Investing in Ethanol: Best Bet Might Be Buying An E85-Ready Car (PEIX, DVSA; ETF: PBW)

Norm Alster in the New York Times explores the issues surrounding the entire area of alternative energy. Some high profile venture capitalists are trying to replicate their successes in technology in the area of alternative energy. The challenge for individual investors is whether there is any public way to play the trends in this arena.

The current excitement over ethanol derives from research that has cut the cost of converting nonfood plant matter like grasses and wood chips into alcohol. Mr. Khosla says he believes that such ethanol, called cellulosic ethanol, will eventually be cheaper to produce than both gasoline and corn-derived ethanol.

Can investors whose pockets are not as deep jump into the ethanol market? Yes, but they are taking a big risk. Picking long-term winners among the companies that make ethanol — or, for that matter, develop other alternative energy technologies — is a very uncertain business. The few public companies that focus on ethanol are typically unprofitable. Pacific Ethanol (Nasdaq: PEIX), for example, has not yet had a profitable quarter and will not until at least the fourth quarter, when its first plant is scheduled to begin production, Mr. Langley said.

There is a bit of a chicken and egg problem here. It is difficult to invest in ethanol in amounts without some guarantee that there will be enough downstream demand for the product. Automakers are only now beginning to outfit significant number of vehicles to be E85 compatible.

Some help in this arena may be forthcoming. Autoblog reports that two Midwest senators have introduced a bill that would encourage the production of biodiesel and ethanol. Of course no piece of legislation is guaranteed passage.

For now, with viable investment opportunities scarce, most investors would be better keeping an eye out for better opportunities down the road. For those who want to jump on the ethanol bandwagon, buying an E85 compatible vehicle is most efficient way to play this trend.

[Editor note: Also named in the NYT article -- Diversa Corp. (DVSA) and PowerShares WilderHill Clean Energy Portfolio ETF (PBW)]