Despite the recent plunge in oil prices, the energy sector is still ripe will potential long term opportunities. From midstream infrastructure to firms’ focused on shale drilling, there are plenty of energy stocks that beginning to look like great bargains for the long haul. Even some of the side plays are looking like decent investments.
Case in point: ethanol.
Yes, that ethanol. Purveyors of fermented corn — used to stretch gasoline supplies — may seem like an odd choice for a bet on energy stocks. After all, we’re using less of the stuff here at home. But the truth is, several ethanol producers have finally found a way to grow demand and profits — by exporting it away.
While ethanol has been a relative joke for much of its history, the potential for exports could finally be the spark to light a fire under several of the names in the sector.
Exports Surging for Ethanol Stocks
Congress gave ethanol stocks a huge boost through the Energy Act of 2005. Under the act and subsequent revisions, the amount of ethanol that must be blended with conventional gasoline has been steadily rising over the last decade. Eventually that amount will hit a whopping 36 billion gallons by 2022. The act also gave producers some hefty tax credits and subsides.
Unfortunately, ethanol stocks haven’t exactly lived up to their promise.
For one thing, we simply aren’t using enough ethanol. As higher fuel efficiency standards for automobiles have been raised, American motorists are using less gasoline. Less gasoline means less ethanol. In fact, back in October, refiners actually hit the so-called “blending-wall.”
Essentially, refiners have maxed out the amount of ethanol they need for the amount of gasoline they are producing — forcing them to incur some pretty nasty fees and fines under Energy Act. They’ve since gone to the EPA to potentially revise/reduce the amount of ethanol required to be blended.
The request seems to have gotten a fair bit of traction. Last year around this time, a bipartisan bill was introduced that would eliminate the corn ethanol mandate within the Federal Renewable Fuel Standards and Energy Act.
Meanwhile, at the end of the 2011, the Federal government eliminated the lucrative blenders’ credit, which provided more than $45 billion in cash to ethanol producers since 1980 when it was first introduced.
So given the headwinds, what’s an ethanol producer to do with the current market in the United States? Ignore it and send overseas where they want the stuff.
Ethanol exports from the United States have surged 31% in 2014 to reach the highest level since 2011. This past October — the latest month available for data — total ethanol exports from the U.S. reached a whopping 300 million liters (79.2 million gallons). That’s a 40% increase over September’s numbers. Analysts’ predict that U.S. ethanol exports of both denatured and undenatured ethanol will hit number between 950 million gallons to 1 billion gallons over the next five years.
Demand for ethanol overseas continues to rise — especially in Asia. Nations with zero domestic energy reserves — like the Philippines and Japan — have been using it a gasoline stretcher, while several emerging market nations have been using as a source of straight fuel in order to meet their rising demands for transportation fuels.
All in all, the domestic ethanol stocks with export power could finally be big buys for investors.
2 Ethanol Stocks to Buy
While it may be tempting to go out buy Pacific Ethanol, Inc. (PEIX) or any producer of the fuel, not all ethanol stocks are going to see the bump from rising exports. However, the ones that do see it will be great buys.
Just look at refiner Valero Energy Corporation (VLO), for example. Back in 2009, Valero purchased several ethanol plants from defunct and bankrupt Verasun and Aventine Renewables. Since then, the firm hasn’t looked back and currently operates 11 plants. VLO is one of the lowest-cost producers of ethanol via its large economies of scale.
And aside from using it in its own gasoline, Valero has continued to use its extensive terminal and logistics capacity — via newly formed Valero Energy Partners LP (VLP) — to begin exporting the fuel in spades. Those exports are staring to pay some serious benefits for VLO on the earnings front. For the first three months of 2014, VLO’s ethanol unit managed to deliver a record $628 million in operating income. Add in VLO’s sweet refining margins, rising gasoline exports, its current P/E of less than 7 and a solid 2.4% yield, and VLO stock look like a steal.
For investors looking for a more speculative pick, pure ethanol producer Green Plains Inc. (GPRE) might be a good choice. The firm continues to see its export fortunes rise. On a recent conference call, CEO Todd Becker noted that foreign sales at GPRE are all booked through the third quarter of 2015. That’s huge for the pure-producer, which is competing with VLO and other more integrated giants.
More importantly for investors, those exports are helping strengthen the firm’s cash flows and pad its 1.4% dividend yield. Perhaps best of all, GPRE shares trade for a cheap P/E of just 6 — well below competitors’ levels.
The Bottom Line: Ethanol producers aren’t looking at the U.S. for growth anymore. The domestic market is fraught with peril. That means it’s time to export.
Ethanol stocks like VLO and GPRE have some of the best ways to play this growing market.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
