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Beyond Corn

Market Summary – 1st Quarter, 2007

In case you haven’t noticed, there’s an energy revolution underway in America. The center of it can be found in some of the most out-of-the-way places imaginable. As millions of us continue to burn gasoline and fret about pending shortages due to growing demand on a global basis, a part of the solution is being grown and harvested in the heartland.

The revolutionary new development is biorefining, a process that turns biomass into renewable energy. Alternative fuels such as ethanol and biodiesel are made from glucose extracted from plant fiber. These renewable energy resources are gaining a lot of attention due to the world’s increasing appetite for gasoline. The heart of this industry is cropping up in rural America.

The initial push for ethanol as an alternative fuel seemed to belong to environmentalists and agricultural interests, but it has moved well beyond the purview of these groups. Given the recent increase in energy costs, it is fast becoming an economic issue affecting the nation’s well being. Maybe even more importantly, in light of the unstable political situations found in some of the biggest oil-exporting countries, ranging from Iran and Saudi Arabia to Venezuela and Russia, it also becomes a national security issue.

q107 cartoonOur Energy Dilemma Today
If current usage patterns persist, America’s demand for gasoline will jump from 131 billion gallons today to 290 billion gallons by 2050.

Raising gas mileage to an average of 50 MPG would reduce U.S. consumption in 2050 to 108 billion gallons.

The U.S. accounts for 25% of the world’s oil consumption today, but only holds 3% of its reserves.

66% of the world’s known oil reserves are found in the Middle East.

The U.S. imports 65% of its oil today, estimated to rise to 71% by 2025.

Ask most Americans what plant source they think of when they hear the word “ethanol,” and the answer almost certainly will be corn. So does that mean corn is the answer to our long-term energy needs (as a gasoline substitute)?

While corn is the key ingredient to current U.S. ethanol refining technology, it is not the future. We hope corn farmers will receive their just rewards for their contribution to alleviating some of America’s energy supply issues. But the simple fact is that corn cannot be the primary source if ethanol is truly going to provide a significant solution for our energy needs.

The reasons are simple:
The amount of energy it takes to create ethanol by growing, harvesting and processing corn is a high percentage of the actual energy produced by corn-based ethanol (in other words, it is a fairly energy-inefficient process).
Rapidly increasing the production of corn could also require heavy use of other limited resources, such as water and land.
• There are some limitations in transporting ethanol via pipeline, one of them being that ethanol absorbs water and impurities that exist in pipelines, so much of it has to be transported by truck or train.
If we use too much corn to create fuel (rather than just a food source), any cost savings may be lost as demand for corn pushes prices up. An unintended consequence of the recent jump in corn prices (due to speculation about ethanol potential) is that it is driving up costs of products like animal feed. This can negate any positive economic impacts that might derive from production of corn-based ethanol.

The “maize” craze has reached new heights and is likely to continue at least through the Iowa Presidential caucus in 2008 (it is hard to imagine any candidate going to Iowa and promoting an alternative to corn). The U.S. Department of Agriculture reported that planned corn plantings for 2007 will top 90 million acres, 15% more than last year and the largest amount of American soil devoted to corn growing since World War II.

Fast Facts About Ethanol

It takes 10 bushels of corn to fill a 25 gallon gas tank, enough to feed one person for a year.

Today, the wholesale price of ethanol is $1.20/gallon, versus $0.75/gallon for gasoline. If more effective processes are in place, the wholesale price of cellulosic ethanol could drop to between $0.59 and $0.91/gallon by 2015.

Biomass products currently can produce 50 gallons of ethanol per dry ton. The goal is to improve efficiency to 117 gallons per dry ton.

Show Me the Switchgrass!
Despite corn’s limitations, there is reason to be excited about the prospects of a more ethanol-dependent energy landscape for the U.S. It centers on cellulosic biomass – in simplest terms – the use of grass, corn stalks, stems, leaves, wood chips and other products that are considered plant waste. The word “switchgrass,” which many heard for the first time when uttered by President Bush in his “addicted to oil” State of the Union speech in 2006, may become a future equivalent of the term “sweet crude” used in the oil industry today.

Switchgrass offers efficiencies that make it more attractive and cost-effective than other energy sources, provided the processing technology can be improved. It can be grown in many parts of the country and generate significantly higher yields per acre.

The plan is to process products like switchgrass and turn them into ethanol. There are a number of reasons why biomass is such an attractive option.

First, from a practical standpoint:

• This is material we don’t eat and are not reliant on as a food source.
• We’re turning what is essentially an unused resource into a potentially valuable one.
• Growing this “fuel” requires less investment than a concerted effort to produce more corn.

