I recently wrote about VeraSun’s cancellation of its Reynolds, Indiana facility. There reason was falling ethanol prices. But this didn’t quite make sense to me. Low prices due to expanded supply indicate a lowering of demand. I’ve been having a hard time wrapping my head around this dynamic. There is a good article on ethanol imports in Ethanol Producer magazine that gives me some help on this:
High-profile ethanol companies, however, are scaling back their efforts and new plant construction is falling, when compared with 2006. Plant operating margins are squeezed and the supply is exceeding the demand. If there is such an over-abundant domestic supply of ethanol, why are oil companies still looking to purchase the oxygenate from foreign sources?
This is an interesting article in that it illustrates that U.S. companies are still importing low-price ethanol in spite of high tariffs. Apparently, the declining ethanol pricing is slowing the importation and making U.S. ethanol look more attractive. This is a bit strange – lower prices are both helping and hurting U.S. producers. There’s three ramifications here that we should take a look at.
Lower Demand Outlook could burst a PE bubble
A lower product demand is a bad omen for this industry. The industry is playing a game of music chairs right now – and the music just stopped. Growing capacity only works when your market prospects are growing. The lowered price coinciding with increasing supply, then, is a strong indicator that the wheels are coming off the ethanol industry. Currently, the U.S. only has enough for around a 5% blend with gasoline (E5). But the industry has projects to double capacity. That’s billions of dollars that has been put down that has to be taken off the table (or just lost).
This is a grave situation for the private equity money that has been put into the industry in recent months. These investments are dependent on continued growth through the next decade. If this stall is short term, than it could just slow down the current momentum the industry is enjoying. If the stall is long term, it could really kill development opportunities.
Narrowing production margins indicates new process technology needed
Look, the biofuels industry is a relatively crappy industry. You have relatively high feedstock prices for relatively low end product pricing. You’re getting squeezed. So having a low ethanol price – something that a lot of politicians are advocating – is really bad for producers.
What this means is that producers have to step up development of reducing production costs. POET recently announced (rather uninterestingly) that it plans on using waste biomass to produce energy for its plant (using a solid waste fuel boiler). There are increasing need for focus on the distillation process – a significant use of energy within the overall production process. So there is evidence that companies are redoubling their efforts to make their production facilities more efficient. Ultimately, it’s one of the few ways they improve their profitability outlook given the pricing risk inherent to the industry.
Cellulosic is mandatory
The biggest impact to this industry is that its future prospects are highly dependent on the commercialization of cellulosic-based feedstocks. Having a cheap, managed, feedstock that can be produced at affordable prices would be a great advantage for this industry. Currently, volume requirements are are limited with corn and, given these changing dynamics, nwe investment dollars would be poorly spent.
