NEW YORK (Dow Jones)--In an effort to make politics a bit more fun, somewatchers of the annual State of the Union Address turn the occasion into adrinking game, taking a shot of their favorite tipple whenever stock phrases like "tax relief" or "war on terror" are uttered by the president.
It's a good bet they weren't ready for "cellulosic ethanol" being mentioned in the speech Jan. 31, 2006, but investors in the biofuel industry certainly raised a glass to President George W. Bush's pledge for a huge boost in its use. In fact, since talk of some statement supportive of the industry had leaked as much as 11 days earlier, traders bought the rumor and sold the fact. Nascent producer Pacific Ethanol Inc. (PEIX) and experimental cellulosic company Xethanol Corp. (XNL) rallied like dotcom stocks, up 89% and 80%, respectively, in just eight trading days.
"In early 2006, I remember ethanol stocks in our index popping, and I didn't know why. And then we heard Bush mention them in the State of the Union," said Rob Wilder, chief executive of WilderShares LLC, which started an index behind the first exchange-traded fund tracking alternative energy.
'Sputtered' An 'Understatement'
The stocks then began a long slide, dropping as much as 80% by the fall. They staged a sharp but brief reversal when Democrats gained control of both houses of Congress in November, since they supported even greater use of the fuel than the White House, eventually pushing through a far more aggressive target for biofuel last December in the Energy Independence and Security Act of 2007.
The industry turned into a great way to make a quick buck, but many long-term investors believed they were buying into the future of energy rather than a business, like many others over the years, that are dependent on government largess and got ahead of themselves.
"The economics aren't what they were a few years ago," said Carey Callaghan, a former Goldman Sachs energy analyst who now runs the American Trust Energy Alternatives Fund (ATEAX).
After another pop around the 2007 State of the Union, the stocks have done extremely poorly as, even with continued subsidies and ambitious targets, surging corn prices and a surfeit of ethanol have trumped $130-a-barrel crude oil.
"'Sputtered' is an understatement," said Wilder.
Since the 2006 speech, Xethanol is down by 93% and Pacific Ethanol by 90%, with several ethanol plants shuttered due to poor economics, even as many more are under construction. It is an echo of the early 1980s when many producers went bankrupt after President Jimmy Carter's "gasohol" push faded and subsidies failed to translate into a government bailout when the market turned. A big collapse in oil prices in the future might exacerbate the situation while the hoped-for efficiencies that would allow the cellulose of non-food crops to be turned into fuel remain elusive.
Even with subsidies and quotas, the numbers tell the story of a worsening glut. One hundred thirty-four U.S. ethanol plants have the capacity to produce 7.23 billion gallons and 77 under expansion or construction will add another 6.22 billion gallons, according to the Renewable Fuels Association.
Despite devouring close to a third of the U.S. corn crop, ethanol provides for less than 5% of our transportation fuel after decades of growth. Production went from 175 million gallons sold during the height of the last energy crisis in 1980 and crossed the billion-gallon threshold in 1992.
After a brief slowdown in the mid-1990s when low oil prices hampered the industry, production crossed two billion gallons in 2002, three billion in 2004, four billion in 2006 and six billion last year, all pushed by the stick of government mandates and the carrot of billions in subsidies, particularly the 54-cent-a-gallon federal excise tax rebate and a controversial tariff keeping out cheaper Brazilian ethanol. The latest "Renewable Fuels Standard" calls for 36 billion gallons by 2022, but 16 billion of these must be cellulosic and depend on breakthroughs in chemistry that may never happen.
'Giving Your Dog Steak To Get His Alpo'
To be sure, many ethanol producers should survive and strong players like agribusiness giant Archer Daniels Midland Co. (ADM) may even benefit from the bust in the long run. Nevertheless, aside from the widespread assertion that biofuels are wasteful, much investor value was destroyed as well. The same has been true of solar and other alternative energy stocks, said Wilder.
"Clean energy doesn't have to only go up. Quite a few people have lost money and the hype, more than anything, is bothersome," he said.
Not letting the corn belt have all the fun, politicians from Western states abundant in low-grade coal or shale rock are pushing for those sources to be exploited in the name of energy independence. One can hear that the U.S. is the "Saudi Arabia of coal," or "of shale." And it's true - sort of. Like ethanol, coal-to-liquids and shale oil can produce large quantities of motor fuel with the right investment, but nobody needs to promise Persian Gulf nations billions in subsidies to drill another oil well.
In an echo of a boom and spectacular bust during the last energy crisis, shale promoters point to "1 trillion barrels" of untapped oil in the Rockies. Their exploitation back then created mountains of residue and, once oil prices fell, major losses as subsidies ran out. Being extremely energy- and water-intensive, one opponent called squeezing oil out of shale "like giving your dog steak to get his Alpo."
The situation with coal-to-liquids is somewhat better, but it would require massive and expensive investment in new pipelines and refineries. Montana's governor boasted a few years ago that his state's "120 billion tons of coal can produce 240 billion gallons of gas. ... Montana, alone, could fuel America's needs for 35 years with just our coal."
A handful of companies with exposure to the sector like Rentech Inc. (RTK) and Syntroleum Corp. (SYNM) have popped and dropped over the years amid favorable mention. However, supporters remain far less influential than the suffering ethanol industry so large-scale development is unlikely.
As with ethanol, investors in these and other areas of alternative energy might be wise to take expressions of government support as an opportunity to take profits rather than to get in for the long haul. Legitimate scientific breakthroughs that make new technologies competitive with fossil fuels may produce some long-run winners, but many losers will precede them.
Given the fact that fossil fuel use is unsustainable, some nascent technologies eventually will work without government help. Wind power is getting close, for example. Wilder surmises that the readiness of investors to push up alternative energy stocks has something to do with a gallon of gasoline being the most visible of all prices.
"It's on huge signs wherever you go," said Wilder. "It's in your face, and it gets people thinking that we can't keep on going, being addicted to oil."
The next and final installment of this series will look at political initiatives to sharply curtail greenhouse gas output and how investors hope to benefit.
Source: Spencer Jakab, Dow Jones Newswires; 201-938-2429; spencer.jakab@dowjones.com