The Bear In The Ethanol Industry

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Includes: ADM, CVRR, PEIX
by: MTS Insights
Summary

Ethanol spot prices in the last three years have fallen below $2.00 and remain trading in a range of 10-20 cents near all-time lows.

Automakers are beginning to embrace the electric car over the E85 car as the alternate fuel vehicle of the future.

In the last six months, five bills looking to reduce the subsidization of ethanol have been introduced in Congress.

In 2008, the soon-to-be President of the United States Barack Obama endorsed the idea of an “ethanol infrastructure” as a response to foreign oil independence according to NPR. Hillary Clinton, a losing candidate in both 2008 and 2016, made similar claims saying she supported “all kinds of ethanol.” Even President Trump has voiced his own support for ethanol at the National Ethanol Conference in February of 2017 saying that he “values the importance of renewable fuels to America’s economy and to our energy independence.” Despite support from some of the most powerful political players in the last ten years, the industry is fading, and investors are facing pessimistic outlooks for some of the major ethanol stocks.

graph of U.S. ethanol production capacity by region, as explained in the article text

From EIA

Because of the corn-rich Midwest, the United States is home to the largest ethanol market boasting the largest fuel ethanol production in 2016 according to Renewable Fuels Association. Based on a report put from the Energy Information Administration, the ethanol industry has experienced steady growth over the last three years as capacity reached 15.5 billion gallons a year (or 1.01 million barrels a day) at the beginning of 2017. That represents a healthy 4 percent growth in the supply of U.S. ethanol, most of which exist in the Midwest. At first glance, these numbers tell an optimistic story, but the picture gets darker on the demand side.

http://www.finviz.com/fut_chart.ashx?t=ZK&cot=025601&p=w1&rev=636343571407232423

From Finviz

Even though U.S. exports are in near term highs, inventories of the fuel blend have reached levels never seen before. After ethanol gained popularity in the late 2000’s, production and demand rose steadily together to create a healthy, profitable market for both energy and agriculture businesses. Since 2015, this trend reversed, and the ethanol spot price fell considerably, slumping into a range about 10-20 cents wide and well below the historical averages. Pricing in the ethanol market has caused producers like Archer Daniels Midland (ADM) to deal with volatile biofuel operating profits fluctuating from losses at the beginning of last year to a slight recovery this year. The firm may be forced to look for demand elsewhere though as Tesla and the electric car begin to take over the alternate fuel vehicle market.

Vehicles that use E85 gasoline (a blended gasoline with 85 percent ethanol fuel) were once considered one of the leading green initiatives on reducing fossil fuel emissions from automobiles. Automakers created their own “flex-fuel” models which allow consumers to have the option to use E85 gasoline. In the late 2000’s and early 2010’s, the growth of these type of alternate fuel vehicles (AFVs) was steady, but that trend has weakened.

From Department of Energy

Popularized by the rise of Tesla, the electric car has taken the spotlight from these E85 models. Based on data from the U.S Department of Energy, a number of E85 models offered in 2016 is down to 66 from its 2014 peak of 90, a decrease of about 27 percent. The same source reported that electric vehicle models have nearly doubled in that time period from 16 in 2014 to 29 in 2016. This category of AFVs has shown the most growth since 2010 when only 1 electric model was offered. Not only was there growth in the number of electric models, but the International Energy Agency reported data in June 2017 that showed 60 percent growth in “registered plug-in and battery-powered vehicles” in 2016, according to Bloomberg. In 2017, the electric car will only get more popular after the introduction of Tesla’s Model 3, a completely electric vehicle slated to be sold at $35,000 before incentives.

The ethanol industry is also facing political uncertainty after President Trump and a Republican majority in Congress took over Washington. Even though Trump voiced his support for ethanol in an Iowa rally, it is likely that he will cut back on ethanol mandates and subsidies that were instated before he was elected. In fact, the Motley Fool pointed out five different bills that were introduced in this year alone.

From Motley Fool

These bills have yet to be passed and only represent political momentum against the industry for the moment, but they could morph into a major force against firms producing ethanol. ADM, the agriculture stock mentioned earlier, saw a slump in its stock price in March after resistance against the Renewable Fuel Standard (RFS) materialized in that month. Shares of Pacific Ethanol (PEIX) and CVR Refining (CVRR) saw similar pressure from the news.

Even though support for green initiatives has been increasing, it is hard to maintain a bullish outlook on the ethanol industry with all the bearish market forces that have emerged. Poor pricing due to record high supply, competition from the electric car, and mounting political pressure have forced investors to be bearish on the industry going forward. Analysts have similar opinions. Both ADM and CVRR have seen their ratings downgraded twice in the past six months.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.