🍷 Your Guide To Investing In Ethanol, Also Known As Alcohol. It’s A Fuel Source, An Antiseptic, And A Recreational Drug.

Brief Background

Yes, ethanol (or alcohol) is a tradable commodity, but it isn’t the kind you drink. The difference is that alcoholic beverages contain a percentage of ethanol, a diluted form of the compound, whereas tradable ethanol is the industrial, pure, undiluted version mainly used for fuel. That being said, the ingredients and processes used to make beverage-grade and industrial-grade ethanol is pretty similar, via fermentation of different kinds of grains like corn, wheat, etc. Nowadays, researchers looking at cellulosic ethanol, using scrap plant and organic material leftover after crops have been harvested to make ethanol. This can be a game-changer.

What Can It Do For You

🧺 Portfolio Diversification. As always, adding commodities to your portfolio can help diversify and lower risk. Adding ethanol to your portfolio means owning an asset that tends to act differently to other asset classes, and even to other commodities. Due to its main use as a fuel, it has a close relationship with other energy commodities.

💰 Profit. Ethanol can certainly provide opportunities for profit for more speculative traders. As a RBOB gasoline competitor, its prices are very much linked to other energy commodities like crude oil, which can certainly be volatile. In the long term, as more countries are focused on “green” and renewable energy, ethanol-blended fuels may be prioritised since ethanol is produced from organic plant material, which will certainly increase its demand. In parallel to this, emerging market demand is set to increase as China and India are looking for cleaner sources of energy.

Price chart of ethanol (blue) & RBOB gasoline (orange) futures contracts over the years. Notice how price movements are similar.

What Affects Ethanol Prices

There are several key factors that are involved in moving the price of ethanol:

• 💰 Production Costs. The US is currently the world’s biggest ethanol producer, and mostly uses corn as the main feedstock ingredient (though other grains can also be used). Because of this, the cost of grains could have an impact on ethanol prices. That being said, ethanol isn’t completely dependent on grain prices because they’re usually bought on contracts, which helps companies lock-in production costs. It’s the newer contracts that could affect ethanol prices, more so than the actual market swings itself.
• Furthermore, Brazil is the world’s second biggest ethanol producer. Unlike the US, which uses corn for ethanol, Brazil uses sugarcane. In our previous article about sugar, Brazil is the largest producer of sugar. The thing is, disruptions in sugarcane supply (for example, due to bad weather) can drive sugar prices, which should then technically affect ethanol prices since sugar is fermented to make ethanol. However, Brazil also has a history of changing ethanol requirements in fuel production when sugarcane supply is disrupted, which in turn, counteracts the disruptions and prevents spikes.
• 🚚 Transportation Costs. The problem with ethanol is that it’s chemically volatile (corrosive, and can evaporate). This makes it unsuitable to be transported via pipelines, unlike some of its energy competitors. This means that it has to be transported on trains and trucks, which can be quite costly.
• 🏛️Government Policy. Since the US and Brazil are two of the biggest ethanol producers, tariffs, subsidies and other taxes on ethanol in these two countries can certainly have an impact on prices. For example, the US heavily subsidises ethanol, which encourages farmers to produce corn for ethanol production, which boosts supply in the market.
• 📈 Stock Levels. The US Energy Information Administration (EIA) publishes a weekly report on ethanol production, as well as a monthly and yearly overview on production, consumption and stock levels. These frequent updates provide a clear picture on supply, which can lead ethanol producers, gasoline refiners, investors and traders to act in response to changes in supply.
• ☀️ Weather. Weather can also have an effect on prices. Firstly, weather can impact grain production, which can affect grain prices, which can affect ethanol prices (as discussed above). Secondly, poor weather can make transporting ethanol a challenge, which can cause supply disruptions in the market. In fact, severe winter weather was partially why ethanol experienced a price spike in 2014, when it impacted rail transportation.
• 🛢️🔄⛽ Substitution (Crude Oil/Gasoline). As mentioned, ethanol prices are linked to other energy commodities like crude oil and gasoline. This is because ethanol is a gasoline substitute. So, if oil and gasoline prices rise, then consumers might switch to ethanol-blended fuels, which should then drive ethanol prices up. On the other hand, if oil and gasoline prices fall, then ethanol prices could also fall if consumers switch to fuel options without ethanol.

Global ethanol production. As you can see, production is increasing at a consistent rate over the years.

Global ethanol production in numbers.
(Source: Renewable Fuels Association)

Here’s the monthly report on an overview of ethanol, classed under “Renewable Energy”. Click on the image to be redirected.
(Source: US Energy Information Administration)

Last but not least, here’s the weekly data on ethanol production in the US. Click on the image to be redirected.
(Source: US Energy Information Administration)

What Is It Used For?

