Wednesday, April 11, 2007

The Oil / Ethanol connection - Pure Genius

Generally I have not been impressed with the strategic moves made by the Bush administration. I'm not talking about Iraq at all here. No, I judge strategic intelligence more on how well America is outmaneuvering others in political and trade areas, and we haven't been doing very well the last few years. For example: by all appearances we can't get a grip on Iran while they show excellent diplomatic manipulations -- kidnapping and then returning some British soldiers right when they were supposed to be castigated about nukes was genius.

Recently I have been watching some events unfold in the global oil struggle that have left me thinking that the white house may be quite clever.

The problem America faced was that Americans spend a disproportionate amount of their income on driving. Increased oil prices were hitting Americans particularly hard with substantial fallout for consumer spending and especially the American auto companies.

Meanwhile the rest of the world (think China & India especially) uses far less oil per citizen. They were not particularly enthusiastic about trying to pressure for lower oil prices. I imagine they may even have had a private smile at the discomfort of America. Buying their political support with "aid" payments (a common strategy) would have been unacceptably costly.

So what did the administration do? They started promoting ethanol production from American corn. On the face of it this may even be scientifically silly with little distribution infrastructure, difficult production versus sugar cane ethanol, and questionable economics.

And yet the move was brilliant! The cost to the government is less than any conceivable diplomatic aid package and stays inside the US (buying corn belt votes for the Republicans, not incidentally). Meanwhile the ethanol boost has raised global food prices significantly as corn gets rerouted into ethanol production. Americans may spend more on oil, but developing countries spend more on food. American food inflation has risen just 1% to about 3%. In China food inflation has jumped to 6% - hitting every family hard and putting massive pressure on the Chinese government. Chinese food reserves are estimated to be near all-time lows. In some parts of Europe food inflation has reached 13%!

Meanwhile the cost of food just keeps going up. In 2006 16% of the grain harvest in the US went to Ethanol production, by 2008 that number is predicted to reach 30%. Among hedge funds grain is the new copper, a hot commodity for trading. Corn is used for feed leading to dairy and meat products and to make the ubiquitous corn-syrup used to sweeten most foods so the impact is universal.

Suddenly India, China, and the rest of the world are interested in lowering the price of oil to reduce the "global fuel emergency." The new political pressure is being felt by producers and oil prices have seen declines recently and estimates are that gasoline in the US will be crest about 11 cents cheaper than last year - putting $33 billion or so back into consumers pockets. This means that the ethanol programs of the US government are already profitable from a political and strategic standpoint.

I have to admit it, the administration has pulled off a brilliant move on ethanol. Assuming all this was on purpose, of course. It would be great if corn ethanol actually makes it as a fuel but even if the programs are cut in failure in a year or two America will come out ahead.

Invest Well,


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