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If you want to talk about volatile stocks, the first thing that comes to my mind is ethanol. Just observe the charts for Verasun Energy (VSE), US BioEnergy Corp (UBSE), and Pacific Ethanol (PEIX). To illustrate, between March 14th, 2007 and April 10th, Verasun appreciated more than 30% on strong sentiment for ethanol demand. US BioEnergy Corp was up about 37% from the end of March till April 25th, and Pacific Ethanol also had an 18% jump in the month of March. The bulls were running on ethanol, and green energy seemed to be the likes of Yahoo (YHOO) and AOL of the dot com era.

Then came the downgrades. Verasun reported disappointing earnings due to rising corn prices and the analysts turned their backs on ethanol. Subsequently, ethanol has been on a slump, the three companies mentioned above have been down 39%, 37%, and 31% since their respective highs. I won’t downplay the concerns, many investors sold because of real worries about profit margins and oversupply, but it is becoming more and more evident that these concerns were overblown and that these stocks are undervalued at their current price levels.

When Pacific Ethanol reported earnings on May 9th, they surprised Wall Street by matching estimates. After a slew of downgrades and bashing of the ethanol industry, Pacific Ethanol was able to hedge the rising price of corn so effectively that despite the increase of costs, they were able to bring in five cents per share. That very day, someone paid up to $15.90 per share for Pacific Ethanol only to see it hit $12 six weeks later.

The question is, if someone was willing to pay more than $16 in May, why is the stock still barely flirting with the $15 mark? If you were trading VSE in the beginning of April, chances are you would have gladly given over $20 per share, yet just recently investors were selling it for $12.90.

So let’s go over the fundamentals. The price of corn, at the time that most of the above mentioned ethanol stocks were hitting their highs, was trading in the range of $3.60 - $4 per bushel. As fears of a shortage escalated, the price of corn rose to about $4.25 per bushel, and the price of ethanol stocks dipped. Fortunately, reason prevailed, and now that we understand that no real shortage of corn exists, and that almost 20% of extra corn was planted this year, corn dived to its lowest level this year. It is now trading at just below $3.50 per bushel for December deliveries. Now if this doesn’t get you drooling, I don’t know what will.

The fact that new energy legislation passed the senate, and that Americans will clearly be using a lot more ethanol in the coming years, should be reason enough to pick up these cheap stocks. If California finally settles its dispute with the EPA, it can have a profound effect on the use of ethanol in California, and directly benefit Pacific Ethanol’s strategic West Coast location. Neil Koehler’s encouraging remarks about how production of cellulosic ethanol can begin in as little as three years are evidence to me that the company is serious about reducing its expenses and seeking more efficient production. Even more compelling is that given that oil is once again over $75 per barrel, if these companies can effectively use futures to lock in the cheap corn, their earnings will be more stellar than ever.

Disclosure: The author of this article has a long position in PEIX.

Source: Ethanol Stocks Making a Comeback: Verasun, US BioEnergy, Pacific Ethanol