Though ethanol is in alcoholic beverages, tradable ethanol is mainly used as fuel and mixed with gasoline. However, there are a number of other applications for the bioethanol, which includes:

• ⚡ Fuel for power generation and fuel cells
• 🧪 Ingredient in the chemicals industry (solvent, antiseptic and preservative properties)

The Case Against Ethanol

There are a number of risks involved when trading or investing in ethanol. As an energy commodity, its price is very much correlated with others like crude oil and RBOB gasoline, which means you’re also exposed to the risks that can drive oil and gasoline prices lower too. Energy consumption tends to be linked to economic growth, and a global economic downturn could certainly impact demand, as we’ve seen in the pandemic. Furthermore, advances in cellulosic ethanol research could significantly increase supply in the market, potentially putting downward pressure on prices.

The Case For Ethanol

Ethanol is still a commodity and can help diversify one’s portfolio. In the long term, there are a number of trends that act in ethanol’s favour and can certainly boost prices. Although cellulosic ethanol can certainly drive up supply, it can also significantly increase demand and adoption in countries that don’t necessarily have a thriving agricultural industry. Demand from emerging markets such as China also seems quite positive and is expected to increase as climate change and global warming become more of a priority for many countries around the world. For example, China has reportedly bought 200 million gallons of US ethanol, which is certainly a positive sign.

Popular Ways To Invest In Ethanol — Pros/Cons of Each

Like some of the other agricultural commodities, you can’t really invest in physical ethanol. Here are some of the more popular ways instead. If you’re still confused about how any of these work, refer back to our basics newsletter for a refresher.

• Ethanol ETNs. Unfortunately, there aren’t any ETF/ETNs that invests in ethanol. There are, however, ETF/ETNs that invests in the agricultural commodities used to make biofuels. Because of this, you don’t quite have a direct investment for ethanol. Regardless, they’re traded on stock exchanges, so they’re pretty easy to buy and sell. Depending on which broker you go with, you may be charged with trading commissions. ETNs also charge an expense ratio, or management fee that gets taken out of their total holdings and is then reflected on your account. Just be aware that since it’s an ETN, you are essentially buying a bond, an IOU, a debt note, and not in actual, physical ethanol. Be sure to read the fine print & understand the risks and costs involved.
• Ethanol Stocks. There are a number of public companies that have varying levels of exposure to ethanol, whether it’s their sole focus, or part of their overall portfolio. However, you aren’t directly following ethanol prices since there are other factors at play, such as stock market sentiment, company performance, etc.. As always, you may want to consider looking at the company’s annual reports (especially operational costs), portfolio of what other products & assets they have, what research & development they’re currently conducting, and potential product-line expansion plans.
• Ethanol Futures Contracts. A binding agreement traded on futures exchanges between two parties where they agree to buy/sell ethanol at a specified time in the future with an agreed-upon price. A standard contract deals with 29,000 gallons of ethanol! These futures contracts are settled via physical delivery after the contracts have expired. Because you are using a significant amount of borrowed money, even small price changes in ethanol can either lead to massive profit, or massive losses beyond what you paid for, potentially leaving you in massive debt. They are certainly high-risk and not recommended for beginners. Further, fees associated with futures trading include broker commissions, and exchange/clearing fees.

TL;DR — Is It The Right Investment For You?

As always, it depends on what your aims are. As an energy commodity, it has a close link to crude oil and gasoline, so you’re also exposed to risk factors related to other energy commodities. This also means that ethanol can be vulnerable to global economic downturns as energy consumption tends to be linked to strong economic growth, as we’ve seen in the pandemic. In the long term however, a number of trends suggests a positive outlook for ethanol. Firstly, demand from emerging markets (especially China) could certainly increase as countries look to “greener” sources of fuel. Secondly, more and more countries are addressing environmental concerns, and policies could be introduced that would increase supply and/or demand of ethanol. Last but not least, advances in cellulosic ethanol research can certainly have a significant impact on supply and demand as it allows countries without major agricultural industries to utilise other organic plant material to produce ethanol.

🧺 If you are considering adding ethanol to your existing portfolio or bundling it with a number of others, you may want to consider doing dollar-cost averaging (regular investments over time) to build your ethanol position so you can take advantage of any volatility in the market.

💰 If you are considering adding ethanol for speculation and profit, you may want to monitor the factors that affect ethanol prices mentioned above. You may also want to keep track of the weekly and monthly reports on ethanol production, consumption & stock levels released by the USEIA, as well as weekly/monthly supply and demand data from the Renewable Fuels Association. In addition to monitoring the factors mentioned above, you may also want to consider performing some technical analysis on ethanol’s price chart to help consolidate trends and patterns to help with your decision. That being said, its prices can also swing unexpectedly, so be prepared and have an exit plan in place.

As always, if you are unsure, check in with a professional financial advisor before making any moves.

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