Editor’s note:

Wire services announced that President Bush would place a significant amount of emphasis on Ethanol during his State of the Union Address on January 31, 2006.

In the two analyses listed below, Doctor Joe Duarte provides guidance, and perspective to the Ethanol phenomenon from both the economic and geopolitical viewpoints.

The analyses listed below appeared on January 13 and January 17, 2006 at www.joe-duarte.com.

Brazil: Energy Independence Through Ethanol
(This analysis appeared on Joe-Duarte.com on January 13, 2006.)

Brazil is on the verge of energy independence, developing a model based on ethanol. Washington should have a look.

According to the Wall Street Journal: "After nearly three decades of work, Brazil has succeeded where much of the industrialized world has failed: It has developed a cost-effective alternative to gasoline. Along with new offshore oil discoveries, that's a big reason Brazil expects to become energy independent this year."

Indeed, Brazil is going way against the grain, using sugar cane as its source for the ethanol, which "now accounts for as much as 20% of Brazil's transport fuel market. The country's use of gasoline has actually declined since the late 1970s. The use of alternative fuels in the rest of the world is a scant 1%."

To be sure, there are some drawbacks, such as the fact that gasoline gets better gas mileage, and according to the Journal: "countries wanting to follow Brazil's example may be leery about following its methods. Military and civilian leaders laid the groundwork by mandating ethanol use and dictating production levels."

In fact, Brazil did some things to reach this point that are politically unpalatable for most countries. "Military and civilian leaders laid the groundwork by mandating ethanol use and dictating production levels. They bankrolled technology projects costing billions of dollars, despite criticism they were wasting money. Brazil ended most government support for its sugar industry in the late 1990s, forcing sugar producers to become more efficient and helping lower the cost of ethanol's raw material. That's something Western countries are loath to do, preferring to support domestic farmers."

Another part of the successful program is the use of "flexible fuel cars," which can use either gasoline or ethanol.

This part of the system has created a built in hedge into the system as "buyers no longer have to worry about fluctuating prices for either fuel because flex-fuel cars allow them to hedge their bets at the pump. Seven out of every 10 new cars sold in Brazil are flex-fuel," which can use gasoline, ethanol, or a mixture of both fuels.

System Attracting Interest

The Brazilian model is attracting attention, as China and India "have sent a parade of top officials to see Brazil's program. India, the world's second-biggest sugar producer behind Brazil, mandated in 2003 that nine of its states add a 5% ethanol mixture to gas. The Brazilian unit of Germany's Volkswagen AG, the first car maker to introduce a flex-fuel model in Brazil, has received 38 delegations from more than a dozen countries in the past year alone, VW officials say."

The U.S. is also watching. According to the Journal "Three members of the Senate Energy Committee recently visited, and Sen. Hillary Clinton has cited Brazil as a role model in cutting dependence on imported oil. When President Bush made a recent stop-over in Brasilia, Brazilian leader Luiz Inacio Lula da Silva hosted a barbecue and described to Mr. Bush how the country has reduced its oil import bill, according to Brazilian officials at the meeting."

Conclusion

There are two major drawbacks to ethanol.

1. The fuel can cause major wear and tear to engines if it is above 10% of the fuel mixture.

2. It is politically difficult to make it cost effective when governments have to deal with subsidies and pork barrel spending.

But, one thing is certain, as crude oil prices remain above $50 per barrel, governments, and private industries are looking for alternatives, and ethanol is increasingly attractive.

In Brazil, one solution to the mixture problem came from Fernando Damasceno, chief engineer at the Brazilian unit of Italian car parts company Magneti Marelli.

Marelli programmed "a standard car computer to constantly calculate the mixture of ethanol versus gasoline in the tank and adjust the engine accordingly. In 2002, the team sold the device to Volkswagen, which introduced its flex-fuel Gol the next year. Mr. Damasceno's black box is now sold by five major car makers in Brazil. "

In our opinion, if Brazil can cut through its own political mess, and deliver a solution, it shouldn't be as difficult as it is in the U.S. or elsewhere to duplicate the results.

If this idea gets some traction, there are likely to be some shivers in Ryadh, Tehran, Caracas, and Moscow.

Iran: Easing The World's Path To Ethanol
(This analysis appeared on January 17, 2006 on Joe-Duarte.com)

Iran seems to think it is scoring points by threatening to use oil as a political weapon in its increasingly tense nuclear standoff. And yet, a strong case could be made for the fact that the ill conceived game of hardball being played by Iran may be just what the rest of the world needed to get busy developing alternative energy sources.

