High Corn Prices Hurt Ethanol Producers
The Dynamic Wealth Report
April 25, 2008
Is It Time To Buy Ethanol?
Oil is getting out of hand. $119 per barrel. Who has that kind of money.
It won’t be long before we see Gasoline prices over $3.50. Oh, wait,
we’re already there! I used to fill my gas tank for $20 and get money
back. Now, I fork over $40 and I’m lucky to get enough change for a pack
of gum.
This is where having a free market economy is great.
When prices get out of hand alternative products start showing up. For
high oil, which results in high gasoline, we start seeing other
replacement fuels. Anything and everything from bio-diesel to ethanol. It’s basic economics. When prices get too high consumers seek out
alternatives.
Ethanol is a perfect example.
Ethanol is a flammable colorless chemical compound that has many
different uses. Originally created from the production of alcoholic beverages,
it can also be used as a solvent or as a fuel.
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The production of ethanol is very simple. Sugar is found in many
naturally occurring plants like wheat, corn, or sugar cane. Mix it with
certain yeasts that consume sugar and you get ethanol as a byproduct.
It doesn’t matter if you’re making ethanol for human consumption or for
use as a fuel, the production is similar. After fermentation, the more
volatile ethanol can be distilled out.
In the 1840s ethanol was used as fuel oil for lamps. In 1908 the Ford
Model T could run on ethanol. Today, in Brazil, it seems like everything
is run on ethanol.
The vast majority of ethanol produced in the world is made in Brazil
from sugar cane. According to some statistics, almost half of the cars
in Brazil can run on 100% ethanol. They use sugar cane because it grows
easily in their geography and the high sugar content is easy to extract.
Clearly ethanol has a place on the world stage as a gasoline
replacement.
So here’s the question. Is it time for ethanol in the US?
With oil reaching new highs every day, ethanol should be more
competitive. Less than a year ago when gasoline prices were trading on
the NYMEX for around $2.00 ethanol cost $1.70. Today gas is now over
$3.00 and climbing. Ethanol is up as well, but is currently priced at
$2.50. A discount of about 16%.
So you’re probably thinking, gasoline prices are up and ethanol demand
should increase. That’s right. And with an increase in demand comes
higher prices. Right again. So now is the time to buy ethanol producers
like Verasun (VSE) or Pacific Ethanol (PEIX). Good thinking, but we’re
missing a key component.
Just because the price of ethanol is up doesn’t mean that earnings will
grow.
Let me explain why. Unlike in Brazil where sugar cane is the primary
input, in the US most of the ethanol is produced from corn. And corn
prices have been rising like crazy. For years they traded for less than
$2.50 a bushel. Now the price of a single bushel of corn is more than $6
up 140% in just a few years.
This makes the production of ethanol less profitable. But don’t take my
word for it. I found this buried in Pacific Ethanol’s 10-K:
The principal raw material we use to produce ethanol and its
co-products is corn. As a result, changes in the price of corn can
significantly affect our business. In general, rising corn prices
produce lower profit margins and, therefore, represent unfavorable
market conditions. This is especially true since market conditions
generally do not allow us to pass along increased corn costs to our
customers because the price of ethanol is primarily determined by other
factors, such as the price of oil and gasoline. At certain levels, corn
prices may make ethanol uneconomical to use in markets where the use of
fuel oxygenates is not mandated.
What lawyer wrote that? All they had to say is “We don’t make money when
corn prices go up.”
Clearly oil prices are high and many are going to look for ethanol as a
replacement . . .at least in the short term. Despite these positive
market actions, companies producing ethanol won’t benefit much. If
you’re looking for an investment in alternative energy I’d pass on
ethanol. You can do much better than the “broken” business models of Verasun or Pacific Ethanol.
• National City (NCC) received a number of upgrades from Bernstein,
Deutsche Securities, and Punk, Ziegel. The company recently announced a
financing of about $7 billion and cut their dividend. The stock fell
more than 30% that day.
• First Solar (FSLR) was downgraded this week by Collins Stewart. The
stock peaked at $308 and has traded lower ever since. The company is set
to announce earnings on April 30.
• Needham jumped into the solar space this week with new coverage on
Solar Power (SOPW). The $1.47 stock traded flat on the news.
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