A Sweet Ethanol Deal

By Aaron Levitt | February 09, 2010 AAA

Of all the forms of alternative energy, none has had a tougher time than ethanol. Once thought of as the savior of high gasoline prices, ethanol has certainly had a rocky few years. High feedstock prices followed by collapsing oil prices gave the sector the needed one-two punch to almost eliminate all the pure players. Many producers filed for bankruptcy, production sat idled and shareholders saw their investments fall to penny stock levels.

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Adding a Touch of Government Intervention
Uncle Sam still believes in ethanol. Through the Energy Policy Act of 2005, at least 11 billion gallons of ethanol needs to be blended with conventional gasoline this year and steadily rise to 36 billion gallons by 2022. More recent developments, the Environmental Protection Agency has begun the process of increasing the ethanol blend required by refiners. The EPA hopes to raise the blend rate from 10-15% ethanol. The agency hopes to have its testing done by June, 2010 and make the final ruling.

Ethanol in a Portfolio
Just as in the financial sector, the Great Recession has brought consolidation to the biofuels market. With the recent bankruptcies and turmoil caused by the credit crisis, larger and better capitalized refiners have done well in picking through the remains of the former pure players. America's largest pure refiner, Valero Energy (NYSE:VLO), was able to fold ethanol producer Verasun's assets through a fire sale last year, and Magellan Midstream's (NYSE:MMP) proposed bio-fuel pipeline deal with producer Poet highlight this trend. Even bigger deals are happening below the equator.

Major integrated energy concern Royal Dutch Shell (NYSE:RDS-A, RDS-B) has joined forces with Brazilian sugarcane ethanol producer Cosan (NYSE:CZZ) to create a $12 billion joint venture. In exchange for a $1.63 billion payment, Shell gains access to one of the most efficient producers in which it can put to work with its massive distribution network. While the deal will initially focus on the Brazilian market, both Shell and Cosan have production targets of 4-5 billion liters annually for the venture, more than enough to export. Brazil's total ethanol mandate is around 3 billion liters.

Not to be left out of Brazil, agricultural concern Bunge (NYSE:BG) wrapped up its acquisition of five mills from the Moema group. The assets have an annual sugarcane milling capacity of 13.7 million metric tons. The deal is valued at $452 million in stock.

Investors wanting to add ethanol to their portfolios should see the Shell-Cosan and Bunge deals as the 800-pound gorilla in the room, and avoid some of the few pure American players remaining, such as Green Plains Renewable Energy (Nasdaq:GPRE). Better options would be to see what well capitalized refiners like Marathon Oil (NYSE:MRO) or the integrated majors like Chevron (NYSE:CVX) do in order to meet the federal mandates. Aside from the dividends, these larger companies will be the major catalysts for any future ethanol growth in the United States.

The Bottom Line
Consolidation continues in the biofuels industry. The recent deals highlight the growing trend of larger and better capitalized competitors buying assets on the cheap. Investors wanting to add ethanol to a portfolio need to look no further than the major refiners and oil producers. (Read more about ethanol and biodiesel in The Biofuels Debate Heats Up.)

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