Energy stockholders have been watching in horror as their investments tank and those with a short time frame are considering cutting their losses, as the oil price rout looks certain to continue into 2015 and possibly beyond.
But one area that could be poised to withstand the oil price carnage and might even toss out some gains for investors is the sector that produces an important, yet controversial element of gasoline: ethanol.
As the prices of oil and gasoline have plummeted, so has ethanol, taking ethanol equities down with it. While that may seem like a good time to hit the sell button, don't. Ethanol stocks are likely to stage a comeback- here's why.
Widely used as a fuel additive in Brazil and the United States, ethanol production has grown exponentially, largely due to government incentives and regulations that mandate a continued increase in the amounts of ethanol fuel required to be blended with gasoline.
U.S. ethanol production increased 15-fold between 1990 and 2010, from 900 million gallons to 13.5 billion gallons. A watershed year for ethanol was 2005, when the Renewable Fuel Standard was passed by the U.S. Environmental Protection Agency. Created by the EPA to drive production of alternatives to gasoline that would thereby reduce the nation's dependence on foreign oil and also lower greenhouse gas emissions, the RFS mandated increased production of ethanol up to the year 2022. That year, the RFS will require 36 billion gallons of ethanol to be produced for the gasoline market.
Naturally, ethanol producers love the RFS, since it creates a guaranteed, state-imposed demand for their product. Not only that, the RFS also provides them some fairly generous tax credits and subsidies.
Critics, however, heap scorn on the program, saying it does little to address climate change and has actually done more harm than good, including creating more greenhouse gases through growing corn, the main feedstock for U.S. ethanol. Steady and growing demand for ethanol is blamed for rising food prices.
And while ethanol was supposed to make gas cleaner, critics say E10 – 10 percent ethanol and 90 percent gas – actually has lower fuel economy, meaning drivers have to buy more fuel to drive the same distance. More fuel-efficient cars and lower-sulfur gasoline have made the need for ethanol blends more questionable. As for reducing America's dependence on imported oil, the shale revolution has pretty much taken care of that argument.
So given all these knocks against ethanol, why would anyone consider buying stock in the producers of the stuff? In a word: exports.
As U.S. ethanol producers face increasing headwinds, including the elimination in 2011 of the blenders' credit that provided them over $45 billion in cash since 1980, they have looked elsewhere to sell their fuel. In 2014 U.S. ethanol exports rose 31 percent, their highest level since 2011, reaching 79.2 million gallons in October. Future buyers include countries like the Philippines and Japan, which are resource-poor and use ethanol to stretch their gasoline needs.
Green Plains Inc, a major U.S. ethanol producer, exported about 15 percent of its production in the fourth quarter, with volumes sold and destined for India, the Philippines, Brazil and Canada. The company is booking sales into the third quarter of 2015. “We typically have not seen export interests that far out in the future,” CEO Todd Becker said in a conference call on Oct. 29.
With the price of ethanol dropping - ethanol futures have lost 17 percent in the last month - it would take a gutsy investor to buy them now, but the market fundamentals for ethanol look strong, and favor the producers. Obviously, as gasoline prices drop, demand for gas, and therefore ethanol, is bound to increase.
The low gas-price environment is playing into an already tight supply situation for ethanol, with producers barely able to keep up with demand. Maximum ethanol capacity in the U.S. is 925,000 barrels a day, and plants have been running over-capacity at around 930,000 to 940,000 barrels. According to Becker, of Great Plains, that's unsustainable.
“You need to produce 940 a day just to kind of break even against the current domestic and export demand... And so, when you look at that, it looks like supply and demand are at least an equilibrium, if not favorable to the demand equation much more than the supply equation.”
Consider that Becker said this at the end of October, just as oil and gas prices were starting to drop. With the average price of gas in the States now at $2.55 a gallon, just imagine what that means for the demand for ethanol.
Quickly adding ethanol supply is not an option, either. Renewable Identification Number (RIN) permits required for ethanol producers are difficult to get, meaning that new plants are unlikely to be built in the next few years.
Put it all together, and ethanol is looking like an interesting sector for investors seeking a silver lining in the increasingly darkening cloud of the oil price drop. As supplies tighten, look for a rebound in the price, and with it, the stock prices of ethanol equities.
By Andrew Topf of Oilprice.com
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