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Ethanol has been beaten down in the press lately as firms that rushed into the market are faced with high raw material prices and low market acceptance. Early on in the boom, farmers who invested in ethanol plants reaped enough profits to pay off their investments in just a few years. As investors saw the profit potential they rushed in, hoping for massive gains and created an inflationary spiral in the corn market. Corn prices more than doubled, causing riots in Mexico (where corn is a basic foodstuff) and creating a situation where farmers stopped producing other crops and switched to corn. In the last year, cotton has lost 30% of its acreage as farmers switched from cotton to corn.

The biggest challenge facing corn based ethanol plants going forward will be the potential for water shortages as water use in making corn based ethanol is significant. While the total water usage may not rise by a large amount, the long-term effects could be severe.

In the Gulf of Mexico there is a 7,900 square mile area known as the dead zone. The area is so depleted of oxygen that fish cannot survive. There are worries about a possible rapid increase in the dead zone due to nitrogen runoff in the water supply from the planting of corn in the Mississippi River basin. Environmentalists fear that a continued increase of nitrogen runoff will set off a chain reaction in the Gulf of Mexico and Mississippi River basin.

30 years ago the Brazilian government put its weight behind ethanol as an alternative fuel. Now as we see oil prices continuing to show strength at the $90 level, Brazil has declared independence from imported oil. This will provide a significant boost going forward for the world's 10th largest economy as none of the economies above Brazil can make that claim.

As long as the US and Europe continue to block attempts by Brazil to slash ethanol tariffs in the WTO, Brazil will continue to gain a competitive advantage with the world. Lowering tariffs would create a more competitive environment globally where low cost ethanol producers will be forced to either become cost competitive or exit the sector.

At the present time, sugar based ethanol is the price leader at the present time with prices approaching $1.25 per gallon. The markets are beginning ot catch on to sugars price advantage and have bid the price up over 10 cents.

In the next few years, if cellulosic ethanol can become viable at levels approaching sugar based ethanol than the US will be able to make a transition from oil to ethanol based fuels. The problem with including cellulosic ethanol in any discussion is that the final costs in producing a gallon are not yet known.

If cellulosic ethanol (especially those made from forms of invasive weeds like Johnsongrass) can come with costs of $1.25 a gallon, challenging sugar based ethanol, versus corn based ethanol at $3 then marginal producers will exit the sector causing a fall in corn prices tumbling down the ladder to tortilla, feedstock, and eventually meat prices. Prices will rise for cellulosic ethanol as farmers switch crops, causing pain for investors who were late to the boom, and eventually the system will move to a point of balance.

One of the risks of cellulosic ethanol is that some of the plants used to create ethanol can be known as aggressive weeds which may cause long-term damage to surrounding farms and areas.

With the 2007 energy bill is now complete the push towards alternative fuel sources will begin in earnest. The rise in national fuel economy standards is a start as is the mandatory use of biofuel but the long lead time before meeting the standard does not impose a sense of urgency which is needed.

Even with an increase in the mandate, the automobile industry has to be ready to meet the increasing and changing demand. This transition period can take years as evidenced by Brazil but will pay dividends in the long run

Source: Ethanol Update: Challenges and Opportunities