Ethanol & Corn Fuel Stocks

Ethanol fuels corn production. Images

Ethanol companies' stock prices rise and fall with government regulations and the price of corn. Because ethanol is a biofuel, ethanol companies' stock prices had their best, if brief, moment to date several months after the renewable fuels standard, or RFS, went into effect in 2005, according to figures from the Morningstar website. Increases in ethanol profits had some analysts bullish about ethanol stocks at the time of publication. The long-term prospects for investment gains, however, are unclear.

A Good Year in 2013

Ethanol companies enjoyed a three-prong profit boost in 2013, putting biofuel stock prices on the upswing. A bumper crop of corn, the chief ingredient of ethanol, put corn prices at a multiyear low of less than $4.50 a bushel, with corn futures prices predicting a low of $4.13. Prices for dried dairy grains, an ethanol byproduct used for animal feed, were strong. Ethanol companies were instituting another high-margin sideline, extracting corn oil from ethanol manufacturing waste. Profit margins rose to an average of about 85 cents per gallon of ethanol, and ethanol companies were humming to meet demand.

An Artificial Market

The biggest factor in ethanol demand is government regulation. The Environmental Protection Agency, which is responsible for the RFS, began requiring fuel-efficiency additives beginning in 1990. Ethanol is one such additive, and it first gained traction around 2003 as a replacement for methyl tertiary butyl ether, another additive that had proved to be a groundwater pollutant. In 2005, ethanol made up 13 percent of the U.S. corn market. In 2007, the RFS created a boom market for ethanol. In 2013, 40 percent of the corn market went to ethanol.

Longer-Term Realities

Ethanol has built-in drawbacks as a fuel. First, ethanol historically costs oil refiners more per gallon than oil to produce because of transportation costs. Ethanol can't be piped in mixture with gasoline, so it's trucked from the Midwest to the East and West Coast markets. Second, ethanol's sole use as a gasoline additive links it to a commodity with a softening price, thanks to the recent increases in domestic oil production. Third, modern automobiles don't work well with gasoline that is more than about 10 percent ethanol. Fourth, the popularity of electric and natural-gas-powered vehicles is rising.

Demand Prospects

In late 2013, the EPA cut its ethanol production targets in conjunction with farm bill negotiations in Congress. A drop in ethanol demand will likely cause an even further drop in the price of corn. Rock-bottom corn prices trigger subsidies for corn farmers. Ethanol has no such subsidy. Still, innovations that would make ethanol work better in consumer vehicles, or new chemicals that would make it possible to pipe ethanol after it's mixed with gasoline, could make ethanol's long-term prospects as bright as any optimist could hope for.