Merrill Lynch Introduces Biofuels Indices

This week, Merrill Lynch introduced two indices designed to offer investors exposure to the fast-growing biofuels market with greater liquidity, transparency and efficiency than financial instruments currently available: The MLCX Biofuels Index and the MLCX Biofuels Plus Index.

Until now, investors seeking to profit from rapid expansion in the ethanol and biodiesel industries typically recurred to traditional agricultural commodity indices or futures. Such instruments are vulnerable to very negative roll returns, or negative carry, due to the storage dynamics of the underlying agricultural commodity markets. 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. The MLCX Biofuels Plus Index offers exposure to biofuels and conventional fossil fuels.

“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.”

The MLCX Biofuels Index weights commodities according to production levels and calorific potential, in order to reflect their 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 commodities in the MLCX Biofuels Index. The MLCX Biofuels Plus Index reflects how current technology and infrastructure is more geared to blending biofuels with conventional fossil fuels than to offering a pure biofuel alternative.

Merrill Lynch expects demand for agricultural commodities to grow in the long term, thanks in part to legislation. E.U. directives adopted in 2003 aim to derive 5.75% of total transport fuel consumption from biofuels by 2010 and up to 20% by 2020. The U.S. Renewable Fuel Standard Program requires that at least 7.5 billion gallons of renewable fuel be blended into vehicle fuel by 2012. Slow progress in finding more efficient ways to produce biofuels means that the demand will have to be met by a massive expansion in supply, increasing competition for cropland, labor and water. This could drive up the price of biofuels related crops as well as other crops such as wheat, rice and coffee.

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