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Investors are embarking on a new Adventure in Wonderland. Actually, the action takes place in Iowa rather than Wonderland, but it might as well be Alice’s Rabbit Hole for all the sense it makes. The otherwise down-to-earth Iowans have taken to chasing the "Ethanol Hare".

According to the Iowa Renewable Fuels Association there are 28 ethanol plants in Iowa alone. Four new ones are under construction and another 26 are in the planning stages. It does not seem to concern anyone that if all are completed, it would require the entire Iowa corn crop to keep them running. Let the cows eat oats!

I am going to miss that yummy Blue Bunny ice cream. Blue Bunny is made with rich, tasty milk from Wells Dairy, Inc., located in LeMars, Iowa. Wells, which is the largest family-owned dairy processor in the U.S., boasts that the Iowa State Legislature once designated Le Mars as the Ice Cream Capital of the World. Now that made sense!

Today the politicians envision Iowa as the “Fuel” Capital of the World. They are getting plenty of encouragement in that fantasy. The National Corn Growers Association describes ethanol as the agriculture success story and devotes quite a bit of its members’ resources to promoting the use of corn for ethanol production.

I acknowledge that using a formula with the right string of government subsidies and fixed input prices, ethanol can be portrayed as an economical alternative to high priced oil. That economic argument does not change the fact that, at the current state of automotive engine efficiency, the amount of grain required to fill a 25-gallon SUV gas tank with ethanol could feed one person for a year. Let the people eat...well, oats!

I do not think I am alone in saying that, while I like my Cherrios, there is nothing like a nice big corn muffin, toasted and dripping with butter. For a large portion of the world’s population, it is not just a matter of taste, it is a matter of survival. The Earth Policy Institute provides an interesting and if not slightly quixotic discussion of the questions that are posed by the use of highly desirable food stuffs for fuel.

It seems that the Street is prepared to sit down at this “mad-tea party.” The Chicago Board of Trade is planning an ethanol futures contract. Web sites, such as Ethanol Market and Investmentu.com, have sprung up to provide investment advice. An FBR analyst recently shifted his focus to the “ethanol industry.”

An “ethanol index” seems like a logical next step. While such an index would likely include large agriculture concerns such as Archer Daniels Midland, Inc. (ADM), the ethanol producers are comparatively smaller. Pacific Ethanol, Inc. (PEIX) closed at $18.25 on August 21, 2006, giving it a market capitalization of $692.4 million. PEIX peaked at $42.39 in early May 2006, falling to $18.25 at the close August 21st.

Less seasoned names could also appear in such an index. Great Plains Renewable Energy, Inc. (GPRE) would be a likely candidate. Great Plains, which sold its first shares in November 2005, in the mid-$30’s, traded to a high of $63.50 and has since fallen back to $27.50. VeraSun Energy Corp. (VSE) debuted mid-June at $30.00 per share, falling precipitously since. Aventine Renewable Energy Holdings, Inc. (AVR) has not faired any better. The AVR was introduced at the beginning of July at $40.00 and closed yesterday at $25.37. The price declines in these stocks have trimmed the market capitalizations down to the small-cap range.

Investors could have bought a lot of Blue Bunny Bars with the losses they have taken so far in the ethanol stocks. Worse yet, the food-fuel fight is likely just beginning. Whenever there is competition for scarce or limited resources it leads to higher input prices and softer profit margins. Ethanol investors should take care they do not end up in Alice’s “pool of tears.”

PEIX vs. GPRE 1-yr chart:



VSE vs. AVR 2 month chart:

Source: Iowa's Adventures in Ethanol