Ethanol stocks have rallied impressively in recent weeks amid the latest surge in oil prices and the enactment of a new federal law mandating ever-greater use of the fuel.
But even with these bullish factors, ethanol experts continue to fret over expectations of at least another two to three years of ethanol oversupply. The upshot: Even in a $100 oil world, ethanol equities remain far from a sure thing.
"We caution investors not to get carried away," Eitan Bernstein of Fairfax, Va.-based FBR Capital Markets, said of the recent surge among ethanol equities, many of which have risen 30% since November amid higher ethanol prices.
Ethanol producers seized on oil's historic surge this week as evidence that the day has come for a fuel that could reduce U.S. reliance on oil. Oil prices breached $100 per barrel for the first time Wednesday, a level that "underscores our economic and geopolitical vulnerability to depleting oil reserves," said Bob Dinneen, president of the Renewable Fuels Association.
But ethanol experts point to a variety of hurdles facing leadingU.S. ethanolproducers like VeraSun Energy Corp. (VSE) and Aventine Renewable Energy (AVR), both of which have risen more than 30% since November. Short-term concerns include an ethanol oversupply, high corn prices and logistical issues with transporting the fuel. Longer-term worries include potential competition from Brazilian ethanol producers and other feedstocks that could displace corn.
"We are cautious on the ethanol stocks due to oversupply concerns amidst historically high corn costs," said Eric Brown of New York-based Banc of America Securities.
By the end of 2008, the U.S. is seen producing more than 9.5 billion gallonsof ethanol a year. This rapid growth surpasses the amount mandated this year - which is just 9 billion gallons - resulting in a likely supply glut. Currently, there's no need for gasoline blenders to use this additional supply, said Robert Lane, a Houston-based analyst with SMH Capital.
The Energy Independence and Security Act, signed into law late last year, sets a rising mandate for renewable energy up to 36 billion gallons a year by 2022. While the standard will trigger additional demand for the fuel, there's a long delay before gasoline manufacturers are required to blend large quantities of the fuel.
In light of these issues, ethanol prices began trending downward during 2007, bottoming out in September at $1.70 per gallon. While the price has risen - to $2.18 a gallon on Friday - it's still below the levels seen in 2006, when it hit $4.23.
The lack of pipelines, trains and other necessary infrastructure to ship midwestern-produced ethanol to large urban markets along the coasts is one hurdle to increasing demand for ethanol, Lane said.
Producers may also be hurt by higher corn prices going forward, said FBR's Bernstein. Corn prices have risen from $3.75 per bushel in September to $4.50 per bushel, increasing ethanol production costs by nearly 20 cents a gallon, he said. Competitors to Corn Beyond oversupply, analysts say there are potential long-term hurdles that may prohibit the sector from seeing the high ethanol prices and terrific producer margins of 2006.
In 2008, a tariff limiting U.S. imports of Brazilian ethanol may be lifted, and an extension to the tariff is unlikely to extend past 2010, said Divya Reddy, an analyst with Eurasia Group. "At that point, Brazilian ethanol could come in," she said. In some regions of the country, like the West Coast, imports of ethanol could make corn-based ethanol less competitive, she said.
Second-generation successors to ethanol that rely upon feedstocks other than corn could potentially challenge the fuel's dominance of the U.S. market. These new fuels, including cellulosic ethanol, could avoid conflict with food sources, and reduce some of the logistical difficulties that ethanol faces.
While the renewable fuels standard calls for 36 billion gallons per year of renewable fuels, ethanol represents less than half of that goal, said SMH's Lane.
The standard places a heavy bet on the commercialization of these new fuels, which aren't yet developed, said Reddy. "Given the RFS, we have a positive outlook for corn ethanol - until cellulosic can come online," Reddy said.