If you think ethanol stocks are bad now, wait until the other shoe drops
Here comes the pain! If you think that stocks of ethanol producers have performed badly over the past year, you haven’t seen anything yet. The other shoe may be about to drop. As it stands, these companies are only profitable because the federal government requires ethanol’s use and because it provides them with massive subsities. What if the government suspended the requirement that oil companies blend ethanol with gasoline. Look out belooooooooooow. Impossible you say? Maybe not.
Iowa State meteorologist Elwynn Taylor recently forecasted that the odds of a major drought this summer are 1 in 3. This is twice the normal risk. In response to a question from the Chicago Tribune, Secretary of Agriculture Ed Schafer recently said that in the event of a drought, the Bush Administration would consider suspending the mandate for blending renewable fuel (i.e. ethanol) into gasoline. He went on to state that this step would not require a vote by Congress. Note, that Schafer only said the Bush Administration would "consider" suspending the mandate. Politics will obviously also enter into the decision making process, especially in an election year.
There are only two reasons why refiners would purchase ethanol. The first would be if it is cheaper than gasoline, which it will not be if corn prices continue to trade higher. The other reason is that the federal government currently requires refiners to use ethanol in their gasoline blends. If the federal government suspends its ethanol blending requirement, the production of ethanol would come to a halt overnight.
If there is a drought, the price of corn is going to skyrocket from its already astronomically high level. High corn prices are already bad for ethanol producers, but the suspension of the government mandate for its use could be lethal for them.
I am short every single ethanol producer that I could find in CAPS (not in the real world). High corn prices are also very bullish for companies that sell things to farmers, like the ones that I wrote about in my article titled Deej’s semi-reasonably priced agricultural ETF (EATME). I have been trying to add shares of !@#$%^ Agrium (AGU) to it in real life, but it ran away from every single limit order that I placed before it could fill. At least I added it in CAPS :).