An Artificial Market Doomed to Crash or an Answer to Our Prayers?

Although Canadians are still playing catch-up, Americans are already convinced that the ethanol market is ripe for the picking. True, buying ethanol IPOs potentially offers a perfect exit strategy for investors, what with all the government support programs and tax breaks on both sides of the border, as well as rising oil prices. Consequently, the line-up of IPO ethanol producers south of the border has become quite long. But, for some reason, the same is not happening in Canada–at least not yet.

There are few things investors should know about the ethanol market; it would not even exist if it were not for governments of both countries footing most of the bill. For example, U.S. refiners that use ethanol in their products receive a $0.51 tax break per gallon. At the moment, subsidies and tax breaks deliver billions of dollars in free money to refiners.

The only problem is that governments change. And, while George W. Bush believes ethanol will wean his “people” off expensive oil, his reign will be over in 2008. Who knows what his successor will think of ethanol. And, if he, or she, decides to stop the handouts, U.S. refiners that are also ethanol “junkies” should better watch out.

As far as Canada’s ethanol policies are concerned, we have gone a step further, providing ethanol producers with not only endless subsidies, but also with a guaranteed market. Justification for such a move is partly based on ethanol‘s alleged environmental benefits, although any such benefits are dubious at best.

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For example, in 2007, Ontario government will put into law a five percent mandatory ethanol content in all gasoline sold in Ontario. Federal government will introduce similar legislation in 2010, while Manitoba already requires ten percent ethanol content in 85% of all gasoline sold in the province.

Moreover, as far as subsidies go, in the past six years, Canada’s federal government shelled out about CDN$268 million in various types of loans, grants and tax breaks. In Ontario, there is something called Ethanol Growth Fund, which is really a $520 million “free money pool.”

Basically, Canada’s ethanol market is both guaranteed and amply subsidized by all levels of government. Plus, ethanol prices are rising and investors love the idea of alternative fuel. Still, Canadian ethanol producers are avoiding IPOs.

Why? Perhaps the thought of being responsible to shareholders once they go public does not sit well with producers that are used to being pampered and operate unquestioned. Here is one more crazy idea–it looks to me that everything about ethanol market in North America is artificially created, including demand and supply. And, what artificial markets often do? Well, they crash! Perhaps ethanol producers in Canada are simply afraid investors would see right through them!