Ethanol producers

Published: November 3 2008 09:22

Sometimes, the best cure for a hangover is to keep drinking. But ethanol investors, hit by the shakes since they binged on the corn-based fuel in 2005 and 2006, should think twice before taking the hair of the dog. The bankruptcy of VeraSun Energy, the biggest listed US ethanol producer, is the latest grim news for a sector where listed companies have lost 80-90 per cent of their market value over the past two years. Ironically, for an industry savaged by rising corn costs, VeraSun shows that falling corn prices are one of the biggest short-term threats.

Like some rivals, VeraSun took out hedges to protect against rising prices after corn hit a record price of $8 a bushel in June. Yet those hedges backfired as bushel prices went on to halve, leaving the company strapped for cash. For others also, the recent pullback in corn prices has offered little respite. As recession fears have grown, ethanol prices have plunged in tandem with corn prices, so depriving producers of any hoped-for boost to margins.
Eventually, demand will improve. The amount of ethanol to be blended into gasoline in the US is set to quadruple by 2022 because of government mandates. With annual sales running at about $20bn, the supply glut that has pushed down ethanol prices should ease by 2010 or 2011 as demand catches up. But in the long run, low barriers to entry – all it takes to become a producer is a field of corn and a simple still – means gains will be fleeting. New producers will compete away margins, leaving the biggest buyers of ethanol – the refiners who blend it into gasoline – able to dictate prices. The likely result is prices that are sufficient to keep ethanol plants ticking over, but barely profitable. All the more reason for investors to pull up the covers and go back to bed.