PLANT CORN AND PRAY for good weather. That seems to be the best agribusiness strategy, following President George W. Bush's plug for biofuels in his State of the Union address Tuesday.
The shares of ethanol refiners ran up as much as 19% in the days before the speech, as Wall Street anticipated the president's call for annual production of 35 billion gallons of alternative fuel by 2017 -- a nearly fivefold increase from the federal government's current goal.
But the ethanol stocks later gave back most of their anticipatory gains, as investors apparently concluded that even the president can't ease the physical and economic constraints weighing on the shares of Archer Daniels Midland /zigman2/quotes/203479136/composite ADM -0.27% (ticker: ADM), Pacific Ethanol /zigman2/quotes/202357419/composite PEIX +16.39% (PEIX), VeraSun Energy (VSE) and Aventine Renewable Energy Holdings /zigman2/quotes/208749912/composite AVTI +14.29% (AVR).
As we warned last summer (" The Corn Conundrum," Aug. 7), rapidly expanding capacity in ethanol-refining has gobbled up corn, the main feedstock for today's ethanol manufacturers.
Corn prices are close to a 10-year high. Meanwhile, oil has slid to an 18-month low. This combination has pinched the "crush spread" that measures the profit from buying corn and turning it into ethanol. In the 12 months before we wrote our story, that per-gallon spread had tripled to more than $3 -- inspiring a rush to add ethanol capacity and to sell ethanol shares to the non-farming public. With the spread narrowed, profits have proven disappointing.
Since our story, the stock of biofuels-industry leader ADM is down 22%, while shares of Aventine Renewable Energy are off 40%. ADM will school shareholders on its latest-quarter results on Feb. 1.
The U.S. ethanol complex has been a long-term beneficiary of government assistance through tax subsidies and tariffs on imported ethanol. The president's call for even more production of ethanol and biodiesel (a diesel substitute, made mainly from soybeans) won't do much to change the biofuel industry's near-term course. Refiners are already straining available engineering resources to add capacity as quickly as possible. Current projects are expected to expand production capacity to six billion gallons a year in 2007.
As reflected in the price of a bushel of corn, supply limits can take some of the fun out of the new ethanol-refining capacity. Those other kinds of corn stocks -- the inventories sitting in grain elevators -- have been drained to 20-year lows. That makes weather a bigger short-term risk factor, should production get pinched by a bad harvest.
In the medium term, farmers will surely shift acreage to corn from other crops. That, in turn, could limit supplies of soy to biodiesel refiners. And the growing appetite of ethanol refiners for corn will make the grain more expensive for livestock and, indirectly, humans.
To be sure, continuing improvements in corn yields will ease some of those constraints. That's why shares of agrochemical outfits like Monsanto (MON) also perked up before the State of the Union address. A boost in corn supply won't be enough to boost the crush spread and make ethanol stocks recover. They'll need another rise in the price of oil. That will happen. The question is when.
But long term, corn and soy farmers would run out of arable land long before they could produce the 35 billion gallons a year that the president demanded in his speech. Meeting his goal would require new technologies that could allow production of biofuels from cellulose-based feedstocks, such as switchgrass and poplar trees, instead of today's sugar-based crops.
Early efforts in those technologies are not yet economic, and there are as yet no great cellulosic investment plays.
-- Bill Alpert