By Mohammed Aly Sergie
The demand for renewable fuel is set to surge, and Merrill Lynch has taken notice.
The demand for renewable fuel is set to surge, and Merrill Lynch has taken notice. The investment bank has introduced two indices designed to offer investors exposure to the biofuels market - the MLCX Biofuels and MLCX Biofuels Plus indices.
Over the past few years the EU and the US have implemented programmes to increase the use of renewable energy sources and biofuels. The EU will derive 20% of total transports fuel consumption from biofuels by 2010, while the US will have at least 7.5 billion gallons of renewable fuel blended into vehicle fuel by 2012.
Until now, investors seeking to profit from the rapid expansion in the ethanol and bio-diesel industries typically reverted to traditional agricultural commodity indices or futures. These instruments, however, are vulnerable to negative roll returns, or negative carry, due to the storage dynamics of the underlying agricultural commodity markets.
"Our indices have been carefully designed to mitigate the negative roll returns inherent to many agricultural commodities markets," said Francisco Blanch, head of global commodity research at Merrill Lynch. "They also offer additional returns by overweighting crops that produce the most energy in biofuel production, notably sugar and soybeans."
Merrill Lynch's new indices use a rolling mechanism to spread the buying and selling process over 15 days. The MLCX Biofuels Index offers exposure specifically to biofuels, while the MLCX Biofuels Plus Index offers exposure to biofuels and conventional fossil fuels.
The MLCX Biofuels Index weights commodities according to production levels and calorific potential in order to reflect economic value. It contains seven commodities commonly used as biofuels feedstock: sugar, corn, soybeans, barley, rapeseed, canola, and soybean oil. The MLCX Biofuels Plus Index adds gasoline and diesel to the agricultural commodities, taking into account that the current technology and infrastructure is geared towards blending biofuels with conventional fossil fuels rather than offering a pure biofuel alternative.
Merrill Lynch predicts that the slow progress in finding more efficient ways to produce biofuels will result in increased competition for cropland, labour, and water. The investment firm expects demand for agricultural commodities to grow in the long term.