Ethanol stocks can be promising energy investments as long as you follow this advice

Ethanol is a liquid alcohol obtained from fermenting sugar, or starch converted to sugar. In Canada and the U.S., fuel ethanol is made from corn, as well as grains such as wheat and barley. Small quantities have been made on an experimental basis from low-cost agricultural cellulosic biomass, like trees and grasses. This has led to two different groups of companies amongst ethanol stocks.

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The first group of companies among ethanol stocks are those working to produce ethanol from more traditional sources. However, they face competition from food companies, as they both consume food crops.

The second group of companies among ethanol stocks are the ones working on experimental methods. But while their raw materials are cheap and face little competition, they are still working with unproven technologies.

Ethanol can be used as a fuel for cars in its pure form, but it is usually used as a gasoline additive to increase octane and improve vehicle emissions. Accordingly, there are two types of ethanol fuels:

1. Low-level ethanol-gasoline blends with ethanol concentrations of up to 10%. They can be used in today’s vehicles and are the main ethanol fuels used in Canada and the U.S.
2. High-level ethanol-gasoline blends with ethanol concentrations of 60% to 85%. They can be used in special factory-produced vehicles called flex-fuel vehicles.

The inclusion of ethanol in fuels has been legally mandated in some districts of North America.

Relative to gasoline, ethanol fuels reduce greenhouse gas emissions. As well, ethanol is made from plants, which absorb carbon dioxide during their growth. On a full-fuel cycle (i.e., from plant growth to use of the fuel in a vehicle), a 10% ethanol-gasoline blend is estimated to reduce greenhouse gas emissions by up to 4% if the ethanol is made from grains and up to 8% if it is made from cellulosic biomass.

Ethanol as fuel, and ethanol stocks as an investment, have a lot of conceptual appeal, especially with investor interest rising for non-hydrocarbon (oil, coal, natural gas), lower-polluting energy sources. However, many ethanol stocks will have difficulty showing profits for a number of years. Several new ethanol plants will open in the next few years, which could lead to oversupply and lower prices. Lower oil prices have also undercut ethanol’s appeal.

We think the best way to profit from increased long-term ethanol use is through a stock like Archer Daniels Midland, symbol ADM on New York. Archer Daniels is the world’s largest producers of corn-based ethanol, but also has a broad base of other businesses. Above all,  avoid trying to profit in ethanol futures and options.

In addition to ethanol stocks investors should use these energy investing tips:

1. The price of both natural gas and oil is highly volatile. It’s a bad idea to base investment decisions on predictions of future oil and natural gas stock prices, because these predictions are simply not reliable.
2. Weather affects prices. In the summer, natural gas prices could jump if it’s an unusually hot summer. This leads to greater demand for natural gas-generated electricity for air conditioning, Also, hurricanes can disrupt production. Hurricane season can last until the end of November in some parts of North America.
3. If natural gas prices continue to stay low, energy companies will have less incentive to drill for natural gas. That will lead to lower supplies and, in the long run, higher prices.
4. Manufacturers can utilize different energy resources. Many manufacturers and utilities are able to switch back and forth between using natural gas, oil and electricity. If oil gets cheaper, this would lower demand, and prices, for natural gas.
5. Pipelines are an important part of natural gas transmission. Natural gas is produced around the world, but the simplest way to transport gas is through a pipeline. Canada, which supplies around a sixth of U.S. consumption, is the main source of imported gas for the U.S.
6. Look for oil exploration companies that have cash flow from existing wells that is sufficient for, or at least contributes to, the development costs of further wells.
7. Look at the market cap of oil exploration companies versus the estimated value of the oil resource they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of their findings. We like an oil exploration company’s market cap to be no more than half the value of the oil in the ground.
8. Invest in oil energy stocks that invest in new drilling and exploration techniques. Staying ahead of the technology curve will keep them in business.
9. Invest in oil energy stocks that own diversified drilling sites in multiple geographic locations where oil exploration has been successful in the past.

Have you invested in ethanol stocks? Have they been profitable? Share your experience with us in the comments.