Why are Ethanol Investments so Volatile?

Investment in ethanol has seen notable popularity as a way to invest in alternative, non-petroleum-based energy. These investments, while attractive because of their novelty, can be very volatile due to a number of factors. Most ethanol made in America comes from corn, so the price of ethanol manufacturing depends heavily on the price of corn. The price of oil also exerts influence on ethanol prices, since ethanol looks more attractive as an alternative energy source when the price of oil is relatively high.

The industry which creates ethanol from American corn is a relatively new one. An unproven industry which makes a new product, however intriguing, will usually be subject to market jitters. Such was the case with the VeraSun® company. After they locked in a futures contract for corn at just under $7 U.S. Dollars (USD) a bushel, the market price of corn fell to less than $5 USD a bushel. VeraSun® announced that because of this, they would experience an operating loss of as much as $103 million USD for that quarter. While this is a significant loss, the market reacted in a huge way, dropping the price of VeraSun® stock by 73% in one day.

The volatility of corn prices is not the only problem for ethanol investments. Many ethanol producers are helped by government subsidies and laws such as those requiring the blending of ethanol with retail gasoline. This federal backing, though, is not as secure from an investment perspective as is market-based consumer demand. It also does not necessarily indicate a profitable future for the ethanol industry.

Investment markets can sense the uncertainty that is present when companies or products are insulated from the usual economic laws of supply and demand. Ethanol investments, then, suffer from this latent uncertainty in the form of volatility. Also, because of the lack of real-world hard data regarding ethanol demand, ethanol investments may be among the first to be shed from a finance portfolio when hard economic times strike.

The prices of oil and gasoline have themselves seen unprecedented volatility in the 2000s, most notably in 2008 when there occurred a rapid increase in the price of oil and gas, followed by an even faster decline. This is an important point to consider because when oil and gasoline are relatively cheap, ethanol investments look less attractive by comparison. For example, if a petroleum-based fuel is cheaper than its ethanol counterpart, most consumers will choose the less costly option, thereby reducing ethanol demand and the profitability of ethanol investments. The corollary is also true- high gas prices tend to bode well for ethanol investments- but rapid changes in price contribute greatly to the volatility of such investments.