How to win big in the ethanol decade

With the oil market becoming increasingly volatile, countries are looking for alternative fuels. So how can investors profit?

The majority of Americans will be waist-deep in Thanksgiving celebrations and likely in the midst of digesting a fat turkey and generous dollop of pumpkin pie as you read this.

But that might not be all you'll be digesting...

If, like millions of others, you'll be traveling to your relatives' Thanksgiving bash this year, you'll again have to contend with gasoline prices that are distinctly unappetizing. Call me a cynic... but wouldn't you know it? No sooner are the mid-term elections over... gasoline prices in eight of the nine U.S. regions (as measured by the Energy Information Administration, a branch of the U.S. Department of Energy) have mysteriously crept up a few cents per gallon - despite oil prices continuing to fall to under $57 a barrel. Hmm...

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The national average price per gallon of gasoline is now $2.23 - meaning consumers are still feeling the pinch in a bad way. And while I'd hate for you to endure any acid indigestion thinking about that this Thanksgiving, the fact is... it could get worse.

But as much as the gasoline companies want to empty out your wallet every time you fill up the tank, there is fortunately a way you can combat this...

The Troubling Trio: Pump... Re-Import... Refine

Demand for gasoline is actually more prone to wild swings than demand for crude oil. Why? Because few countries have the ability to refine crude for use as gasoline. That adds an extra layer of time and cost to gasoline inventories and production.

Consider that countries like Iran, which pumps out more crude than 80% of the rest of the world's producers, must re-import their own crude as gasoline because of limited refining capability.

Here in the U.S., the situation, while not as dire, is pathetic. And it could mean 'barrels' of profits for the companies solving this problem...

The Cartel Controls It All... Or Does It?

For all the talk about America freeing itself from the shackles of the Middle East oilmen and gaining greater oil independence, the country hasn't built any new oil refineries in more than two decades.

But building a refinery is no easy thing - it takes years and lots of environmental studies and approvals before a refinery can start producing gasoline. There are a couple of refineries on the board right now, but the first drop of gasoline from these proposed facilities is years away from your gas pump.

Naturally, politics is also a major factor in gasoline production. Since it's derived from crude oil, much of the world is at the mercy of the OPEC oil cartel that can play havoc with supply and demand.

And because crude prices are determined at the margins, it's not the first 30 million barrels a day that determines the price; it's the last million barrels. And if those last million barrels are taken off the market, you've got a simple supply-demand equation at work: The price of crude can spike because there are no substitute sources available.

But OPEC doesn't have to control all the oil - in fact, the U.S. gets most of its oil from Canada, Mexico and Venezuela. But when OPEC opens or closes the oil spigots, the price reacts because the cartel controls the oil that can be pulled off the market during peak demand or supply. Right now, we're in peak demand... thanks largely to China and India's mega-consumption.

China in particular needs gasoline to power its tremendous growth. This is an additional demand that simply wasn't around a decade ago. But today, demand from China - a country growing at more than 10% a year - is tugging at the margins.

There's Corn In Them Thar Hills!

There is no room for error or natural disaster in the crude oil market. Sure, you may see some short-term fluctuation, but that does nothing to address the long-term demand for crude oil and gasoline. And that demand is not projected to slow - rather it is expected to outstrip the ability to produce more oil.

Therein lies the long-term problem... and the long-term solution: Alternative energy.

So far, only one form of alternative energy has proved economically efficient - ethanol.

Ethanol, which is energy derived from non-carbon sources, can be produced in mass quantities around the world. It can be used with current engine technology with few modifications - there is no need for battery technology, hydrogen fuel cells, etc.

Ethanol is here now - and it represents one of the best long-term alternative energy solutions. Countries like Brazil are already ethanol dependent, and almost fossil fuel independent. And the resource has the firm backing of some of the biggest governments and private investors in the world (Bill Gates and Sir Richard Branson, to name just two).

20 Years To The Ethanol Era?

Yes, ethanol has it downsides. For a start, it has to be transported by wheel technology, because there are no ethanol pipelines yet. The fuel must then be dispensed through special hoses and pumps developed to withstand ethanol's unique chemical features. Cars and trucks must be modified or built to use ethanol.

Fortunately, those issues are being addressed in real time. And within the next decade, ethanol could end up replacing 12% of the gasoline market. And if enough money is poured into ethanol development, it's feasible that ethanol could completely replace gasoline within 20 years. If you think that seems unrealistic, Brazil has shown that it can work. For the U.S., even a 25% replacement rate would achieve significant environmental and economic savings.

There are several companies that are top players in the field. Some are pure producers - but as such, and considering they're in the developmental stage, they're consequently prone to huge swings in volatility.

You could also buy a company that is a major agricultural and ethanol player. But the bottom line is that to invest in ethanol, you must have a three- to five-year time horizon. And as we'll see in the 'ethanol decade,' the potential returns are incredible.