8 Ways to Understand the Biofuels Investment Rollercoaster

It’s a topsy-turvy time in the biofuels sector.

Despite a slew of downgrades, underweights, rumors of an ethanol glut, and cancellations of numerous ethanol projects, the Biofuels Digest Indexâ„¢ rose 8% in the last two weeks to reach a 52-week high on Nov 1.

What gives?

Here’s are summary of what is happening at the moment.

1. Large-cap boomlet.

Larger, diversified companies like Archer-Daniels-Midland (ADM) and The Andersons (ANDE) are, well, getting even bigger. AMD is up 8%, and The Andersons is up a point in that past four weeks. Why? A good corn harvest, with 15.5 billion bushels expected, which is a lot of processing for ADM to do. Plus, ADM and The Andersons have the financial strength to ride out a short-term imbalance in the corn ethanol market. Not to mention that ADM just launched its first biodiesel plant in Velva, ND. And did I mention that ADM is launching a partnership with ConocoPhillips to produce bio-crude, a synthetic fuel which can be refined into gasoline or diesel and be distributed along existing oil pipelines. Something ethanol can’t do.

2. VeraSun hanging on.

Despite a pounding in the financial press and from analysts, the Big Ethanol pure play VeraSun Energy (VSE) is hanging tough, down only 6% in the September Slaughter that ethanol stocks had been thrown into. Competitors like Pacific Ethanol (PEIX) and Aventine Renewables (AVR) are down more than 20% in the same period. What has VeraSun been doing? Consolidating for economies of scale, with the acquisition of three plants it acquired from ASAlliances in August. Reducing risk in the near-term by canceling new plants. Investing in the future, with projects like the Q Microbe for cellulosic ethanol. Working hard of distribution, by getting exposure for the VE85 ethanol brand through distribution partnerships with Kroger and others.

3. Small-caps going glug-gurgle-glug.

Among the smaller companies, the biodiesel stocks have been doing better than others, with Nova Biosource (NBF) down 10%, and services stocks like Environmental Power are down about 7% since August. Elsewhere, its a nightmare, with stocks down 15-50% in the past two months as rising corn prices and collapsing ethanol prices have squeezed margins to the limit.

4. Farm Bill imminent.

Amidst all the suffering, there’s talk of eliminating the ethanol excise tax credit, which would turn every gallon produced into the US into a loser at current corn prices., Inexplicably, the move to reduce the excise credit is coming from Sen. Tom Harkin of Iowa, the leading corn ethanol producing state. It looks as if the Senate will vote to reduce the credit from 51 cents to 46 cent credit. The nickel will hurt but not kill the industry. The Senate and House bills will have to be reconciled and the prospect of a final bill before December are thin. Meanwhile, President Bush has waded in with the threat of a veto over farm subsidies. It would be the first Farm Bill veto since 1956, and I wouldn’t bet on it. Bottom line? There will be an ethanol excise tax credit, probably around 46 cents, and it will probably kick in around the first of the year. The chances of President Bush vetoing a Farm Bill while the Iowa caucuses are in view are, to put it generously, zero.

5. “Blame Biofuels”: Big Oil is selling it, but the public isn’t buying it.

A Harris Poll just released today found that 72 percent of US adults said that higher oil prices have had a substantial impact on food prices, compared to only 35 percent who believe the same for ethanol. 78 percent said they believe ethanol usage would lessen the country’s dependence on foreign oil. 88 percent of US adults agreed that the U.S. should pursue renewable energy sources. So much for all the work by the Grocery Manufacturers Association, the American Meat Institute, and the American Petroleum Institute, to blame seemingly everything short of the obesity crisis on biofuels.

6. Prices, overcapacity is bottoming out.

Bob Dineen, CEO of the Renewable Fuels Association, said ethanol prices are “at or near a bottom”, and said he expected to see an increased renewable fuel standard in the final energy bill now before the US Congress. Dineen, in a call with Citi analysts, said that overcapacity has delayed new construction, but that he he expected that Florida, Georgia, California and Midwest markets alone to require up to 5.5 billion gallons per year of ethanol, based on new blending mandates. Immediately after his comments, ethanol stocks shot up.

7. More mandates and conversions mounting up every day.

Palm Bay, FL; Biscayne Park, FL; San Antonio, TX; Somerville, MA; Lawrenceville, GA and Minneapolis, MN are just a few of the cities that have converted to biofuels or increased their biofuels consumption this month. No matter what else is happening, demand is building. But biodiesel is growing faster than ethanol. Sheetz, the Pennsylvania-based fuel retailer, said that that they doing 50% less business on pumps they converted from unleaded to E85.

8. Who loves ethanol?

An article in USA Today covers the presidential campaigns and their attitude toward ethanol in the period leading up to the critical Iowa caucuses in January. “Prepare for three words,” says the article, ” I love ethanol.” Even Fred Thompson, who voted against two key ethanol subsidies when he was serving in the Senate, says that he has seen the light. If you keep these trends in mind, I expect you’ll have an easier time bobbing and weaving during this period of biofuels turbulence, and emerging richer and smarter on the other side.

—

Jim Lane does not own any of the stocks discussed in this article.

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