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Andrew Topf

Andrew Topf

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Ethanol Producers Poised To Gain From Oil Price Drop

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.

Related: New Cellulosic Ethanol Plant Commercializes Renewable Fuel

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.

Related: The Global Outlook For Biofuels

“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.”

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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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  • george gest on December 19 2014 said:
    And so, Americans provide tax subsidies to produce ethanol to sell over seas at low cost to stretch fuel stocks of countries that have not such fuels?

    Furthermore, because content is mandated we are forced to pay more for this junk fuel supplement instead of buying more efficient and less costly gasoline.

    Brilliant. Just brilliant.
  • Timothy Conway on December 19 2014 said:
    Overall, Andrew, this is a fairly good article-- I find "pure play" ethanol companies REX American Resources (REX), Pacific Ethanol (PEIX) and Green Plains (GPRE) to be really excellent, well-managed companies, with splendidly profitable operations in any "normal year" of corn and natural gas input costs and an average/normal range of ethanol and DDGs (dried distiller grains) selling prices.

    The year 2014 up through August was really terrific for ethanol companies and their investors. Finally, stockprices of these companies irrationally plunged on the massive, indiscriminate selling of all energy-related names in latter part of Sept up until now in mid-Dec. Now a company like REX (which has by far the best earnings-per-share, profit margins, and balance sheet) is trading at a ridiculous trailing P/E down around 6 (!), after having colossally grown its trailing-12-month EPS from 1.80 to 10.15 on successively "best ever" quarters in its history. (REX and GPRE were trading at P/Es up in the teens and twenties for much of 2014!) With hefty share-repurchases and completely zeroing out their debt (no more interest charges), REX is in great position to increase yearly earnings in 2015, especially since corn prices should subside from a recent upmove once the delayed harvest (best-ever USA corn crop) is fully in, enormously growing the stockpiles of corn well into 2016 (meaning low corn prices).

    PEIX, on track to make in 2014 at least 2.60 EPS (in adjusted earnings beyond GAAP earnings distorted by their warrant situation), is also trading at a ridiculously low P/E right now.

    GPRE is the biggest producer, but has $660 million in debt on its balance sheet as a result of buying so much production from acquired plants.

    Your article, alas, repeats some of Big Oil's propaganda, as heard for instance from the American Petroleum Institute (API). So, for instance, there are no tax breaks for these companies-- they pay somewhere around 35%, depending on their specific situation. And having examined the 10-Q statements for these companies, I can say that only Pacific Ethanol is getting a small govt "subsidy," specifically from the state of California as a kind of carbon credit. Oh, and GPRE i believe is getting a small subsidy for its experimental algae program.

    Furthermore, your repeating of the critics' line, "Steady and growing demand for ethanol is blamed for rising food prices," is in fact completely untrue. Corn prices have gone down this year on ethanol's biggest production year ever, and the USDA is forecasting corn-prices up through year 2023 in the mid- to upper-$3s/bushel, regardless of how much ethanol is produced.

    These rebuttals aside, thanks, Andrew, for your coverage of this topic of ethanol-- one of the great American business success stories.
  • Roland on December 19 2014 said:
    Why wouldn't these buyers of exported ethanol just buy corn? Ethanol isn't that difficult to make. Shipping prices are low, and they would get the use of spent mash as livestock feed.
  • Jordan on December 23 2014 said:
    "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" The Volumetric Ethanol Excise Tax Credit for ethanol ended in 2012 so I am not sure which tax credit you speak of. Also what is ethanol production right now vs the implied demand in regards to gasoline demand? How much are we exporting vs importing? If anyone is reading this article and planing on investing I would urge you to do some simple research.
  • Joseph Toomey on December 25 2014 said:
    Some corrections:

    The EPA did not "pass" the RFS in 2005. It was enacted into law by the Energy Policy Act of 2005, known as EPAt. EPA is authorized to administer the program.

    EPAct did not establish the 36 billion gallon threshold. The volume, called RFS2, was enacted two years later by the Energy Independence and Security Act of 2007, known as EISA 2007.

    And the actual ethanol threshold under EISA 2007 was 35 billion gallons. The additional one billion gallons was for biodiesel.

    As to the thesis, it is difficult to understand how ethanol producers can benefit from low fuel prices. Their margins are being squeezed on both revenue and cost sides. The ethanol program is self-evidently driving up the price of retain fuel, needlessly adding about 13 cents per gallon to gasoline prices. It is also boosting food prices.
  • Billy on December 25 2014 said:
    The remains of alcohol extraction has no {or very little} nutritional value as animal feedstock. A misrepresentation (sometimes called lies). Peanut oil residue is sometimes called feedstock for the same reason. Ethanol entrepreneurs should do their schlock in some foreign country (as some do tobacco production) where they can exploit resources for their snake oil science. Some day the truth of this deception will be revealed..but not expected.

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