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The Corn Ethanol Myth & My Retirement

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert & Spencer Wright
June 3, 2008

IN THIS ISSUE:

1.  Ethanol: A Feel-Good Political Ploy

2.  No Solution To Current Fuel Woes

3.  Potential Negative Economic Impact

4.  No Benefit From Existing Infrastructure

5.  Other Types Of Ethanol Show Promise

6.  Conclusions – Ethanol Is Not The Silver Bullet

7.  Pondering My Retirement

Introduction

You don’t need me to tell you that oil and gas prices are at record levels. It seems like folks talk about little else these days and rightly so. The massive increase in oil and gas prices has stunned the consumer. How far have prices risen over the past year? On May 22, 2007 crude hit a high of $66.35 and one year later on May 22, 2008 it hit an all-time high of $135.08; a 104% increase! Gasoline prices over the same time frame have gone from $3.22 a gallon to $3.93 a gallon on average nationwide.  And if you are thinking that gas still has room to the upside, you are exactly right.

With that unpleasant news on all of our minds, we want to take a look this week at what many politicians are pushing as the key to our energy independence - corn ethanol. Corn ethanol is being promoted by politicians as the “silver bullet” to our energy problems, and farmers are racing to plant as much corn as they can everywhere that they can. But is corn ethanol really the answer? This week, we argue that the answer is probably not.

In the discussion below, Spencer Wright will walk us through the pros and cons of corn ethanol. Together, we will point out that corn ethanol is likely no more energy or cost effective than fossil fuels. Some experts argue that a gallon of corn ethanol requires more energy than it produces. We believe that corn ethanol is not the promised answer to US energy independence, and that the widespread promotion of ethanol, should it continue, will cause food prices to continue to ratchet higher in the years to come.

This is why we entitled this article “The Ethanol Myth.”  What follows is a good deal of information you are not likely to hear in the mainstream press and certainly not from the politicians in Washington who have bought hook-line-and-sinker into the ethanol story for their own political gain.

And finally, as much as I hate to admit it, I am having thoughts of retirement even at the ripe old/young age of 56.  I will share my thoughts with you at the end of this week’s E-Letter.  Let’s get started.

THE ETHANOL MYTH
by Spencer Wright

Ethanol: A Feel-Good Political Ploy

Corn-based ethanol was first championed by US agribusiness during the 1970’s gasoline crisis and has now returned with a vengeance. This time it has been totally and completely embraced by politicians on both sides of the aisle in Congress. Why? Simple, it is green, it is economical and it will help us reduce our dependence on foreign oil, or so the politicians in Washington tell us. Yet as you will see below, corn ethanol is likely none of these things. By embracing corn-based ethanol, politicians can claim that they are environmentally friendly and that they are doing something about rising fuel costs all at the same time.

Of course it is no coincidence that massive agribusiness combines like Archer Daniels Midland have been promoting (read: lobbying for) corn ethanol in Washington since the 1970s. And they have been very, very successful. So successful, in fact, that ethanol receives a government price subsidy of apprx. $1.90 per gallon! And that is only part of the massive government perks for ethanol producers.

ADM is one of the largest grain producers in the world, possessing the capacity to produce over 1.1 billion gallons of corn ethanol per year for which it receives nearly $526,000,000 in total subsidies from the government. As a result ADM and other agribusiness combines are big time lobbyists for corn ethanol.

It is also important to remember that Iowa is a major corn and ethanol producer. Why is this important? Well, Iowa holds the first in the nation presidential caucus to launch each general election season. Prospective presidents can’t come through Iowa and bash corn-based ethanol. Those that do tend to lose.

So agribusiness lobbyists convince the politicians that corn ethanol is actually a viable alternative to petroleum; the politicians, in turn, redirect federal tax dollars to support the ethanol industry and agribusiness through subsidies and tax credits ($5.7 billion in federal tax credits over the next five years alone); and then they return to their constituencies where they tell us how green they are, and that they are working hard for a solution to high gas prices and are also making America more secure as we wean ourselves off of foreign oil.

I am sorry folks, but this is nothing but a “feel-good” political ploy that is terribly wrong.

