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If you think ethanol stocks are bad now, wait until the other shoe drops

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April 19, 2008 – Comments (7)

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 :).

Deej

7 Comments – Post Your Own

#1) On April 19, 2008 at 8:46 PM, cubanstockpicker (21.14) wrote:

good post and i see you share my negative sentiment for ethanol stocks. I have only two I like because one is from brazil, where it is succesffuly being used in sugar, and the other is not an ethanol stock at all. CZZ and MGPI

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#2) On April 19, 2008 at 9:51 PM, abitare (88.86) wrote:

Food riots are happening sporatically over the world and many countries are blocking exports of food in order to stock pile in countries. People that live on $2-10 dollars a day (70% of the worlds population) will be forced to cut back on calories or starve or rob/riot.

All due to a political kick back to some heavily lobbied firms and farmers. So Americans ca fuel a gas guzing SUV on food.

Berkshire Hathaway Charlie Munger on Ethanol

When asked by a shareholder about ethanol, Charlie Munger made the following statement: Wheat and Corn Fields

"Running cars on corn is about the stupidest thing I ever heard of. Our government is under tremendous political pressure [to keep pushing and supporting corn ethanol] even though it makes no sense." He goes on to state an unpopular view in Nebraska, "More energy is used producing ethanol than it creates and that's without considering the damage to the topsoil producing fuel when we could be producing food." Munger further states that it's silly to drive up the price of food in order to provide an uneconomic fuel, as well as a dumb government policy.

I have to say that it takes some guts to be against anything that drives up the price of corn. Brave Mr. Munger, very brave.

Mr. Buffett said, "Well Charlie, we'll be sneaking you out of Omaha tonight."

http://thepanelist.com/Neubert's_Trades/Neuberts_Trades/Berkshire_Hathaway_Charlie_Munger_on_Ethanol_20070505306/

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#3) On April 20, 2008 at 12:21 AM, dwot (46.92) wrote:

Excellent post...

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#4) On April 20, 2008 at 8:15 PM, sunnybrasil (27.73) wrote:

Very good post 

Corn is not the best crop to make  ethanol, Sugar Cane is

Make up time with Cuba and ethanol imported from Cuba. might be a step to far for George Bush.

80% of cars in Brazil use ethanol

60% on mpg of gas but slightly higher  bhp from engine.and at half the price. 

Brazil managed to drive up the price of sugar  x6 by introducing ethanol and of course in the process became a net oil exporter.

Brazil  exports ethanol to China  pity about the free trade agreement 

Car companies made money by developing modified engines that can burn either fuel, taking a lot of older cars off the roads. 

 Much less polluting than gas. So it can be a winner but not with corn......

 

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#5) On April 20, 2008 at 8:37 PM, kristm (99.74) wrote:

Ethanol is a loser. It makes the energy production system LESS efficient and actually consumes more energy than it produces.

http://caps.fool.com/Blogs/ViewPost.aspx?bpid=27871&t=01002575315252242252

Once people realize this, ethanol stocks will die and congress will forget ethanol ever existed.

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#6) On April 21, 2008 at 12:11 PM, NightBengal (99.26) wrote:

sunnybrasil:

I hate to say it, but the US will probably not enact an approach that will reduce the amount of oil being imported just to increase the amount of ethanol being imported.

I know that being fixated on corn ethanol is a bad idea for everyone except the corn growers and ethanol producers, along with limited impact on the rest of the ag market (seed companies really don't rake it in as the cost of their inputs and grower payments also increase with corn prices).  Fact is, though, that sugar cane can be grown on a comparatively tiny portion of the US, and businesses are not going to see it as cost advantageous to build plants for such a greatly reduced fuel capacity... unless the corn plants could be somehow converted, I suppose.

Not saying it's the right solution... just speculating on why sugar cane isn't on the radar in the US yet.

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#7) On April 21, 2008 at 1:14 PM, AnomaLee (28.73) wrote:

Ethanol stocks are bad because ethanol technology and its applications are bad. They're bad for consumers and bad for the enviroment. The only ones benefitting are fertilizer companies and the employed workers who could've been trained and used to work with more beneficial ways to produce biofuels.

The biggest problem with corn-based ethanol (besides its inefficiency) is that it quickly depletes the soil of nutrients. That is the reason why fertilizer is being used more & more to replace the nutrients lost due to farmers no longer rotating crops.

The best idea for a biofuel has been to use switchgrass. Switchgrass requires nearly zero fertilizer and grows remarkably fast all throughout North America. It's faster growth could also be harvested twice a year unlike corn. Switchgrass yields over 1000 gallons of fuel per acre. Whereas sugar beets yield nearly 700 gallons per acre in France, sugarcane yields over 650 gallosn per acre in Brazil, and currently corn-based ethanol typically yields under 400 gallons per acre in the United States.

Recent research conducted at the University of Illinois has shown that miscanthus, a tall reed like grass, can produce as much as 1,500 gallons of ethanol per acre.

The problem as well is the amount of energy used to produce corn-based ethanol. Sugarcane, at 1:8, yields about eight units of energy for every one unit invested to grow. Switchgrass's net energy yield is slightly less, at about 1:4 ; Sugar beets yield nearly two units of energy for every one unit that is used to grow and convert the crop into ethanol. Corn lies near the very bottom of the list at 1:1.4

Even with agricultural engineering corn-based ethanol will never be a good net-positive alternative fuel. We're just wasting tax-payer dollars when we all could be subsidizing with different forms of switchgrass that grows everywhere.

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