Ethanol Industry Will Do Just Fine, Despite Analyst Calls

MarketWatch reported Thursday:

Bank of America (BAC) downgraded four ethanol makers, giving three of the companies sell ratings, on concerns of a 70% slide in margins by 2009.

While record gasoline prices have led to a 30% increase in ethanol prices and a 180% jump in production margins so far this year, analysts at the bank said they expect producers "will face an extended period of deteriorating margins resulting from new ethanol capacity."

Starting this quarter, 1 billion gallons of new capacity is scheduled to come online each quarter through at least the fourth quarter of 2008. The new supply could depress ethanol's premium to gasoline, drive corn prices higher and pressure distillers' grains values, Bank of America said.

The Andersons (ANDE), VeraSun Energy (VSE), Pacific Ethanol (PEIX) and Aventine Renewable (AVR) were all downgraded.

Here is the mystifying part. For two years we have been hearing that ethanol is not the answer because we will never be able to replace enough gas to make a difference. Now we are talking about an ethanol glut?

Let's make up our mind here folks. If ethanol priced drop far below that of gas, demand will pick up immediately, especially with the increase in E85 vehicles coming online. Right now it is only blended in 3% to 4% of all gas, the goal is 10% so there is still plenty of room to grow. Wal-Mart has been talking about installing E85 pumps all over the place but supply problems currently prohibit it. A glut? WalMart (WMT) will gladly take it, they could use the good PR. If prices drop far enough, there will be an inevitable consolidation in the industry in which case the strongest players will pick up cheap production and make up for smaller margins with increased output.

Let's talk politics. Does anyone really think anyone running for the White House is not going to woo Midwest voters by promising higher ethanol mandates and more support for producers? Don't you think the battle cry will be "let's spend the money here instead of Iraq". Now whether you agree with the policy or ethanol or not is irrelevant, the reality of the situation is. This industry has the support of the American people and lawmakers, it will be just fine.

Disclosure: Author is long ADM

Comments

[Paul Meisel:]

Think of it another way. Ethanol is increased supply to the tight energy market. Tight markets are good for sellers but increased supply is usually bad....

Long-term ethanol should do well....it's just picking an entry point that is problematic.

2007 Jun 01 09:40 AM

[Tom Konrad:]

We can have both local ethanol gluts even if we can't replace more than a few percent of gasoline with ethanol. Ethanol is much more difficult to transport than gasoline, and so the Midwest may end up producing more than it can consume, while the coasts still don't have enough. See my article published here 2 weeks ago, and on AltEnergyStocks.com.

2007 Jun 01 08:49 PM

[marinus romano:]

First time writer.
The way I see it--Ethanol will sell in the U.S. in an E10 mix. It may even sell well in the
midwest if major gas companies sell the E85 mix. To do this they will have to replace their pumps,hoses,gaskets,et... to accompany Ethanol. Who do you think is going to pay for the conversion?
Surely not the Ethanol producer. Here Wal-Mart may have a head start in that they could place a gas station at one end of their parking lot with all new Ethanool pumping equiptment. In any event the price of gas in going up,up and away. I'm walking- just a thought. Love your comments.

2007 Jun 02 04:29 PM