Time for Ethanol Companies to Make Hay While the Sun Shines

(excerpts from A BusinessWeek article, “Ethanol Making Comeback as Valero Sees Profit Where Gates Lost” By Mario Parker, published March 9)

Ethanol, the commodity that cost Bill Gates more than $44 million the last time prices collapsed, is poised to rally as much as 20 percent as the fastest drop since 2008 spurs demand.
Falling corn prices and record ethanol supplies have driven the price down 17 percent in three months to $1.634 a gallon, its worst run since 2008’s fourth quarter. It will average $1.96 a gallon at the peak of the U.S. summer driving season as refiners from Valero Energy Corp. to Sunoco Inc. mix more into gasoline made from increasingly pricey oil, according to the median of 10 analyst estimates compiled by Bloomberg.

Using more ethanol can improve profits for refiners who get a 45-cent tax credit for each gallon they blend. The incentive has effectively been more than doubled by falling corn prices, which account for 70 percent of the alternative’s cost. Corn has plummeted to $3.75 a bushel from a record $7.9925 in June 2008.
Corn has fallen 17 percent from its 2009 high in June as oil rose 19 percent. Ethanol has been depressed further by increased production, which averaged an unprecedented 788,000 barrels a day in December, 20 percent higher than a year ago. Stockpiles that month totaled a record 16.7 million barrels, Energy Department data show.
Record Supplies
The result: a 65.5-cent difference between gasoline and ethanol that producers can combine with the tax credit, for a total discount of $1.11. Production of conventional gasoline mixed with ethanol ballooned 22 percent to a record 4.4 million barrels the week ended Feb. 19.
“Considering what we see in gasoline, there will be a formidable amount of resiliency for ethanol,” said John Kilduff, a partner at Round Earth Capital, a hedge fund in New York that focuses on food and energy commodities.

Futures traders are less bullish than forecasters, with ethanol for July fetching $1.676 a gallon yesterday, 2.6 percent more than now.

Higher corn prices would squeeze refiners’ profits. Corn prices are forecast to jump 20 percent to $4.64 a bushel by Dec. 31, according to the median of eight forecasts.
A loss of political support also would undercut ethanol. The 45-cent tax credit and a 54-cent tariff on imports from Brazil, the biggest exporter, will expire at the end of this year if they’re not extended. Production of biodiesel, a diesel additive, has ground to a near halt since its $1-a-gallon tax credit ended on Dec. 31, said the National Biodiesel Board, a trade group in Jefferson City, Missouri.

Our Take:
For the moment, ethanol prices are a bargain compared to gasoline, thanks to relatively low corn prices. And unlike in times past, oil refiners are seeing the light and making themselves more cash by blending more ethanol—the 4.4 million barrels for the week of Feb. 19 shows what’s possible in a favorable pricing situation. Analysts think ethanol’s price advantage will last through the summer driving season this year. So we hope ethanol companies maximize the benefit to be had, but also remember that the rollercoaster will peak and take a downward turn again.

The wild cards in the ethanol price picture are political—E15, the 45 cent blender credit and ethanol import tariff. BusinessWeek points out what happened to biodiesel when they failed to get its tax credit renewed. The outcome of these issues will have a huge impact. The industry simply can’t afford a reversal of fortune on any of these. So now is the time to make political hay, also.

Before corn prices strengthen and before any potential lapse in these important incentive and protection programs, we think ethanol companies should heed the advice of CPA John Christianson and other ethanol finance experts who tell ethanol companies to put in place the means to track their grind margin in real time. When things get lean, consistently getting a dime more margin will make a big difference. If the analysts are right and CBOT corn hits $4.64 by year-end, the companies that don’t adopt that discipline may end up being just another bargain for Valero or Sunoco.

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