No Solution To Current Fuel Woes

At this point, I want to clarify that most of my comments are related to ethanol made from corn, and not other sources such as sugar cane.  While corn is something that America has in abundance, it is among the least efficient raw materials for making ethanol, as I will discuss in more detail below.  All of the abundance and lobbying can’t change this fact.

Corn ethanol is very expensive to produce and would never make it in a free market without its massive federal subsidies. Even at $3.93 on average for gasoline? Yes. The current average price at the pump for E85 ethanol is $3.12. If we add on the $1.90 government subsidy, you get a per gallon price of $5.02. There are some who price E85’s real cost to the consumer at $6.89 per gallon after a number of other government subsidies and perks are added in. While I would not go that far, clearly corn ethanol cannot stand on its own.

Of course, it isn’t only the cost that weighs on corn ethanol. It is also highly inefficient. Ethanol from any source is 20-30% less efficient than gasoline, making it more expensive per highway mile. It takes about 450 pounds of corn to produce the ethanol to fill one SUV tank, or enough corn to feed the average person for a year.

But wait, it gets worse: some studies show that more than one gallon of combined fossil fuels is required to produce one gallon of corn ethanol. How can this be? Well, fields must be plowed, corn must be planted and grown, fertilized, harvested and trucked to ethanol producers - and all that uses fossil fuels. As a result, the energy production to energy output ratio of ethanol is very nearly 1:1. Not exactly an energy saving proposition, is it? 

In addition, the process of making corn ethanol requires an estimated four gallons of water to produce one gallon of ethanol, and some studies show an even higher water-to-ethanol ratio.  The pro-ethanol lobby disputes this assertion with some claiming that there is actually a gain of clean water from the process.  Reading the pro-ethanol material, however, reveals that they do not consider the approximately 80% of the water used which evaporates during the cooling process as “lost.” 

Here, I guess you have to think like an ecologist.  While most of us think that alternative uses for water pulled from aquifers as being for irrigating other crops, drinking or other industrial uses, the pro-ethanol forces feel it’s just as valuable released as water vapor to return to the earth as rain at some point, eventually making it into reservoirs and the underground water table.  To say the least, this is going to take quite a bit of time. 

To an extent, they may be correct, but the question is how long are you willing to wait?  Depleting scarce Midwest water resources now and then waiting for the water to return in the form of rain at some point is not an exact science.  The Ogallala Aquifer below much of the Midwest is currently being depleted faster than it can be recharged, and cranking up more ethanol plants will accelerate this process.

Of course, that doesn’t seem to deter the corn ethanol faithful. 147 corn ethanol refineries have been built over the past 30 years, and hundreds more are under construction to be completed over the next decade. The Bush Administration has championed an increase in corn ethanol production over the next decade, seeking to create nearly 11.5 billion gallons a year of ethanol by 2017.  Never mind that this level of ethanol production would require the usage of an estimated 50% of the nation’s corn crop each year.

Even IF this goal is accomplished, it will only replace approximately 10% or less of the nation’s fossil fuel usage. Currently ethanol represents only about 3% of total fuel consumption, hardly amounting to energy independence

Potential Negative Economic Impact

The government’s plan to drastically ramp up corn ethanol production to its 2017 goal is, to say the least, problematic.  Diverting half of the nation’s corn crop to ethanol will create alarming repercussions in other areas – all of which will be felt in our pocketbooks. Consider this from the EPA:

According to the National Corn Growers Association, about eighty percent of all corn grown in the U.S. is consumed by domestic and overseas livestock, poultry, and fish production. The crop is fed as ground grain, silage, high-moisture, and high-oil corn. About 12% of the U.S. corn crop ends up in foods that are either consumed directly (e.g. corn chips) or indirectly (e.g. high fructose corn syrup).

So if 80% of the crop is used as feed, 12% as food and the remaining 8% or so is used for ethanol, what happens to the equation when ethanol skyrockets to 50% of total crop usage? It doesn’t take a genius to realize that prices will rise! As I write this, corn has just hit an all-time high of $6.00 per bushel. Just imagine where we go from here! Food costs are rising rapidly and will likely continue to do so. It is basic economics that all costs are passed along.