That’s the good news. Unfortunately, the technology to convert biomass to ethanol in a massive and cost-effective way does not yet exist. The cellulosic structure of most biomass products is difficult to break down the way current technologies can do with corn. But there seems to be much more of a will, both in terms of government incentive and by private investment, to make mass production of cellulosic biomass a reality.

Energy challenges = opportunity for biorefineries
We’ve been talking for several years about the investment opportunity tied to energy. The rapid rise in crude oil prices that began in 2003 confirmed our view that skyrocketing demand worldwide would drive oil prices higher.

Those higher prices have created an opening for alternative approaches to fuel, and for greater conservation measures as well. The numbers show that something has to happen on this front.

Today, cars in America use a total of 131 billion gallons of gas each year, a number that is steadily rising. Corn-based ethanol represents roughly18% of the nation’s corn harvest and substitutes about 2.1 billion gallons (or 1.6%) of the nation’s gasoline diet, but this could change dramatically. If America reaches a stated goal of replacing 30% of petroleum consumption with ethanol in less than 25 years, that would amount to at least 40 billion gallons.

The development of cellulosic biomass refineries has the potential to be one of the next great industries, both in America and around the world. These could become the 21st Century version of oil refineries. Companies with a foot in the agricultural door are not blind to the possibilities.

What makes biomass refining so attractive to these companies is that it isn’t just about ethanol. The processing of biomass can also create a variety of products, such as chemicals, proteins, acids and animal feed. The key to making biomass more useful is the development of technology to separate sugars in cellulose and hemicellulose (fibers), a difficult process, but a primary focus of R&D efforts today. As the processes improve, it will be easier to utilize biomass material for purposes beyond ethanol. This makes ethanol production more cost-efficient, and from an investment standpoint, more profitable.

ADM at the revolution
Archer Daniels Midland is a prime example of a company in the forefront of the new alternative energy solutions. ADM’s experience and existing technologies related to agriculture make it a frontrunner in the development of biorefining. ADM is an attractive company for other reasons too, but it represents a good way to capitalize on new energy trends.

ADMs new Chief Executive comes from Chevron – an interesting choice for a company primarily known for its food business. While it only represents a small part of ADM’s story, the company is expanding ethanol distribution and growing its biofuels business. Its ethanol production capacity will be increased by 50%, to 1.6 billion gallons, by next year. ADM is also big in the production of biodiesel (using products such as soybean oil).

ADM’s expansion beyond corn and into biomass as a source for ethanol is focused on using its existing supplier market (which includes a lot of corn farmers) by processing corn stalks. There are more questions about making switchgrass and other products a viable resource at this point, and for ADM, corn waste appears to be the shortest distance between here and there.

This is just one example of a company that is well positioned in the biofuels marketplace. There are others, and they all represent what we anticipate will be an increasingly important part of our long-term energy play.

Additional benefits of biofuel production
Efficiencies in biofuel production will come, in part, from subsidiary products that can be developed from the process, used for purposes ranging from water filtration to cosmetics to specialty chemicals.

The use of just 10% blends of ethanol reduces greenhouse gas emissions by a range of 18% to 29% compared with conventional gasoline.

The production of biomass (during the growing cycle) removes the same amount of carbon dioxide (CO2) that is returned to the atmosphere when it is processed and used, resulting in a carbon footprint of zero.

What it will take
One of the reasons ethanol is such a hot topic is that the technology is either here, or closer to being here than with many other alternative energy options. Light-duty cars and trucks can already run on 10% ethanol. Those in the Midwest are familiar with the product E-85, using 85% ethanol and 15% gasoline. More than a million flex-fuel cars with the ability to operate using E-85 are on the road today. It costs about $200 more per car to make it E-85 capable. That is much less expensive than building hybrid versions (gas-electric) of existing fuel-based automobiles.

Talk of solutions like hydrogen cars (another Bush administration favorite) are much farther away from becoming a practical reality, and still require a significant investment to get there. On other fronts, fusion technology has tremendous potential, but most agree we are decades (and billions of dollars) away from seeing it become a commercially-viable energy source.

The demand for energy is not going away. The price of oil, while fluctuating from time-to-time, is likely to remain either close to today’s level or drift higher, a reflection of increasing world demand. Price spikes may occur as well, a reaction to certain seasonal effects and geopolitical events. The world is ready for biofuels, and we expect that the markets will begin to recognize the opportunity for years to come.

Renewable energy sources now represent an industry that serious investors need to explore. We see biorefining as a natural extension of our investment focus on energy.

