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June 20, 2008

more bad news for ethanol producers

Floods, $13 nat gas, continued control of Ethanol channel by Big Oil Companies means US ethanol producers are screwed. I expect oil companies to make offers to buy Verasun or Aventine before the end of the year. They have achieved their goal of driving the valuation of these companies down below the asset replacement cost. The math is still WAY in the oil company favor. Lets see Ethanol spot prices $2.93. the RBOB is $3.43. With the $.51 rebate, the net cost of a gallon of Ethanol to the blender (oil company) is $2.42. So lessee buy something for $2.42, blend it with my product and sell it for $3.43. Hummm.... I would do that business all day long. At the current run rate of over 7B gallons of ethanol a year, the Ethanol blending mandate is bringing over $7B of NEW 100% MARGIN revenue to the big oil companies.
hummm.....

m

> Investment Conclusion:
> We are reiterating cautious view on the ethanol producers. Recently
> two events have occurred that have the potential to tighten supply in
> the industry - flooding and the rise in corn prices. We believe this
> tightness in supply will be temporary and imports and a potential
> change in legislation are likely to tip the balance against the
> producers again.
Coming to two things that are taking supply off the market.
1) Flooding: the last data point we have is that 300 million gallons or
3 percent of capacity was shut in due to flooding. We estimate that this number is likely to
increase not only due to the actual flooding of plants but also because corn cannot reach some of the plants.
2) Margins: gross margins for ethanol producers at spot ethanol, corn and natural gas prices are almost zero if not negative. Some small marginal plants have
already started to shut in. VeraSun Energy (VSE) announced that it will delay the start-up of two plants that were slated to come onstream in the next month.
These two events will likely imply some tightness and a consequent rise in ethanol prices. However, any such rise will be temporary, in our view because of three reasons:
1) Imports from Brazil: the price differential is already favourable to import from Brazil. We estimate imports from Brazil become economical at an ethanol price of
about US$2.50/gallon and the current ethanol price is US$2.90/gallon. Brazil had about one billion gallons of spare capacity and exported 300 million gallons to
the US last year.
2) US industry capacity is already 9 billion gallons or equal to the mandate for this year. Delays in new plants is going to impact 2009 supply demand, not this year,
in our view. Any shut-in capacity can be quickly brought onstream once water recedes or margins come back even slightly.
3) Legislation: even before the floods, there were calls to reduce the ethanol mandate. Kim Wallace, from our Washington Research team, had put the probability of
legislation to lower the mandate passing this year at 35 percent and next year at 60 percent in his morning report of May 20. Now after the floods, the corn situation
looks even more bleak with 3 million acres lost and prices touching US$ 7.50 a bushel. We believe this increases the probability of Congress passing legislation this
year and this will likely be negative for ethanol producers, in our view.
To sum up, shut-in and delays due to both flooding and poor margins are likely to tighten the market. However, this will be temporary, we believe, due to imports and the risk of a lower ethanol mandate.

If you have any questions, please give us a call.
US Integrated Oil Research
Mansi Singhal, CFA +1 212 526 8729
Paul Y Cheng, CFA +1 212 526 1884
Christina Cheng +1 212 526 5580
Saurabh Bharat +1 201 499 2017

Posted by Martin at June 20, 2008 12:19 PM

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