No doubt there is a ton of hype about alternative fuels at the moment, and a lot of interest in Ethanol in general. For a class at Sloan, I did a lot of research into the market and see why there is a lot of hype. A typical 40 million gallon per year plant running on Corn is making upwards of 45% margins on an ongoing basis. I believe its called a "money machine." Natural gas and corn prices are the main supply costs and MTBE reductions across the country are spurring enough demand to drive prices for Ethanol to crazy high levels. As they increase, however, ethanol's price advantage over gasoline will erode and the fickle economics may start to break down. That fact will likely stabilize prices in the short term, while rapid increases in supply will stabilize prices in the long term. Thats why this summer I expect Ethanol prices to be very close to on par with gasoline in a per BTU comparison.
As far as investing goes, I think Pacific Ethanol is interesting only in that it is one of the few public options for investing in the future of Ethanol. As more and more capacity enters the market, the firm must find ways to establish a competitive advantage or the firm will fall into a pure commodity trap. Parallels to Exxon and Mobil are unfounded because of a distinct disadvantage in terms of vertical integration. Exxon and Mobile control end-to-end production, refining and distribution. The last link in this value chain is where a large percentage of the profits come from and where Exxon and Mobil extract a great deal of their advantage. PE owns one small link in the chain, one where there is little opportunity for differentiation in the future (think of ways to cut down on input costs and improve distribution). At the moment, it serves as an alternative higher value fuel (replaces MTBE and has some psychological advantages over oil) but as ligno-cellulosic ethanol and more efficient bio-diesel options become available this advantage will erode. Unless PE can ride the technology advances to stay at the forefront and find a way to integrate down into the distribution level of the value chain, they should remain a short-term investment option that you monitor carefully and exit at the moment of greatest hype. Unfortunately, the hype moment looks like its closer and closer. I think you had better be careful with this one. Hold for now.
I like Archer Daniels Midland (ADM) only a little better because its tied more tightly to the entire value chain and has the ability to extract more value from the creation of these fuels than does PE. I also like ADM's diversity of businesses which can help them bridge turbulent times and defend against the possibility of OPEC dropping its drawers to kill alternative fuel production. Still, I remain cautiously optimistic on ADM -- like the profits it can earn in the short-term, but am hesitant about its long-term strength in the market. Its a bit overvalued at the moment, but I expect it to become even more over-valued if the market for alternative energy continues as it has been going ths year...
As far as investing goes, I think Pacific Ethanol is interesting only in that it is one of the few public options for investing in the future of Ethanol. As more and more capacity enters the market, the firm must find ways to establish a competitive advantage or the firm will fall into a pure commodity trap. Parallels to Exxon and Mobil are unfounded because of a distinct disadvantage in terms of vertical integration. Exxon and Mobile control end-to-end production, refining and distribution. The last link in this value chain is where a large percentage of the profits come from and where Exxon and Mobil extract a great deal of their advantage. PE owns one small link in the chain, one where there is little opportunity for differentiation in the future (think of ways to cut down on input costs and improve distribution). At the moment, it serves as an alternative higher value fuel (replaces MTBE and has some psychological advantages over oil) but as ligno-cellulosic ethanol and more efficient bio-diesel options become available this advantage will erode. Unless PE can ride the technology advances to stay at the forefront and find a way to integrate down into the distribution level of the value chain, they should remain a short-term investment option that you monitor carefully and exit at the moment of greatest hype. Unfortunately, the hype moment looks like its closer and closer. I think you had better be careful with this one. Hold for now.
I like Archer Daniels Midland (ADM) only a little better because its tied more tightly to the entire value chain and has the ability to extract more value from the creation of these fuels than does PE. I also like ADM's diversity of businesses which can help them bridge turbulent times and defend against the possibility of OPEC dropping its drawers to kill alternative fuel production. Still, I remain cautiously optimistic on ADM -- like the profits it can earn in the short-term, but am hesitant about its long-term strength in the market. Its a bit overvalued at the moment, but I expect it to become even more over-valued if the market for alternative energy continues as it has been going ths year...
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