The US is currently experiencing the worst food price inflation in 17 years. Food prices rose 4% in 2007 and could rise as much as 4.5% or more in 2008 according to the Department of Agriculture. The April CPI summary from the Bureau of Labor Statistics has food and beverages increasing at an estimated annual rate of 6.1%! Compare this to an average annual rise of only 2.5% over the last 15 years.

Is corn ethanol solely to blame for these increases? No, at least not yet. But if the government’s plans to ramp up corn ethanol production to 11.5 billion gallons per year by 2017 actually come to pass, much higher food prices could be in our future.

As the average American family feels the squeeze of higher food and energy prices, farmers are poised to harvest a bumper crop of government cash. Through hundreds of billions of dollars in federal subsidies over the years, there has been nothing less than a naked transfer of wealth from non-farmers to farmers. Corn-based ethanol will only bloat federal subsidies and hasten this transfer of wealth.

Take the latest record large farm bill, for example. On May 14 and 15, the House and Senate voted overwhelmingly to pass the latest $307 billion farm bill which is loaded with pork and earmarks that will go to wealthy farmers in addition to windfall profits from soaring crop prices.  Not only will the latest farm bill spend over $300 billion of taxpayer money, it also extends dozens of other federal farm subsidies for another 5-10 years. So the farm lobby succeeded in winning another government windfall even as farm incomes are exploding.

Don’t you find it interesting that consumers cry foul and want windfall profit taxes and an end to oil company subsidies when gas prices rise, but allow huge subsidies to corporate farms to go unchecked when food prices follow suit?  Of course, no politician wants to be seen as turning his or her back on the “family farm,” so expect such misguided government giveaways to continue.  Oh well… back to ethanol.

No Benefit From Existing Infrastructure

Another factor in the inefficiency of corn ethanol lies in the way it must be transported.  The current energy flow infrastructure in the US is designed to transport fossil fuels, petroleum and natural gas, through specially designed and constructed pipelines. This means that no matter where you live, generally speaking you have roughly equal access to these fuels and at roughly the same market price across the country. This is not so for ethanol.

Because corn ethanol cannot be easily transported through existing petroleum pipelines, it has no existing national infrastructure and must therefore be transported by truck to one of the 1,556 E85 stations across the country.  That is only about 8% of all gas stations in the US, and the trucks that transport the E85 are burning diesel or gasoline, thus contributing to corn ethanol’s inefficiency.

The lack of a unified infrastructure also leads to regional price instability. Currently there is a 15% or more spread in the price of E85 at the pump across the country, largely due to delivery costs. In my home state of Texas alone, there is a 9% spread across the state.

Since ethanol cannot use the current oil and gas infrastructure, a new one will have to be built specifically to handle ethanol, if the politicians have their way. Who knows how many hundreds of billions of dollars it will cost or how many decades it will take to build it? So we face the potential of a burgeoning ethanol industry with no centralized means of distribution that will only contribute to higher prices at the pump in the future.

Other Types Of Ethanol Show Promise

Not all forms of ethanol are as seemingly hopeless as corn ethanol. A significant step up from corn-based ethanol is sugar ethanol, which is the leading form of ethanol in global production, accounting for well over half. It is sugar and its byproducts that have fueled Brazil’s amazingly successful ethanol industry, which is far and away the world leader.

Brazil’s ethanol program uses cheap sugar cane, mainly bagasse or cane-waste. This, combined with modern equipment, provides a 22% ethanol blend used in petroleum nationwide, as well as a 100% hydrous ethanol for the country’s four million cars. Today, Brazil gets more than 30% of its automobile fuels from sugar cane-based ethanol.

Unlike corn, sugar ethanol provides a much higher energy production-to-output ratio of about 1:6 to 1:8. This makes it several times more efficient than corn. So why don’t we use sugar based ethanol? Actually, we do, non-maize (corn) ethanol production in the US accounts for 3% of total production. 

Why so little when it is clearly superior to corn?  Well, for one thing, the agribusiness lobby is far too strong to allow sugar to have a chance in the US. The other limitation to producing sugar ethanol in the US is our climate. Only Florida, Louisiana, Hawaii and Texas have suitable climates for growing sugar cane, and only in certain areas of those states.  And forget about importing sugar-based ethanol, because there’s a stiff $0.54 per gallon tariff on all imported ethanol, thanks to the agribusiness lobby.

