Ethanol, Boom – Bust – Boom
By Dmitriy Vilenskiy | June 11, 2007
It should not be surprising that the largest ethanol producing companies are at or near 52-week lows. (ADM, PEIX, USBE, VSE ) Nor is it surprising that most analysts covering ethanol are pessimistic about future profit margins with corn over $4 per bushel. They are partially right.
Investors that are long on ethanol producers should keep a number of things in mind. First, despite record high corn prices, ethanol producers are still making money. The corn spike is a result of much speculated futures buying. Much like oil has spiked last summer to record levels, corn is experiencing a similar frenzy. The difference being, that while oil is in the hands on our dear friends at OPEC who minimize production to maximize profits, corn is being grown by thousands of American farmers who are feverishly increasing capacity. Corn planting, it should be noted, is also at near record levels. If an excess supply of ethanol does occur, the price of corn will also dip to accommodate the decrease in production. In other words the market will reach an equilibrium where both parties will make an appropriate profit.
Secondly, long term investors have something to look forward to. There are three items going on in Washington that will rally ethanol stocks in the next few months.
The first will be the 2007 Energy Bill set to be discussed within the next few weeks. If the politicians are to be believed the tax incentives for gas station owners, flex-fuel car manufacturers, and consumers will prop ethanol consumption for at least several years to come.
The 2007 FARM bill which gets redrafted every five years, will be out of the House Agriculture Committee by July 4. The current farm bill expires on September 30th and new bill’s alternative energy scope should be far reaching. Congress wants to ensure that ethanol producers get enough subsidies for this ethanol boom to endure.
California’s battle with the EPA is not close to resolution; however, if the EPA does allow CA to establish its own emissions caps, California and eleven other states will mandate new vehicles to get better MPG. Since this feat is not exactly easy to achieve, car manufacturers will have to rely on ethanol for support. If the EPA stalls, California has pledged to sue by this November. Surely, they do not want a big legal battle to ensue.
Lastly, consider this: technology is constantly innovating. If the price of corn does prove to be a much bigger burden for ethanol producers than previously thought, they will shift to cellulosic ethanol. Plus, technology and biology has already created a process to grow more efficient corn that yields higher ethanol production.
Unless OPEC puts up a big clearance sign, ethanol will be a substitute and complimentary product. Watch for price weakness, and get ready to buy at any sign that the above legislation is ready to go through
DISCLOSURE: The author of this article has a long position in PEIX. | |