Oil prices are rising. Unrest in the Middle East has everyone, including the president, looking for alternative fuel sources. Sounds like a perfect storm for the ethanol industry, right?
Sort of, but there are plenty of challenges ahead in turning Midwest farmland into a major source of fuel. As Pacific Ethanol's (Nasdaq: PEIX) fourth-quarter loss shows, it isn't moving everyone into profitability. Pacific Ethanol reported a loss of $11.6 million, or $0.14 per share, down from a $245 million loss last year. But this should be a perfect storm that should send Pacific Ethanol's earnings through the roof, or should it?
Food vs. fuel
This has been the battle cry of ethanol opponents since ethanol was invented, but there are market factors at work that will sort this out for us. Assuming food demand is relatively constant, if ethanol demand rises, so does the price of corn, leading to lower margins on ethanol and a higher cost of food. So the average consumer feels a pinch at the grocery store and what looks like a bonanza of good news for ethanol producers ends up being a squeeze on margins.
Even Cosan's (NYSE: CZZ) sugar-based ethanol runs into the same food vs. fuel problem, although sugar products are far more efficient at making biofuels.
So when Bloomberg reported this week that the second-largest area of corn planting since World War II wouldn't be enough to meet demand for feed and ethanol, I saw this as bad news for the industry. If supply won't meet demand, higher corn prices will be bad news for ethanol producers' margins.
In the long term, ethanol will encounter these problems over and over again as food demand worldwide increases. I would much rather stick with fertilizer companies that benefit whether agriculture products are turned into food or fuel. Mosaic (NYSE: MOS) and PotashCorp (NYSE: POT) are two solid picks in this space and provide a much better risk/reward profile than pure ethanol plays.
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