In fact, although it may seem a bit surprising to the casual observer, with oil trading above $65 per barrel, as it was on 1-17, prior to the Wall Street open, we are now seeing prices, just $6 below the all time highs, near $71.

Indeed, oil prices are moving quietly, but steadily higher, following a scenario clearly delineated by us and host Jim Puplava on the Financial Sense News Hour radio program and on these pages for several weeks, as the combination of tight supplies, due to the still unrepaired hurricane damage, and the false sense of security from the warm weather.

And as tensions rise, the outlook for a widely available, relatively economical, and reliable alternative fuel is hopeful, but still very murky.

The Rising Rhetoric

Europe, the U.S., China, Russia, and Iran had their hands full over the weekend.

Feathers were ruffled, and veins were visible all around the globe, as foreign ministers, secretaries of state, U.N. functionaries, and heads of state were all worked up about Iran's nuclear program.

The Iranians, who some feel may have an atomic bomb within six to twelve months, or sooner, played a familiar game. On the one hand they blustered, while their nuclear experiments continued. On the other hand they continued to suggest that they were willing to negotiate, although no one is really sure on what.

The Europeans, talked tough, threatening to throw the Iranians to the mercy of the U.N. Security Council.

And the U.S. said that Iran with a nuclear program would be a bad thing.

By Monday, Everyone, but the Iranians agreed, at least in principle, that Iran with a nuclear bomb would be at least a little troublesome.

Looking For A Spark

When governments start moving in one direction, apparently oblivious to potential consequences, it sets up situations, in which a spark, regardless of how small it may seem otherwise, could set off a huge set of problems.

And the current set of developments, suggest that this is one of those times, as the world is suddenly realizing that it is facing a rather complex set of problems, built around energy.

This is not new, as experts have been warning about it for some time. We have noted the Peak Oil theory here for sometime, at least conceptually, while others have supported the notion wholeheartedly.

One such incident, either as a contributor, or as the spark itself, could be a new spat between Iran and Iraq.

Here are two interesting items that may be the start of a trend.

According to Stratfor.com: "Iran's coast guard killed one Iraqi soldier as Iraq's military tried to prevent a ship from smuggling oil out of Iraq, Al Jazeera reported Jan. 16. Basra Gov. Mohammed al-Waili said Iran's coast guard also kidnapped nine Iraqi soldiers."

Meanwhile, MarketWatch.com reported: "The International Energy Agency said that the global demand for world oil should rise 2.2% in 2006 after a 1.3% climb in 2005. It also sees OPEC capacity rising by one million barrels a day in 2006. "The same fundamental support for prices that was seen in 2004 and 2005 remains in place for the time being at least. Global demand growth is forecast to recover strongly this year and supply side factors are likely to continue to be at the forefront of concerns despite some increases in capacity on the refining and production side," it said."

Dow Jones NewsWires reported: "The International Energy Agency Tuesday trimmed its forecast for growth in crude supplies this year from non-OPEC producers by 7%, but said new projects this year would result in a net increase in crude flows in contrast with no growth at all last year."

Consequences Beyond The Rising Rhetoric

So, demand for oil is rising. Non-Opec production is stalling. And OPEC's production numbers, from countries such as Venezuela, and Saudi Arabia are being openly questioned, even as Indonesia's numbers are showing a clear decline there.

Demand is starting to rise.

And political hostilities are threatening to increase the worry premium on oil.

It doesn't take much to figure out that somewhere, somebody's looking for a way to become less dependent on petroleum.

And that's exactly what's happening, as some are starting to make startling predictions about ethanol and other alternative fuels.

According to Bloomberg: "Global demand for ethanol may quadruple to 20 billion gallons by 2010, according to Roland Jansen, founder of the $1.9 billion fund-management arm at Liechtensteinische Landesbank in Vaduz, Liechtenstein."

Brazil is at the forefront of using ethanol as its main fuel for powering cars, and elsewhere in the world, exploration for oil and natural gases at a pace not seen in decades.

To be sure, much of the activity to find alternatives to oil, is being driven by the persistently high oil prices. But a look at the CRB index, a commodity index heavily weighted toward grains, suggests that the market is seriously putting its money into alternative fuel sources, namely grains.

