Ethanol Companies take another hit… Flooding

Posted by Tim

June 13, 2008

Citigroup Pans Ethanol… On Flooding (VSE, BIOF, ADM)

The ethanol industry just keeps getting hammered by bad news. The news yesterday that Citigroup was downgrading the stocks is just another example (linked above). Yesterday I wrote about news I have received concerning the corn crop in Iowa and Minnesota and there is more flooding news today. The stocks downgraded by Citi took big hits, down at least 10%. BIOF lost a quarter of it’s value.

Today corn prices sit just north of $7 per bushel, a big jump from the $6 price that has been prevalent through the spring. However spot ethanol is pushing $2.70, up from $2.30 a couple of weeks ago, keeping the crush spread in positive territory. A $1.00 increase (or decrease) in corn price requires about a 35¢ change in ethanol prices to maintain the same gross profit margin.

The one item in the analyst (David Driscoll) report that I find especially interesting is his contention that up to 5 billion gallons of ethanol production could drop off the market in the next few months. I find this highly unlikely for several reasons. First, I assume he means annualized production, since the entire ethanol industry only produces about 850 million gallons per month. Second, 5 billion gallons is about 50% of the total annual ethanol capacity and the producers are currently having no problem selling every gallon they produce. Finally, the combination of clean air mandates and pricing advantage is pushing the country to 10% ethanol for all gas. Currently ethanol accounts for 7% of all the gas sold in the country and that amount is not going to drop.

The bottom line (my hypothesis) is that ethanol prices will rise and fall with corn prices to maintain some level of profitability for ethanol production. However, I do not believe that the market will realize this anytime soon and on-going bad crop news (I do not see any positive news this year for corn) will continue to hurt the ethanol stocks or at least prevent serious price gains.

Note: I have a long position in VSE.