Tuesday, October 02, 2007

Ethanol Obituary

The news media often prepare obituaries for famous people long before their passing. Presidents and Popes, even famous movie stars, get considerable coverage even before the door closes behind the Grim Reaper. Is it time to put some notes together for the ethanol industry?

Judging by stock prices, the industry barely has a pulse. Public ethanol producers are setting new lows with each passing trading session.
Pacific Ethanol (PEIX: Nasdaq) is now at $8.90, off 74% from its 52-week high. Things are not looking any better for Green Plains Renewable Energy (GPRE: Nasdaq), which closed last at $10.00, down 65% of its 52-week high.

Is this a good time to jump in and buy quality at a bargain? As much as I like the contrarian play, the answer is a resounding No.

What has put investors into such a gloomy mood are the very problems we pointed out months ago in some of our first ethanol and biofuel posts. (See a collection of those early posts in the Crystal Equity Research market paper,
“Biofuels: Weblog Commentary and Index” published in March 2007 or cruise through the archives to the right of this column). It is a matter of costly inputs (skyrocketing corn and natural gas prices), inefficient transport infrastructure (highly corrosive ethanol cannot be sent through gas pipes so it has to be sent by tanker truck) and inadequate distribution outlets (low scale).

A consolidation of ethanol producers is a likely.
Archer Daniels Midland (ADM: NYSE) is a likely consolidator with its integrated business model and strong balance sheet. Indeed, a likely consolidator could be any entity with technologies to create efficiency in the ethanol process or to convert the plant to an alternative biofuel technology. For example, DuPont (DD: NYSE) or BP, Plc. (BP: NYSE) with their jointly developed biobutanol technology could be potential acquirers. However, we note that DuPont and BP chose the UK and a new plant as the demonstration site for their biobutanol development work.

Production flexibility and plant value may very well have played in the decision by
VeraSun Energy Corp. (VSE: NYSE) to stop construction of a new plant in Reynolds, Indiana. VeraSun is moving forward with four other plants that are in the final stages of construction. VeraSun management cited falling ethanol prices, rising corn prices and the stages of construction as the reasons for their decision.

The high cost of retrofit to other technologies could be the last nail in the coffin of ethanol producers which are not able to turn a profit with a corn-based production model.



Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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