the
U.S. Department of Energy, projects massive growth for the fuel. That's
despite the fact that the EIA models only tiny demand for E85 -- their
estimates are based almost solely on ethanol's use as a fuel additive.
My chart shows the EIA's projected growth for ethanol compared to growth
in gasoline demand out to 2030. As the chart clearly shows, ethanol use
is projected to grow more than 4 times as fast as conventional fuel.
