Investments: Ethanol Lives
Ethanol Lives
By Nick Hodge
It's been some time since we've discussed the benefits of biofuels--in particular those of the next generation in ethanol.
That's probably because the sector as a whole hasn't been doing all that great lately, what with all the food versus fuel worries and all the talk about a biofuel bubble.
A look at the charts of a few key industry players will instantly illustrate how this negative press and perception has affected the sector:
US BioEnergy Corp. (NASDAQ: USBE)
Pacific Ethanol, Inc. (NASDAQ: PEIX)
Verasun Energy, Corp. (NYSE: VSE)
Over the past two months, these stocks have fallen an average of 21.5% (but notice where they're heading now).
It all started in mid June, when a few large banks decided to downgrade several ethanol producers for one of two reasons. One, a decline in profit margins or two, an excess supply.
Let's take these one at a time.
One Bank of America report went so far as to say, "We expect the relentless supply of new ethanol production capacity will lead to a 70 percent decline in margins by 2009."
Their fears stemmed from what they saw as rising corn prices because of increased ethanol production. And while it's true that corn prices have risen nearly $1 per bushel in the past year, what remains unclear is how much that will actually affect the bottom line of ethanol producers.
I commented on this scenario in an article about ethanol production all the way back in March.
You see, when an ethanol company purchases corn, the money it pays out is not a total loss. This is a fact that many analysts overlook.
In reality, some of that cost is regained through the sale of Dried Distillers' Grains (DDGs), the corn byproduct of ethanol production. One third of the corn can be regained in this manner, resold to ranchers, and fed to cattle and pigs.
In fact, a press release this week announced that US BioEnergy has acquired Millennium Ethanol LLC. The purchase is expected to add 100 million gallons per year of ethanol and 320,000 tons of DDGs annually to USBE's operations.
As more companies begin to sell their DDGs, I think the market will begin to realize that high corn prices shouldn't affect the margins too severely--especially if the price for DDGs rises as well.
And let's not forget about the 25-cent phrase vertical integration. Through mergers and acquisitions, and as the industry matures, ethanol companies will start to own more and more of the process from start to finish, eliminating many of the middlemen--and increased costs--associated with ethanol production from field to pump.
That brings us to the second argument for downgrading ethanol stocks: excess supply.
I still don't understand the logic behind this one.
Last year the United States produced nearly 5 billion gallons of ethanol. Federal law currently mandates that we have 35 billion gallons of renewable fuel in our pipelines by 2017.
It would seem to me that we have a shortage, not an overage. I'm still long on ethanol.
Here I Come to Save the Day
As if all that weren't evidence enough that ethanol isn't a dead-end investment road, we now have the emergence of the cellulosic ethanol industry--the Mighty Mouse of biofuels.
In that March article, I said:
"But for the next five years or so, corn will remain a key component of the ethanol industry . . . until cellulosic ethanol comes online commercially.
"And that's when you're going to see the kind of production necessary to make a significant dent in foreign oil consumption."
We are starting to see this happen at this very moment. This industry is going to be absolutely huge, not only because it is inherently good, but because it eliminates all the naysayers' arguments.
It doesn't required food for fuel. The price of its necessary raw materials will remain relatively low because they are otherwise monetarily valueless crops.
I've extrapolated data from a joint study by the US Departments of Agriculture and Energy (USDA and DOE) that indicates we can sustainably harvest enough biomass to produce 95 billion gallons of cellulosic ethanol annually.
Compare that to the mere 4.8 billion gallons of corn ethanol we made last year. Talk about room for growth.
I think the Street is finally starting to re-realize that this is a worthwhile industry. Today, Lehman Brothers upgraded two major ethanol players.
The first demonstration-scale cellulosic plants are nearly completed, and the construction of the first commercial-scale plant was just announced a few days ago. The $400 million facility is being built by Abengoa Bioenergy in Kansas.
You can bet stock prices are only going to rise as more and more of these announcements are made.
As you can see from the charts above, those three companies are starting to pull out of their two-month long skid already.
And at Green Chip, we've got our eyes on a few little gems that could be the new darlings of the (cellulosic) ethanol industry.
Folks, it's a whole new ball game, and Green Chip just keeps knockin' 'em out of the park.
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posted by Victor Lloyd Smith @ 9:33 AM
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