MPMG Second Annual Speaker Series Event

On an annual basis MPMG holds a forum with the goal of providing the Twin Cities investment community with insight on industry trends and information relative to investing in today’s global marketplace. Following last year’s event, headlined by Dr. Jeremy J. Siegel, many of you have been eagerly awaiting details regarding this year’s speaker, and date – and who are we to keep you waiting. This year’s event will take place on the evening of July 26, 2007 and once again, due to capacity limitations will require those planning to attend to reserve their tickets ahead of time. And our speaker will be…

“Bueller….Bueller…..Bueller.”
This line (“Bueller…Bueller…Bueller”), as many may recognize, was delivered in a deadly monotone by a high school teacher conducting roll call who brought back many of our worst memories of the classroom. For those who are not familiar with it, the quote comes from the 1986 classic comedy, Ferris Bueller’s Day Off. We are excited to announce that this year’s Speaker Series Event will feature the unforgettable actor, economist, author and former game show host, and the man who delivered this famous line – Ben Stein!

A comedian of world-class wit and financial acumen, Ben Stein is the nation’s self-styled “hope for a new millennium.” His deadpan delivery carries an unexpected wisdom that made him a national celebrity.

Funny Man
Stein offers laughter, insight and tears as he explores society’s most quirky conundrums.

With a Serious Side, Too
Ben is an exceptionally gifted economist whose market analysis is sought by companies and organizations nationwide.

And a Resume to Envy
Ben Stein has led a colorful career, including speech writer and lawyer for Richard Nixon and Gerald Ford. He has been a columnist and editorial writer for The Wall Street Journal, a syndicated columnist for the Los Angeles Herald Examiner and a frequent contributor to Barron’s. He has also written a number of books including, How to Ruin Your Financial Life; Yes, You Can Time the Market!; and Can America Survive?: The Rage of the Left, the Truth, and What to Do about It. His most recent books are The Gift of Peace: Guideposts on the Road to Serenity; and Yes You Can Become A Successful Investor.

We always appreciate the wit, common sense and logic Ben Stein brings to his writings. To give you a flavor, here are a few highlights we have pulled from his recent scribblings in The New York Times.

(From Where Are the Grown Ups When You Need Them, March 11, 2007, on the ethical failures of corporate America):

It used to be assumed that along with great power in the corporate world came great responsibility. To stockholders above all that duty was owed. That was how grown-ups played the game.
But to the adolescent mind, everything is owed and nothing is owed in return. To the adolescent mind, it’s all about what can you do to feed a bottomless maw of self-regard. How else to explain the collapse of ethical standards in terms of excessive C.E.O. compensation, backdating of options, spring-loading, lavish-beyond-words severance packages for failed C.E.O.’s?

(From So Many Millions, So Little Body Armor, Jan. 7, 2007, on the contrast between riches created by huge Wall Street bonuses and questionable stock option deals for corporate executives and the dilemma facing U.S. troops lacking sufficient body armor):

WHERE is the outcry? Where is the rage? It’s not a partisan thing. The Democrats are just as complaisant about this as the Republicans. Have the leaders of both parties and the boys at the research groups been so thoroughly blinded — or corrupted — by the plutocrats that no one will say ”boo” about it?
I guess so. My letters tell me that there are a lot of angry people out there, and some of them have children in Iraq and wonder why all this looting is allowed while their sons and daughters are at war for a law-abiding and just America.
I’m no longer sure what to tell them, except that it’s all about money, and if you don’t get it, you don’t get it. And it’s deeply sad.
(From The Hard Rain That’s Falling on Capitalism, Jan. 28, 2007, on the loss of trust engendered by actions of greed in corporate America):

Empires come and go. Economic systems come and go. There is no heavenly guarantee that capitalism will last forever as we know it.

It’s built on man’s notion that he can trust his neighbor with his money, and that if the neighbor misbehaves, the law will chase him and catch him, and that the ladder of law has no top and no bottom, that even the nobles get properly handled (Bob Dylan again) once they have been caught.

“If that trust disappears — if the system is no longer a system for the ordinary citizen but only for the tough guys — how much longer can the miracle last?

Ben Stein is, above all, an expert on bringing meaning to both life and work. We look forward to a night like no other including useful insight (if you want it!) or simply great memories of a fun time had by all. Please note that access to this event is by reservation only.

~MPMG

Although the information in this document has been carefully prepared and is believed to be accurate as of the date of publication, it has not been independently verified as to its accuracy or completeness. Information and data included in this document are subject to change based on market and other condition. All prices mentioned above are as of the close of business on the last day of the quarter unless otherwise noted.

The information in this document should not be considered a recommendation to purchase any particular security. There is no assurance that any of the securities noted will be in, or remain in, an account portfolio at the time you receive this document. It should not be assumed that any of the holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable. The past performance of investments made by MPMG does not guarantee the success of MPMG’s future investments. As with any investment, there can be no assurance that MPMG’s investment objective will be achieved or that an investor will not lose a portion or all of its investment.