Tuesday, May 27, 2008

Corn at $6.00

A little over a year ago, I spent time driving across the heartland - South Dakota and Iowa to be exact - checking up on ethanol producers like VeraSun (VSE: NYSE) and POET (called Broin back then). Admittedly, back then my posts on ethanol and bio-fuel production dripped with pessimism. If for no other benefit, the trip reinforced my concerns that biofuels from food sources make little economic sense.

During an interview with POET’s investor relations representative I asked about the price of corn and whether POET’s management was concerned that mushrooming demand from ethanol producers would drive up the cost of corn for food. Even at that time, Mexico was reporting increased prices for corn flour and the price of tortillas was moving up sharply. His response: “We don’t use that kind of corn.”

At the time I was not certain whether I was more shocked by POET management’s lack of understanding of the commodity markets or the apparent deficit in basic culinary knowledge.

Anyway, as we face corn prices near $6.00 a bushel it is quite apparent that the ethanol industry as a group may have had a very weak understanding of commodity markets. Maybe they just swallowed whole the propaganda of the corn producers lobby which extracted from Congress a series of concessions and support measures that are certain to skew grain crop production for some time to come. Most recently, for example, the Congressional mandate passed in December 2007, calls for refineries to incorporate 36 billion gallons of alternative fuels by 2022. The mandate can be filled with up to 17 billion gallons produced from grain crops and other food sources.

Now Congress is having second thoughts as the cries of paid from consumers and investors are drowning out the voices ethanol producers and their farm lobbyist friends. Whatever move Congress makes next, it is still likely to favor alternative fuels. Remarks made recently by Senator Joe Biden at a Congressional hearing have been widely quoted. “We must push harder in the search for alternative [fuels], and not just because of the price of food. Our foreign policy is held hostage to our dependence on imported oil.”

The switch from fossil fuels to alternative fuel sources is likely to be a long messy affair. Consumers and investors should get used to volatility in commodity prices as long as biofuels - especially fuels using feedstocks from the food chain - remain the primary replacement for fossil fuels. Even reliance on some of the non-food feedstocks, such as jatropha or algae or bio-waste, has implications for the commodity markets. All biofuel production requires land, energy for production, and materials even if the feedstock is a non-food source.

I sat out the ethanol opportunity because it makes no sense to burn up food - especially a food that is costly to produce in terms of inputs of fuel and fertilizer. I am still searching for strong plays in the alternative energy sector. In my view, the most successful investments will be in energy producers that rely on low or no cost inputs - solar and wind come to mind first. Waste-to-energy is another example. Crystal Equity Research has a buy rating on Darling International, Inc. (DAR: NYSE), the largest U.S. collector and processor of food production wastes from rendering plants and restaurants. We expect Darling to become a 21st Century “upstream” supplier of feedstock for biofuel production. That said investors should expect to see increases in the price of the waste commodity from food production.

In the next post we will look at some other basic elements to choosing the alternative energy play with the greatest chance for long-term profitability.


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. Crystal Equity Research has a Buy rating on DAR shares.

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