Adventures in Ethanol
Over the last week I have played some parts of the ethanol yo-yo well and other parts not so well. Let me review.
On the well side, I significantly reduced my extremely over-sized position in Pacific Ethanol (25% of my portfolio at its peak) at prices of about $23 per share. On the not-so-well side, I added/subtracted and then added back my position in Rex Energy on continuously declining prices and held on to a still not insignificant percentage of Pacific Ethanol (about 5% position) through the declines of Thursday and Friday. What is yest to be determine is that I added back some of Pacific Ethanol at $20.15 on Thursday. While I sold half of that on Friday morning for a bit of a profit, I held the other half through the decline on Friday and now sit with those shares at a lower price than I had purchased them for.
How this all ends remains to be seen. This blog is not intended to be an account of my infallibility. Unlike many others on the blogosphere and on twitter, I have no omniscient insight into what can be absolutely stated as a good or bad decision. Thus it is that you rarely see me laying out the ridicule, condescension or my favorite, the passive-aggressive rhetoric, that seems to be so prevalent in these mediums. I can only wish for such certitude. Unfortunately my world is far too gray to not feel empathetic for those who hold a different opinion than mine.
The beauty and horror of the ethanol stock is that it only takes a small difference of opinion to lead to a drastically different conclusion. To take an example that I tweeted earlier tonight, in my model I get a $1 quarterly earning swing by adjusting the ethanol price by 20 cents – from $2.05 to $1.85 per gallon (note I originally had written 80c but I hadn’t been making an apples to apples comparison in my model). A similar point could be made about Pacific Ethanol. The significance of course is that 20 cents is about the swing that ethanol prices took in the last week.
I’ve heard a lot of talk that the decline is because of the recent subsidy put in place by the Brazilian leader Dilma Rousseff, who is desperately trying to protect her diminishing lead in the upcoming presidential election. I even was forwarded a newsletter writer who sold out of his position in the ethanol stocks on this news. I find that puzzling. The subsidy is 0.3% on exports this year and 3% on exports next year. This seems to me to be a minuscule amount which I can’t see affecting production decisions, saying nothing of the Brazilian drought that I would think makes any near term impact moot.
Far more interesting will be the conclusion of the Brazilian election and whether there is a change to the gasoline ceiling. Both leading presidential candidates have publicly stated that they will raise the price of gasoline if elected (articles here and here). As the second article points out “only 25 percent of Brazil’s flex-fuel cars were filled up with ethanol last year, down from 82 percent in 2009, as the fuel became relatively more expensive than gasoline in most parts of the country”. If Brazil allowed gas to float at market I would suspect you would see somewhat less ethanol available for export, even if it was 3% cheaper via tax.
I think that the true culprit of the decline is the drop in the price of oil. The drop in oil has lead to the drop in gasoline which has, at least to some extent, led to the drop in ethanol and perhaps more importantly, led to fear that the bursting of the oil bubble is upon us. That has created a lot of fear that ethanol margins are fast disappearing for good.
What makes me doubt this thesis is that we are actually pretty close to the lows that the ethanol market has seen in some time. You have to go back to 2010 to see a time when prices were able to sustain a price below $1.80 per gallon. This includes long periods where inventories were much higher.
To think we are going to see another sustained leg down in the price of ethanol suggests to me the expectation that something has fundamentally changed in the market. Yet the most likely fundamental changes I see are likely to the upside. I refer you to the Green Plains second quarter conference call. On that call they said that while third quarter export volumes were weak, they had seen a significant pick-up in the fourth and first quarter. They had already sold forward about 15% of their production in both quarters to the export market. They saw demand from “non-traditional” sources such as India and Brazil. And that they were holding back on hedging too much production in the fourth and first quarters because of the “interesting” pricing dynamic that they saw developing. I think these points, taken together, are worth considering.
At the same time we wait for the EPA ethanol mandate decision. With corn holding a 3-handle, gasoline demand in 2014 proving stronger than was originally expected and some election races in the corn belt looking too close to call, its not hard to imagine a significant revision up to the ethanol mandate.
On the other hand, momentum is certainly against these names and sometimes that is all that matters.
There are indeed many moving parts to the ethanol story but I think the focus is only on the negatives the last couple of days. If you think oil is going to $85 then maybe there is further downside. But if you think we just saw a reversal in oil,that we perhaps saw a reversal in ethanol on Thursday, then I’m not so sure its a good idea to panic into this decline.
With all of that said I reserve the right to change my opinion as the facts change and to sell shares even as my opinion does not change but the share price does. Because I, unlike many others, do not see anything wrong with holding dissenting views with equal compassion, and I do not see anything wrong with acting against one’s own convictions even as those convictions are still held. Such, in my opinion, is the nature of survival. Perhaps if we all actually had to survive rather than be buoyed into complacency by whatever compensation that makes it worth our while, we would not be so quick to judge others as though the world was black and white.