Chart Courtesy of StockCharts.com

According to the New York Times, farmers in Iowa are making decisions for their next corn crop bases "not just the demand for food," but also on the "the demand for ethanol, the fuel that is made from corn."

Ethanol is still cheaper than gasoline, but "farmers expect it to go higher soon if oil prices stay high. Ethanol was up to $1.75 a gallon, last year, from just over $1 the year before.'

And ethanol is suddenly a growth industry. According to the Times: "A change is under way that experts say will tightly tie the price of crops to the price of oil: ethanol plants are multiplying. Iowa has 19 ethanol plants now and will have 27 by the end of the year."

And Iowa is not the only place where this phenomenon is taking hold. According to the Atlanta Business Chronicle: "A new ethanol plant in the Savannah area has commitments for funding and could be producing the alternative fuel from biomass by 2007 -- likely the first of several planned ethanol facilities to be realized as part of Georgia's emerging ethanol industry."

Last week, General Motors introduced an initiative aimed at increasing the number of filling stations that provide Flexible Fuel vehicles, which burn either gasoline or ethanol.

According to Renewable Energy Access.com: "GM currently has 1.5 million vehicles on U.S. roads capable of using a blend of gasoline that contains up to 85% ethanol (referred to as E85), which is mostly derived from corn. (Its principal U.S. competitor, Ford, also has a significant number of FFVs on the road.) E85 vehicles can run on either conventional gas or E85 without any additional modifications, aftermarket conversions, or cumbersome switches for vehicle users. The cars automatically sense the current fuel mix and adjust accordingly."

More interesting, the green energy web site added: "there are better, more energy- and environmentally friendly ways to make ethanol. Energy Department studies show that producing ethanol from some types of plants or crop waste -- known as "cellulosic ethanol" -- instead of from corn or other crops has an impressive net energy ratio of more than 5:1"- compared to the 1.34 yield from corn. "It's at that level that E85 becomes a true environmentally friendly fuel. Researchers are making strides in bringing affordable cellulosic ethanol to market."

Loopholes Abound

And while ethanol is making serious inroads, there are some peculiar aspects to keep in mind.

Although ethanol is seen as environmentally friendlier than gasoline, it is still a pollutant. And a closer look at some data suggests that automakers have been using a loophole which has increased dependency on fossil fuels.

According to AP: "A federal push for cars that run on an alternative fuel straight from the heartland isn’t winning many converts among American drivers — but is a hit with automakers who use it to skirt mileage standards."

That means, that at least in the U.S., ethanol is a regional phenomenon, which according to AP is giving U.S. automakers a nice loophole.

"Fortunately for carmakers, a 1988 law designed to decrease oil use gives them credits for building vehicles that run on the alternative fuel whether anyone uses it or not. Those credits allow automakers to relax gasoline efficiency standards on other vehicles — which drives oil consumption up instead of down."

In effect, Congress leapt into chaos, and delivered a new set of unintended consequences, as "Relaxed fuel economy standards resulting from flex-fuel credits, meanwhile, were responsible for increased petroleum consumption totaling 772 million gallons —enough gas for a Jeep Grand Cherokee to drive from San Diego to Boston and back more than 8,000 times."

Conclusion

Gasoline prices have been reset at what could be permanently higher prices, albeit within a new price band, with somewhere above $3.00 per gallon being the recent standard.

The Iranian crisis is perversely timed, though. Aside from the obvious political, and geo-military possibilities, Iran's threats to the oil markets, are making one thing perfectly clear.

The bottom line, is this though: No country wants to be held hostage by oil.

Brazil has proven, that for better or worse, a country's highways can be full of cars burning something besides gasoline.

Most countries can grow some kind of crop that can be used as oil, while other countries, such as the U.S. can easily produce surplus crops, or expand their capacity to produce ethanol.

The evidence is clearly mounting. Yes, ethanol, like any expanding industry, is likely to have its ups and downs.

And it could take several years to make the whole world switch.

But, unless we're missing something, a new trend, albeit a regional one, is starting to emerge.

It won't take more than one or two more significant, even if temporary conflicts in the Middle East to lead to what could be a major move toward ethanol.

In other words, Iran, might ironically, be the straw that broke the OPEC camel's back.

The flip side is that it could take several years to break or even alter the world's dependency on oil.

A great many things, both good and bad can happen from now until then.

Meanwhile, politicians have their hands into every aspect of this situation. Enough said.