Are Ethanol-Based Fuels Economically Viable Alternatives for Gasoline?

More and more often of late when one opens the paper there is an article about ethanol being used as a fuel alternative for petroleum-based products such as diesel fuel and gasoline.    While reading one of these recently I started to wonder if ethanol was actually an economically viable alternate fuel source for the American public.

There are two major hallmarks of high-growth industries: the ability to grow turnover (sales generated by each unit of operating assets), and the ability to earn excess economic profits. Using just these two concepts it is obvious that the ethanol industry is not likely to be populated by strong growth companies. Despite the fact that many companies within the industry are experiencing rapid sales and profit growth, they are not real growth companies creating long-term value.  Though the companies are expanding, their margin of profit is fundamentally limited, as ethanol production is close to a perfectly competitive market.  There are several reasons for this.

The first is that an ethanol producer cannot easily grow total asset turnover. The production model for an ethanol company is essentially that a fixed number of units of ingredients are put in, and a fixed number of units of ethanol come out. There is no way to increase the efficiency of this process without the development of new methods of manufacture. It is physically limited by the ability of yeast to ferment glucose into alcohol.  As distillation and fermentation technologies have been under development since roughly 700 AD, it is reasonable to assume that no single distiller has a proprietary technology which gives it a lasting competitive advantage over other producers.  To get more ethanol, the companies will have to invest in larger facilities. These companies cannot grow revenues without additional capital expenditure, and that increase is always going to be proportional to the investment. None of these companies can increase the return on operating assets over time. They will never see the rewards of growth on growth, or increased asset turnover efficiency.

Because ethanol is a pure commodity (or a homogenous good), ethanol distillers operate in a highly competitive market. The product of every supplier is the same, and the sale goes to the lowest bidder. Basic economic theory demonstrates that over time the ethanol market will settle into an equilibrium in which no excess economic profits are earned.  The combination of an inability to increase return on operating assets and eventual maturation into a competitive market without pricing power means that the ethanol sector will not accomplish real long-term excess growth and as such the current economic viability will likely remain constant.