14 April 2008 00:00 [Source: ICB]
One Wall Street analyst has suggested that food price inflation will force the government to backtrack on its ethanol mandates. Will the market evaporate?
Ed Zwirn/New York
MARK GULLEY of Soleil Securities is taking the other side of the trade. Within a year, he says, ethanol could go from boom to bust.
The scenario begins with imbalances intensifying among Wall Street, Main Street and the Corn Belt. On Wall Street, US equity markets remain in bear-market territory. On Main Street, food price rises and consumer sentiment slumps. In the Corn Belt, however, farm income marches to another record as grain prices hit record highs.
The US Federal Reserve is faced with a nearly impossible task, the analyst continues: stimulate the economy, especially the sluggish consumer control inflation in commodity prices and fight deflation in the housing market - all at the same time. In the absence of cooperation from the European Central Bank, the dollar continues to weaken, exacerbating commodity-driven inflation.
Mother nature also refuses to cooperate. In August 2008, a drought, similar to the one that hit the Southwest in August 2007, hits the Corn Belt, sending near-month grain futures and out-year contracts soaring.
To top it off, food inflation enters the election debate after the Presidential campaign's Labor Day kickoff. The Democratic candidate attacks President George W. Bush's administration, claiming mismanagement of the economy.
"There is little the Fed can do to control global commodity inflation, save raise interest rates. And there's little it can do to control global food inflation," says Gulley, drawing his scenario to a close. "The lame duck Bush Administration has little interest in tackling this controversial issue. Waiting until after the November election, to rein in at least a portion of commodity inflation, the Fed urges Congress to temporarily suspend Federal ethanol mandates. The 111th Congress eventually relents."
ETHANOL AND THE CORN BELT
In fact, although the ethanol provisions of the 2007 Energy Independence & Security Act seemed to be a slam dunk when it was signed into law in December, some measure of doubt has arisen, particularly concerning the relationship between biofuels and the cost of food. While Gulley's contrarian scenario seems to be the only such dire prediction coming from Wall Street so far, the skepticism is by no means limited to the political left and environmentalists.
The 2007 Energy Independence & Security Act passed both houses of Congress by comfortable margins. More significantly, the affirmative votes included all three senators now considered the leading candidates to succeed Bush. Senators Barack Obama, Hillary Clinton and John McCain, no doubt with one eye to looming Iowa political caucuses in the heart of the US Corn Belt, all supported the goal of encouraging corn production as a means to secure ethanol to help wean the country off its dependence upon foreign oil.
For the chemical industry, renewable fuel standards increasing the blending of ethanol in US gasoline by almost 50% to 9bn gallons this year are, with blending credits and protective tariffs, the most conspicuous aspect of the bill. Government support for biofuels is making the agricultural sector "a notable bright spot" for an industry noticeably blighted by the credit crunch and housing-sector downturn, says Kyle Loughlin, analyst at US credit ratings agency Standard & Poor's.
Most other Wall Street analysts agree that this trend, which benefits not only pure-play ethanol projects but also companies with significant product exposure to agriculture, such as Monsanto and DuPont, both US, will only gather momentum as the US progresses toward 2022, when the mandate will require fuel producers to use at least 36bn gallons of biofuel.
HAS THE BACKLASH BEGUN?
However, there is growing skepticism over the claim that the US can wean itself off foreign oil using the country's great corn-growing capacity. Grain prices have already begun to spike worldwide, and while the effect upon the average US consumer has been relatively muted, with overall food prices up by 4.6% year-on-year in February (a far cry from the 18.9% spike seen for energy prices over the period), more severe food shocks may be on the way.
"The vast majority of that ethanol is coming from corn, and that's good if you're a corn grower," President Bush said at a March renewable energy conference less than three months after signing the energy bill. "But there's a lot of challenges. If you're a hog raiser in the United States, you're beginning to worry about the cost of corn to feed your animals. I'm beginning to hear complaints from our cattlemen about the high price of corn," the president continued.
"The high price of corn is beginning to affect the price of food," he added.
"US energy policy has unwittingly linked global food inflation to oil inflation via ethanol," says Gulley.
Although the scenario may not play out exactly as he has written it, there is nonetheless a "tipping point," he says. Nobody "knows where it is. The risks have increased, and when things end, they end suddenly."
Global grain prices are at record highs, up by 250% in just five years and inventories are at record lows, with the stock-to-use ratio at 15%, down from 24% in 2002, he points out.
Gulley also takes issue with what is perhaps the central premise of the government's ethanol program. Noting that ethanol represents only 3% of the nation's petroleum supply while consuming fully 30% of the anticipated 2008 corn crop, he says it is "a real stretch to say ethanol is lowering our dependence on foreign oil."
The ethanol industry and many other Street analysts have a different take on the matter.
Reacting to recent comments from "representatives of the nation's petrochemical, corporate livestock and food processing industries" disparaging "America's farmers and ethanol producers, US-based trade group the Renewable Fuels Association issued a blistering statement in March. Its president, Bob Dineen, called efforts to blame rising commodity, food and energy prices on the ethanol industry "misleading and diversionary."
CHICKEN LITTLE RHETORIC
"This kind of overheated, Chicken Little rhetoric is meant to distort the truth and deliberately misinform the American public," Dineen said. "Fortunately, the American people see through these smokescreens and understand that this nation must break its addiction to oil."
Whether the sky is falling or not, Wall Street analysts other than Gulley seem to be more bullish on the prospects for ethanol and the companies prospering as agriculture booms.
"Following a very solid 2007, 2008 is shaping up to be another spectacular year, driven by strong global demand, robust pricing power and tighter supply/demand conditions [and we] believe that the ag/fertilizer sector, with its terrific fundamentals, will prove unique in an otherwise challenging and eroding macroeconomic environment," says Robert Koort, analyst at Goldman Sachs. "We remain enthusiastic buyers of Monsanto, Potash, Mosaic and DuPont."
S&P's Loughlin remains optimistic in regard to the agriculture sector, although he acknowledges some risk in the outlook.
"I believe any chilling would be incremental to what is already a booming uptick in supply and demand," he says. "Most of the companies that we follow with involvement in agriculture are exceeding expectations."
On the other hand, he says, "we're in a recession, and there are a lot of people concerned about their prospects. Some consumers have already started to straddle back a bit on discretionary food purchases, passing up meals in restaurants for meals at home and canned vegetables."
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