Thursday, May 17, 2007

Falling Corn and Rising Gas: Good for Ethanol Producers

Corn prices have fallen 25% since their early March highs and the weather the past two weeks has lead to a surge in planting with up to 40% increases in some areas. The beneficiary? Ethanol producers. Versun (VSE), who recently experienced a 31% increase in revenue, reported a quarterly loss and said the culprit was increased corn prices that had them paying $4.05 a bushel in Q1 and a inexplicable $33 million "loss" contributed to hedging. How do you lose money hedging against higher corn prices when corn prices go higher??

When you consider Aventine (AVR) reported a profit and said they paid $3.58 a bushel in Q1, Verasun's results seem to be an indication of poor management rather than rapidly deteriorating fundamentals in ethanol. Considering estimates have ethanol being profitable to produce at corn prices up to over $4.80 a bushel, ethanol will remain profitable for the foreseeable future. Archer Daniel's Midland (ADM) reported Q1 results recently and while they do not release their price paid for corn (I presume this is due to it being dramatically lower than their rivals and would put pressure on suppliers to provide these prices to others), they reported an increase in Q1 corn processing results. Shares of Pacific Ethanol (PEIX) are traded up 12% after their earnings actually came in it a profit

Now that we have a record corn crop going into the ground at a rapidly increasing rate, corn prices look to plummet before the summer is finished. When you add the fact that new ethanol production capacity that was scheduled to come online has slowed due to the higher corn prices, anticipated demand will not materialize. For ethanol producers who managed their businesses well during the price spike, this will mean a series of earnings estimate beating results will come rushing in. Ethanol producers are in a unique position to be able to hedge their input prices against spikes. The rise in corn prices seems to have taken no one other than Verasun by surprise and producers actually benefited from it. Now that prices are falling and gas prices are going in the opposite direction, more good news is in store for investors.

With the current outlook poor for the sector, shares ought to spike on the unexpected good news.

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