The Great Corn Rush Of 2006

Ethanol profits are drawing in investors, but can the heyday last?

Facilities that can turn kernels into clean fuel seem to be sprouting up faster than the corn itself. There are 101 ethanol plants in existence, more than 41 new facilities and expansions in the works, and another 100 in the planning stages. At an average construction cost of $75 million, that's potentially $10.5 billion headed into ethanol.

Why the rush? Investors are wowed by the combination of short supply, surging demand, and government subsidies that top $2 billion annually. Already much of the nation's production capacity of 5 billion gallons is being soaked up by government mandates. Last spring, regulators ordered that ethanol replace MTBE, an environmentally suspect agent, as an emissions-cutting additive in the nation's gasoline. What's more, Washington is pushing for "renewable fuel standards," setting national sales targets for fuels such as E85, a mix of 85% ethanol and 15% gas.

The result: Wholesale ethanol prices now sit at just under $3, compared with around $2 a year ago. And since a gallon of ethanol costs just $1 to $1.30 to make and the government pays an additional 51 cents in subsidies for each gallon of ethanol, profits are booming. "These [plants] are money-printing machines," paying for themselves within a year, says Jason S. Grumet, executive director of the National Commission on Energy Policy, a bipartisan group of energy experts.

But don't break ground on your own backyard ethanol plant just yet. There are plenty of reasons for doubting that corn fuel is the answer to the nation's energy woes. Using today's production methods, it would take 85% of the U.S. corn acreage to produce enough to replace just 10% of gas demand, according to Alexander E. Farrell at the University of California, Berkeley. And since people and cows like to eat corn, too, rising demand could send prices soaring, making ethanol investments much less of a sure thing. Already, the Agriculture Dept. expects a bushel from this summer's harvest to fetch 24% more than last year.

What's more, since corn kernels must be cooked to make ethanol, producers are vulnerable to energy-price spikes. "Is money being thrown around? Yes. Is some of it unwise money? Yes," says Brian Jennings, executive director of the American Coalition for Ethanol.

Some investors are making moves to cut the risks. In Mead, Neb., E3 BioFuels is building a plant smack next to a cattle feedlot. To fire its distillers, the plant draws in methane captured from manure, cutting operating costs by 35%. Even the waste is cheaper to dispose of: The remnants of the corn kernels are fed to the cattle next door, rather than dried and shipped out. Overall, the plant will be 15 times more efficient than a traditional plant.

Investors such as Royal Dutch Shell, Goldman Sachs (GS ), and venture capitalist Vinod Khosla are betting that bigger payoffs await in next-generation ethanol from so-called cellulosic sources. That's because cellulosic ethanol, made from corn stalks, saw grass, and even municipal waste, yields nearly seven times more fuel than corn kernels. The first cellulosic plants are expected to come online in 2009.

Still, it's costlier to break down cellulose into ethanol than it is to break down kernels of corn. Giants such as Archer Daniels Midland (ADM ) and Abengoa Bioenergy, and startups like Goldman-backed Iogen and Khosla's Celunol, are developing a variety of approaches to crack the problem. And many of today's kernel-fed facilities are built to be convertible to cellulosic production once the kinks are worked out.

With all of the troubles on the near and distant horizons, ethanol can't be considered a panacea. But more of it will soon find its way into cars -- and investors are sure to go with the flow.

By Heather Green

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