Short Term Pain for Ethanol Could Create Longer Term Opportunity - CNBC By The Numbers

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Dec.08

9:27 AM ET

Monday, 8 Dec 2008

Short Term Pain for Ethanol Could Create Longer Term Opportunity

Posted By:Yolaiki Gonzalez | Ariel Nelson

Topics:Alternative Energy | Ethanol | Barack Obama | Stock Market

Companies:Methanex Corporation | Green Plains Renewable Energy, Inc. | Andersons Inc | Aventine Renewable Energy Holdings Inc | Pacific Ethanol Inc

Is the alternative energy boom long gone? It seems the environment for ethanol stocks is gloomier than ever. In 2005, the U.S. government ordered a mandate under the Energy Policy Act, requiring gasoline producers to quadruple the use of renewable fuel, in this case ethanol by 2022. The 2008 minimum mandate of 9 billion gallons of ethanol will significantly grow to 36 billion gallons of use by 2022. With such high growth expectations, why are these stocks so depressed?

Lower ethanol prices which move with corn and crude prices are facing downward pressure. Corn which is the chief ingredient in ethanol has been the main culprit in the sharp declines in ethanol stocks. Corn Futures on the Chicago Board of Trade (CBOT) for March 09 delivery have fallen to their lowest level in 26-months, as the commodity moved to an intraday low of $3.06/bushel on Friday, far below its all-time record high of $7.96/bushel, and currently off ~61% from its market peak in late June.

Following corn, ethanol prices began a downward spiral during the end of July after reaching a peak of almost $2.88/gallon. Ethanol prices also tend to fall with the price of gasoline as most states require a 10% blend rate of ethanol in gasoline. CBOT Fuel Ethanol January-front contracts are now down more than 33% year to date as they traded at $1.489/gallon last Friday. See chart below for comparison of ethanol and corn.

While one would expect that lower corn prices would generate greater profitability for ethanol producers, this is not the case in the short term. Unfortunately, many of the producers of ethanol, hedged on corn contracts at higher prices. One of the largest publicly traded ethanol makers, VeraSun Energy [VSUNQ Loading... () ], filed for bankruptcy protection in October after bad bets on corn prices resulted in mounting debt and poor margins. VeraSun cited that it entered contracts to buy corn at a preset price of $6.75-$7/bushel at a time when corn prices fluctuations were at its highest, to protect the company from surging corn prices during the beginning of third quarter. When corn prices dropped, VeraSun was forced to purchase corn above the market rates. Another major ethanol producer, Pacific Ethanol [PEIX Loading... () ], is now trading down 93% YTD, well below its 52-week high of $9.88/share. The cash strapped company had reported in November a quarterly loss of $54.9 million compared to its prior year loss of $4.8 million. The ethanol maker also noted that it was having troubles repaying loans and also suffered from high corn prices in the third quarter.

Similarly, shares of many of the ethanol producers have sagged in the past month, as 78% of the companies have dropped to their 52-week lows in November, and are down more than 65% year to date. The ethanol market is overstocked due to the sharp drop demand for gasoline and oil and the continued weak economic conditions. However, as their hedging contracts reset, surviving ethanol producers may be well positioned to rebound back into profitability and growth thanks in part to low prices and the legislation for mandated use of ethanol. A pro-renewable energy Obama administration will add momentum to the existing legislation as well.

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