Market Spotlight: Once-trendy ethanol struggles

The idea of reducing dependence on Saudi Arabian oil, lending a hand to farmers and fighting global warming won over Washington. Congress gave the industry a 51-cent per gallon tax subsidy, a 54-cent per gallon tariff and specific orders for petroleum refiners to blend with ethanol. The suddenly lucrative sector was also a magnet for Wall Street investors.

But things are changing.

Food riots in Haiti, Bangladesh and Egypt, record high grain prices and mounting scientific doubts about the effect of ethanol fuel on the ozone layer have the sector on the defensive for the first time in memory.

"Corn ethanol was presented as an almost Holy Grail solution," said Rep. Mike Doyle, D-Pa., recently. "But I believe its negatives today far outweigh its benefits. ... We need to revisit this ... and back away from the food to fuel policy."

A House-Senate compromise farm bill -finalized Thursday and facing a possible veto -reduces ethanol's tax break from 51 cents to 45 cents a gallon, and 26 U.S. senators want the administration to cut mandated ethanol usage levels.

The controversy has become a presidential campaign issue.

On Sunday, both Democrats running for president, Sens. Barack Obama of Illinois and Hillary Clinton from New York, said U.S. ethanol policy deserves a closer look in light of the current food crisis.

Wall Street is already giving ethanol a closer look. Where once analysts advised clients which ethanol stocks to buy, they are increasingly warning investors to take a wait-and-see attitude on the whole sector.

Earlier this month Thomas Weisel Partners analyst Jeff Osborne cautioned his clients about "increasing negative public sentiment to Ethanol as part of the 'Food versus Fuel' debate, which could lead to adverse regulatory changes."

And last month analyst David Edwards of Morgan Stanley began covering the sector by downgrading the shares of three of its key companies -Aventine Renewable Energy Holdings Inc., Verasun Energy Corp. and Pacific Ethanol Inc. -partly because of scientific concerns and their possible effect on Washington.

"Scientific studies have raised questions about the carbon cost of biofuels, and proposed legislation could drive a reassessment of corn ethanol," he wrote.