NEW YORK -- The U.S. ethanol boom could push lofty natural gas prices even higher as the explosion of new distilleries and a soaring corn crop raise industrial and agricultural demand.

Ethanol refineries tend to use natural gas-fueled boilers, and natural gas is also used in the production of fertilizer for corn, which is the main feedstock for ethanol in North America. (Sugar cane is the main feedstock in South America.)

"It's another way we're becoming dependent on natural gas," said senior analyst Christopher Jarvis at Caprock Risk Management. "A rise in gas demand is in the cards for this year, and next, and an additional uptick from ethanol could definitely have a material impact."

Experts said that the ethanol boom — which has already contributed to inflation in the prices of bread, meat and diesel fuel — could add roughly 1 percent to U.S. natural gas demand within a year and a half, magnifying an already tight balance between production and rising consumption from homes, businesses and power plants.

Story Continues Below

Ethanol production increased by 25 percent last year and is set to rise even more in the next few years as the administration of President George W. Bush offers farmers millions of dollars in incentives to produce the fuel in an attempt to cut imports of foreign oil.

The United States already has about 116 ethanol distilleries, with 78 plants under construction and seven undergoing expansion. If all the new plants and expansions come on line, total capacity will be above 12 billion gallons per year, according to the Renewable Fuels Association.

Up to 95 percent of U.S. ethanol plants use natural gas boilers because they are seven times cheaper than ones that burn coal, Gil Yang, an analyst at Citigroup Global Markets, said in a research note.

In addition, farmers this year are planning to plant a bumper crop of corn, the main U.S. ethanol feedstock, possibly the most since World War Two. Corn fields consume large amounts of fertilizer, the ammonia of which comes from natural gas.

A recent Raymond James research note said the ethanol boom could push U.S. gas demand up by as much as 1 percent over the next 18 to 36 months.

Natural gas prices were nearly $7.60 per million British thermal units on Thursday, up nearly 9 percent from last year's average, though below the 2005 record annual average of $8.81 when a hot summer and hurricane damage cut into stockpiles.

Gas prices this year are expected to average 7 percent higher than last year as growth in domestic production and imports fails to keep up with rising demand. For a Reuters forecast on natural gas prices, click [NGAS/POLL] .

Citigroup's Yang said that every 1 billion gpy of new ethanol production boosts U.S. natural gas consumption by about 28 billion cubic feet. If all the new ethanol plants on the books are built, U.S. natural gas demand would rise nearly 0.8 percent, he said.

A small number at first glance, but the balance is already tight, said Caprock's Jarvis. The number of rigs exploring for natural gas in the United States is at about a 25-year high but production is flat, which Jarvis called "a major red flag."

Raymond James analyst Pavel Molochanov said that while natural gas demand has traditionally been seasonally driven with home heating and cooling, the constant operation of ethanol plants could begin to keep demand strong year-round.

U.S. dry gas production is expected to rise 1.4 percent this year to 18.74 trillion cubic feet, but will be below levels hit a decade ago, according to the federal Energy Information Administration. And after rising to an expected 19.41 tcf in 2008, U.S. gas production is expected to be steady to lower for the next three years, it said.

Meanwhile, U.S. demand is expected to rise 2.5 percent to 22.40 tcf this year and increase steadily for years.

While analysts declined to say how high ethanol could push gas prices, they agreed the direction is up. Barring any major global economic meltdown from an overheated Asian economy, "it's almost frightening where natural gas prices could be in two or three years," Jarvis said.

© Reuters 2007. All rights reserved. Republication or redistribution of Reuters content, including by caching, framing or similar means, is expressly prohibited without the prior written consent of Reuters.

Editor's note:
This service made $125,427 on a $10,500 investment in 42 days!
Try Intelligent Options for $99. Our lowest price ever.
What Happens When Easy Money Disappears? 12 Ways to Profit.