The Long and the Short of Biofuels: The short-term and long-term outlook for ethanol and biodiesel

What’s the long term outlook for ethanol? What’s the short term? More important, which stocks should I go long on, which should I short? Tantilyzing questions; possibly lucrative. Let’s try to bring some perspective to it.

The short term ethanol outlook.

In a word, ugly. There’s an interesting conversation going on in the halls of Congress and enterprise as to why exactly we have 140 billion gallons of gasoline per year retailing briskly at $3.00 or more per gallon, while ethanol is available for a dollar less in the wholesale market, and yet we hear talk about an ethanol glut.

What we have is a take of two ramp ups. Congress is right now debating a mandated 36 billion gallon ethanol target for 2015, yet the current target is 7.5 billion gallons by 2012. The ethanol industry is ramping up based on the 36 billion target, while oil refiners are blending ethanol based on the 7.5 billion gallon target. The result? Lots of ethanol, not so much blending. Meanwhile, the price of corn has been rising, primarily due to expanded international demand for corn-fed beef, and that has squeezed margins down from 70 cents a gallon to 15 cents.

It makes pure-play ethanol companies like Pacific Ethanol (PEIX), Aventine Renewables (AVR), and VeraSun (VSE), susceptible to investor sell-offs due to collapsing profitability. Analysts have slashed price targets to $8 and $9 per share for the pure-plays, and unless you can get in at that price, best to wait out the storm. After the Energy Bill is passed — and especially if oil resumes its steep price climb– expect these stocks to make a comeback in 2008 in time for a robust 2009.

The long-term ethanol outlook.

In a word, great. But don ‘t take it from me. Take it from the giant of long-term biofuel forecasting, Will Thurmond. His Biodiesel 2020: A Global Market Survey, Vol. 2 and Ethanol 2020: A Global Market Survey set the pace for the industry. You can find out more here.

With respect to biofuel investments, the first question is whether we are looking at the US only or also offshore, and what time frame we are looking at. In general, the sector looks quite good. The fact that the oil industry is engaged in a jihad against biofuels right now will tell you they are downright worried about the threat. In the US, ethanol demand is tracking ahead of mandates, and mandated usage targets 35 or 36 billion gallons in 2015 depending on which version of the Energy Bill you think will pass. Right now the industry is producing 7 billion gallons, so the math is good.

The short-term biodiesel market.

On the biodiesel side, the US does not have mandates but many countries are looking at B5 or B10 requirements, and some US states are mandating biodiesel now (e.g. Oregon). In general, biodiesel should track the ethanol market in growth rate.

The short term biofuels outlook – stocks.

Picking individual companies is less easy, because it is a question of picking technologies. Personally, I like algae-based biodiesel and biobutanol as extremely promising if “not ready for prime time” technologies. None of the pure play public ethanol companies have butanol in their radar.

Archer-Daniels-Midland (ADM) is developing bio-crude with ConocoPhillips which suggest that they “get it” when it comes to the limitations of corn ethanol. I like VSR for its continued investment in new technolgies in these tough conditions. PEIX I think has the focus on the West Coast which worked well for Chevron.

Among potentially hot IPOs, keep an eye on Imperium Renewables. They are doing bioidiesel, which is smart, and on the big scale, which is also smart. I wish they were more invested in algae — but PetroSun looks interesting along those lines.

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