Brazil has managed to carve out a thriving ethanol industry that employs over a million people and exports hundreds of millions of barrels a year - including about 160 million to the US (despite the tariff). Notorious global financier George Soros has recently invested $900 million in Brazilian ethanol production.

Actually, there are forms of ethanol that are even more efficient than sugar. Cellulosic ethanol is produced from “lignocellulosic biomass which is wood residue, paper waste, agricultural residue and some dedicated crops like tall woody grasses. This form of ethanol has the capacity to produce 1:10 to 1:12 input/output ratio. Cellulosic ethanol facilities are currently under construction, though they will represent only a small portion of overall US ethanol production for now.

Conclusions – Ethanol Is Not The Silver Bullet

It is clear that corn ethanol, despite being a darling of the politicians, is not the answer to rising fuel costs or energy independence. As discussed above, corn ethanol is inefficient to produce and results in an input output ratio arguably no better than 1:1. But even if we include the more efficient forms of ethanol such as sugar and cellulosic, ethanol is still not the answer to our energy dilemma. There is no panacea to replace fossil fuels. It is going to take more than one new source of energy.

Ethanol may be a step in the right direction, as will other promising technologies such as advanced electric power and fuel cell technology.  The key point to remember is that petroleum is an extremely versatile resource.  As such, it does not lend itself to being replaced by a single alternative fuel.  Instead, it will take several new sources of energy to replace fossil fuels.

Unfortunately, the fact is that even in the best of circumstances, these emerging energy technologies are likely 10-15 years away from having any significant impact. Thus, the only short-term solutions to domestic fuel costs is to increase the supply of fossil fuels from existing sources, and this means opening up more wells in the US (including ANWR and offshore), tap more proven reserves, construct new refineries, build both coal and nuclear power plants and change our consumption levels thorough elevated CAFÉ (Corporate Average Fuel Economy) standards and lifestyle alteration. And all of that will still take at least five years or so to have a substantial impact.

It now appears that high energy prices are here to stay and we all need to find a way to adjust.  Back to you, Gary.

My Take On Ethanol
by Gary Halbert

Thanks, Spencer.

When I asked Spencer to research and write a piece on ethanol, I knew it would result in competing claims. For every argument in favor of corn ethanol, you can find one (or more) on the other side of the issue. Each side has its own set of studies, but they point in very different directions.

That being the case, how can we non-scientists know which claims are correct and which are bogus? I wish I had the answer, but I don’t. What I do know is that corn appears to be an inefficient raw material upon which to base our hopes for energy independence and, more importantly, if we commit 50% of future corn crops to ethanol, food prices will skyrocket even further.  I’m not sure that American citizens realize the economic impact this feel-good policy may have on their pocketbooks.

With politicians having now jumped on the corn ethanol bandwagon, one might think that we could depend upon our elected officials to cut through the confusion and come up with a solution based on the real facts. Unfortunately, we all know that money greases the wheels in Washington, so the lobbyists will likely have more influence than any objective scientists.

The result is that it is likely to cost us all more money to buy food and fuel because of a politically expedient solution that embraces an inefficient technology. The thought of all the other political “solutions” that ended up having unintended consequences later on comes to mind.

Along that same line of thought, I have been following another piece of legislation that also has its genesis in questionable science. The Lieberman-Warner “Climate Security Act” is now making its way through the US Senate. While I do not intend to open the entire global warming can of worms at this point, I do know that it is now becoming very popular to be seen as “green” on Capitol Hill.

As a result, it is important for all of us to keep an eye on this legislation, as it also holds the potential to increase all of our cost of living in an effort to curb greenhouse gases, while other countries such as China continue to produce greenhouse gases unabated.  President Bush says he will veto this bill if it gets to his desk, so the politicians are likely to delay this bill until the next president takes office.  Stay tuned!

