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The price of corn is way down, and ironically ethanol producers are still screwed / I'm glad that I sold my ag plays

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October 24, 2008 – Comments (7) | RELATED TICKERS: VSE

I spoke with a friend of mine this afternoon who has connections in the ethanol industry.  If you thought that things were bad there a few months ago, you ain't seen nuthin' yet.  Much like the airlines that, scared out of their minds by rapidly escalating prices, hedged a large portion of their fuel at significantly higher prices than we have today, many of the ethanol producers freaked out when corn hit eight bucks this summer and they did all sorts of hedging at extremely high prices relative to where the corn sits now.

Even the producers who didn't hedge at the top are in trouble.  All of the ethanol companies have been buying corn on its precipitous drop from $8.00 to its current $3.70.  Margins on the production of ethanol (I suppose that you could call it the crack corn spread to make a bad joke) are absolutely terrible right now and they are likely to get even worse if the price of gasoline continues to fall like it has.

Further hurting margins is the fact that way too much production capacity was built during the rush to alternative fuels caused by the high price of oil.  There is now too much capacity chasing too little demand.

Producers have begin to respond by shutting down plants.  VeraSun (VSE) just shut down its Linden Indiana plant yesterday and word is the plant will be closed "indefinitely."  The Cloverdale plant 40 miles west of Indy closed down ten days ago.  The combined production capacity of these two plants is 55 million bushels of corn per year.  Things are so bad right now that the closure of these two plays probably still will not be able to improve the rapidly falling margins.

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On the flip side of this situation is the demand for corn.  When ethanol plants shut down, the demand for corn falls.  The government's estimate for how much corn will be used to produce ethanol this year is probably at least 500 million bushels too high.  Add to this the slowdown in economies across the globe, which always reduces the demand for grains and the fact that the U.S. estimate for U.S. corn exports is probably high by 400 million and the fact that favorable weather conditions will likely cause the USDA to raise its production estimate for U.S. corn on November 10th and the supply of corn will likely be way larger than current government estimates.  Putting additional pressure on prices are hedge funds which have been net long grains for a long time, but are now gradually being forced to unwind these positions.

A high supply of something combined with falling demand is a recipe for falling prices.  This is not good for farmers.  I suspect that seed, fertilizer, and ag machinery companies will soon find that their recently implemented price increases are unlikely to stick.  That obviously bad for their margins and eventually bad for their stock prices.  I sold the last of my ag plays a couple of weeks ago and I am very glad that I did.

Long term, the demand from emerging markets and their growing middle class will probably be bullish for ag companies, but in the short term they all are going to feel some pain.

Deej

Have a great weekend.

7 Comments – Post Your Own

#1) On October 24, 2008 at 4:10 PM, lquadland10 (< 20) wrote:

Now add that to the new job loss tally.

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#2) On October 24, 2008 at 4:14 PM, TMFDeej (99.30) wrote:

Some additional information.  According to a study that I saw today, margins for ethanol are now negative.Ethanol plants in Illinois are estimated to be losing 39 cents per gallon.  Plants in Iowa are estimated to be losing 29 cents per gallon.Deej

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#3) On October 24, 2008 at 4:15 PM, goldminingXpert (29.64) wrote:

those weren't sustainable jobs. Just a passing government fad that has ended. Time to find a new way to milk the taxpayer.

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#4) On October 24, 2008 at 4:53 PM, awallejr (81.36) wrote:

That is one of the downsides of declining oil, making alternatives too expensive to continue. 

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#5) On October 24, 2008 at 4:58 PM, socialconscious wrote:

Im sorry folks may lose their job but I am with Tuffsleding fool.It is immoral to use food as fuel  Lets forget corn or other crops that produce starch ethanol that requires natural gas to produce. We can make ethanol from switchgrass ( a grass found in the midwest ). The subsudies are another form of government handouts to business and neglect for the people especially now in trying times. Besides business just use tax cuts and grants to move jobs out of the US. Have you tried calling customer service lately for any product? 80 % you are calling India. Business can move jobs anywhere they want just not with the taxpayer money.  

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#6) On October 24, 2008 at 6:30 PM, dexion10 (27.78) wrote:

great post

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#7) On October 28, 2008 at 5:23 PM, geologics (79.55) wrote:

The problem with using switchgrass is transportation.  With corn, only the kernels, which are the *high energy density* part are brought to the silos.  The stalk and cob are left in the field.  With switchgrass, even though there may be more energy density per acre of field, you have to haul the whole plant to the silo like bails of hay in order to wring out the ethanol.  This creates an organics deficit in the field as well.

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