The Ethanol Paradox: Higher Prices on Lower Demand

Hot, dry weather in the nation’s main corn-growing region have pushed corn prices to nearly $7.80/bushel this morning, a level not reached since last September. About 40% of the US crop is used to make ethanol, which is driving up costs to ethanol producers like Archer Daniels Midland Co. (NYSE: ADM), Valero Energy Corp. (NYSE: VLO), BioFuel Energy Corp. (NASDAQ: BIOF), Pacific Ethanol Inc. (NASDAQ: PEIX), and Green Plains Renewable Energy Inc. (NASDAQ: GPRE).

But as US drivers consume less motor fuel, Valero and others have cut production in an effort to keep ethanol prices high enough to pay for the higher cost of corn. In June, according to a report from Platts, profit margins on ethanol were negative, at -17%, lower even than the -10% margin reported in May, and the lowest level since reporting began in 2005. The average price of a gallon of ethanol in June fell to $2/gallon from $2.11/gallon in May, while corn prices in June averaged $6.26/bushel compared with $6.28/bushel in May.

For the first week in July, ethanol production fell to 821,000 barrels/day, the lowest in two years. Compared with a year ago, ethanol production is up slightly on a cumulative daily average, but inventories are down nearly -6%.

So, if prices for corn are rising and demand is falling, why is BioFuel Energy seeing a pop of as much 24% this morning and Pacific Ethanol getting a boost of nearly 13%? The answer appears to be that ethanol prices are rising, up more than 13% so far in July and up nearly 30% since hitting a low in June. At Friday’s close, ethanol spot prices were up 12% to $2.5425/gallon.

It appears that the production closures have taken enough ethanol off the market to support the rising costs of corn and put some profit back into the ethanol makers’ pockets. Low pump prices for gasoline have put a few more drivers back on US highways for the summer which would have the effect of increasing demand for ethanol. Combined with lower inventories, the belief that ethanol demand and prices will continue continue to rise gained some traction today. Whether that belief pans out over the next few months remains to be seen.

BioFuel Energy shares are up 16% about half an hour before noon today at $2.89 in a 52-week range of $2.49-$24.80. The 52-week low was set last Friday.

Pacific Ethanol shares are up about 13.5% at $0.32 in a 52-week range of $0.25-$1.85.

Paul Ausick