PONDERING MY RETIREMENT
by Gary Halbert

It was 32 years ago this month when I began my career in the investment business in 1976 at the ripe old age of 24.  I have been in it ever since.  It has been an interesting ride, and I have always had the hands-down best clients on the planet.  But this year, I’ve been thinking of retiring.  Yes, retiring at the age of 56.

But before you drop your jaw, let me assure you I am not thinking about retiring from my career in the investment business.  Rather, I am considering retiring from my other job which is coaching youth sports.  My son graduated from high school in May and will be off to college in the fall, so my coaching days, with him at least, are officially over.

I never had any intention of coaching my kids in sports.  I was not a star athlete in high school or college, although I did play football, basketball and baseball as I was growing up.  No, I was abducted into coaching, completely to my surprise.  The abduction began in 1995, I think it was, when I took my son to his first tee-ball practice.  When we arrived, I saw only one adult man there with 12-14 little kids.  Out of concern for safety, I hung around waiting for the other coach to show up.  No one did, so I stayed and helped for the whole practice.  The same thing happened the next day.

At the end of the second practice, the coach called me over to his pickup truck.  He reached inside and handed me a cap and a tee shirt and quietly said, You’ll be my assistant coach.  What, me a coach?

What I didn’t know was that this man was the head of the local Youth Association in our area.  What I also didn’t know was that he coached everything year-round - baseball, football and basketball.  The tee-ball season was such a joy, despite my lack of experience, that I followed him into football as a coach in the fall, and on to basketball after that.

I had no idea that I would end up coaching my two kids year-round for the next 12 years.  More importantly, I had no idea that coaching would become such a demanding and rewarding part of my life.  The folks in my office call it my “other job.”

I can’t begin to describe how much coaching has meant to me, how much closer it has drawn me to my two kids, and how it has introduced me to some of the best friends I have ever had. 

Most of the guys I coached with in the early years sent their kids to public schools, so their coaching careers ended after only a few years.  My kids, on the other hand, have always attended a private Christian school that is always looking for volunteer Dads to coach.  So I continued to coach my kids through middle school and high school. 

Coaching these kids over the years has given me many of the best memories I have had in my life.  My daughter will be a junior in high school this fall, but I don’t coach her basketball team anymore.  So when the final pitch was thrown and the final out was made in my son’s last baseball playoff game in early May, it hit me in the dugout afterward as I was packing all the equipment: my coaching career may be over.

I have a standing invitation with the Athletic Director at our school to return next year and continue coaching.  In fact, he frequently asks, You are coming back, right?  I’ve been thinking about it a great deal over the last month. I just don’t know if I will continue to be so passionate about it without a kid on the teams.

I haven’t made my mind up yet, but I am thinking of just being a fan next school year, and see what that’s like.  If I can’t stand being in the bleachers, I can always un-retire the next year.  I know I’ll dearly miss those kids calling me Coach Halbert.

Kudos To My Son

Since this E-Letter is free of charge, I want to brag for a moment about my oldest child who just graduated from high school.  He graduated Magna Cum Laude along with seven other students in his class, making straight As in his senior year.  In football, he made the All-District and All-State first teams as a record-setting wide receiver.  He also made the All-State Academic Team based on his school grades.  In basketball and baseball, he also won All-District honors. 

He was the only student in his class to win such honors in three different sports in one school year.  He was nominated by our Athletic Director for “Athlete of the Year” in the Texas Association of Private & Parochial Schools statewide. 

Watching him present his Senior Thesis (a requirement at our school) and hit it out of the park, if I do say so myself, and then watching him graduate from high school has been a very emotional experience for me.  I’m not ready to let him go, but at the same time, I have every confidence that he will do very well in college where he plans to pursue a degree in engineering.

Debi and I are very proud of him! 

Now that our son will be off at college, our high school sports focus will now be my daughter's activities.  While she doesn't play as many sports as our son, she is definitely just as competitive!

(Thanks for indulging me.)

Best regards,

SPECIAL ARTICLES

The Many Myths of Ethanol
http://www.realclearpolitics.com/articles/2007/05/the_many_myths_of_ethanol.html

The Clean Energy Scam
http://www.time.com/time/magazine/article/0,9171,1725975,00.html

Forget the Ethanol Myth
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_wasik&sid=aOS8e5kvDESE


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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