Rising World Food Prices Spell Trouble for Biofuels

As crop prices rise, biofuel producer margins fall. Some of these companies are more at risk than others.

Apr 16, 2014 at 9:43AM

Domestic ethanol margins have grown with decreasing corn prices over the past few years, but the days of cheap feedstock may soon be a thing of the past. American biofuel companies reliant on domestic corn and oilseeds along with advanced biofuel companies reliant on sugar may both be challenged by the March rise in the Food and Agriculture Organization of the United Nations (FAO) Food Price Index. A look at crop futures markets implies that the March increase may be the start of a longer lasting trend, which may play a big role in established biofuel companies' financials and may delay the first realized positive earnings from emerging advanced biofuel companies.

A recent history of crop prices
March's 2.3% increase in the FAO Food Price Index brought prices to their highest level since May 2013. Corn and sugar prices have been especially volatile over the past decade, and prices for both commodities are experiencing gains since the beginning of the year. Corn futures have jumped this year based on the effect that increasing exports and demand for livestock feed have had on corn stockpiles. Much-needed rain in Brazil has brought down sugar futures recently, though prices are still up from the beginning of the year due to drought conditions. Along the same lines, oilseed futures have been on the rise as reserves have been steadily dropping.

The recent rise in crop commodity prices and futures are following what have been slightly declining prices for corn, sugar, and oilseeds. Consumers may see a somewhat direct impact of rising crop prices at the grocery store, but biofuel producers may be the ones most directly affected by rising feedstock prices.

The end of big margins
The largest biofuel producers have been enjoying comparatively low feedstock prices. Archer Daniels Midland Company (NYSE:ADM) realized record profits in 2013 while the actual processed volume of corn and oilseed remained mostly constant from the year before. The one big reason for the profit: margins. Lower corn costs paired with steady or increasing demand for ethanol, sweeteners and starches, and renewable chemicals to expand margins. Lower oilseed costs similarly were met with strong domestic and international demand to expand margins in the company's oilseed segment.

Overall, near-term demand is unlikely to drastically change as concerns over Renewable Fuel Standard (RFS) revisions are mitigated by increasing biodiesel demand in the EU, meaning that the greatest factor affecting future profits will be crop feedstock prices. Double digit price increases have already taken hold this year, and if the trend continues, ADM and other major biofuel producers like Renewable Energy Group (NASDAQ:REGI) could see their profits drop. Long term feedstock purchase contracts may help soften the impact, but rising prices still equate to tightened margins. The advantage that Renewable Energy Group has over ADM is their ability to utilize a variety of lower cost feedstocks. The advantage of a lower cost starting product is clear, but the other contributing factor is the ability to use a variety of potential feedstocks like used cooking oil and animal fats, as opposed to just corn or oilseeds, that allows Renewable Energy Group to better respond to individual crop price increases.

A major decline in raw sugar prices in 2013 was one of many factors that contributed to both Solazyme (NASDAQ:SZYM) and Amyris (NASDAQ:AMRS) voicing expectations to turn a profit over the next two years. The focus of these companies on sugar-based products may delay their abilities to capitalize on expanding markets for their products, though the higher value nature of their revenue-generating products will not be as affected by feedstock prices as would fuel products with substantially narrower margins.

The takeaway
The profits from crop-based bio-production companies will always be dependent on crop commodity prices. ADM and Renewable Energy Group have found a way to profit and incremental price changes to their feedstocks will not immediately spur financial difficulties. Amyris and Solazyme have been able to bring down production costs which, over the long run, will have a much greater impact on their abilities to become profitable. Variation in feedstock prices is a reality that all bio-production companies need to live with. If marginal crop price increases are going to drastically affect a company's ability to generate positive earnings, then the company probably isn't worth your consideration unless you can accurately and consistently predict future of crop prices.

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Shamus Funk owns shares of Amyris. The Motley Fool owns shares of Solazyme. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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