BIOFUELS from the Wall Street Journal of 02.12.2007

Interest in alternative transportation fuels -- mostly ethanol -- soared following President Bush's declaration a year ago that the U.S. is "addicted to oil." Many potential fuels are being discussed, from biodiesel to hydrogen. Most of the buzz is around what's already by far the biggest alternative transportation fuel in the U.S.: ethanol made from corn.

There's lots of talk about the possibility of using ethanol as a standalone fuel to power cars. But virtually all the ethanol consumed in the U.S. today is used in a less-sexy way: It's blended into normal gasoline.

That's done mostly in parts of the country with bad air-pollution problems, because adding ethanol to gasoline reduces smog-causing emissions from the cars that burn the fuel. Ethanol also is used as a gasoline "extender."

The cost of producing ethanol depends largely on the cost of corn, ethanol's main feedstock. It also depends on the cost of the energy -- typically natural gas -- used to power the process that turns the corn into ethanol. Keith Collins, chief economist at the U.S. Department of Agriculture, estimates that today it costs about $1.60 to produce a gallon of ethanol.

Ethanol producers sell their brew on a wholesale market -- sometimes to gasoline refiners and sometimes to middlemen who sell to those refiners. The price of ethanol typically rises and falls with that of gasoline, which itself is a function of the global oil price. Ethanol typically has sold for up to 51 cents per gallon more than gasoline, because the federal government gives ethanol blenders a 51-cent-per-gallon tax break to encourage production of the supplemental fuel.

Over the past year, the industry that produces ethanol has had a wild ride. Last summer, ethanol prices soared, due to increases in both gasoline prices and ethanol demand. Gasoline blenders who had been using another emission-reducing additive -- methyl tertiary butyl ether, or MTBE -- were switching over to ethanol because of concerns that MTBE was contaminating ground water.

Ethanol's per-gallon price premium over gasoline widened to more than $1. Margins for ethanol producers ballooned. Yet by late last year, the ethanol boom was cooling. The sudden profitability of the ethanol business, combined with increasing federal requirements for the production of alternative fuels, sparked a rush of investment in new ethanol plants.

Meanwhile, gasoline prices, and thus ethanol prices, were falling from their mid-2006 highs. The production costs for ethanol were also rising, largely because the rush to produce more ethanol had driven up the price of the fuel's main feedstock, corn.

On Friday, the price of ethanol for March delivery closed at $2.06 a gallon on the Chicago Board of Trade, and the price of gasoline for March delivery closed at $1.61 a gallon on the New York Mercantile Exchange.

Where ethanol prices will go from here is a matter of debate. President Bush, in his State of the Union speech last month, laid out an ambitious target for the U.S. to consume about 35 billion gallons of ethanol and other alternative transportation fuels by 2017. (The U.S. currently consumes about 5.2 billion gallons of ethanol per year.)

Reaching the numbers outlined by President Bush won't be easy. It probably would require significantly increasing the concentration of ethanol that's blended into gasoline. That, paradoxically, is a move that scientists say raises potential air-pollution problems of its own. Studies show that while ethanol added to gasoline in low concentrations helps reduce certain emissions, such as carbon monoxide, it tends to increase some other emissions.

Another option to meet the government mandate would be to increase the use of ethanol as a standalone fuel. That would require the installation of ethanol pumps at gas stations -- a move that could cost the oil industry billions of dollars.

--Leila Abboud and Jeffrey Ball contributed to this article.

--Ms. Smith is a staff reporter in The Wall Street Journal's Los Angeles bureau