US Drought Reignites Ethanol Debate

Once again economics and politics are colliding as the ongoing drought, the worst in 50 years in the United States, has reignited the debate about ethanol. The debate centers on whether is makes sense, at a time of food shortages globally, to turn corn into fuel. The U.S. ethanol industry uses roughly 5 billion bushels of corn annually, or about 40 percent of the U.S. crop.

Already strains in the industry are showing thanks to high corn prices in excess of $8 a bushel. Not to mention stagnant demand for fuel and the expiration of some subsidies which ended in December. Output of ethanol from producers has fallen to the lowest levels seen since October 2009.

The slowdown in the ethanol industry has already affected the producers. One of the largest producers of ethanol (with a capacity to refine 1.7 billion gallons a year), Archer Daniels Midland (NYSE: ADM), recently reported poor earnings. The company said it lost money on ethanol thanks to already-high inventory levels, weak fuel demand and low inventories of corn. Another large ethanol maker, Valero Energy (NYSE: VLO), also recently reported negative ethanol profit margins citing the same reasons as ADM. Both companies have shut down some ethanol producing plants in the Midwest.

Many organizations, including the United Nations, have asked the U.S. to waive government mandates for ethanol usage this year. The mandates will ensure that more than 13 billion gallons of ethanol will be used this year, no matter the price of corn. Also asking the government to suspend for a year its mandate for ethanol use are members of the U.S. livestock and poultry industry. Animal feed is the second biggest use for corn, behind ethanol. It accounts for about a third of corn usage, so the two industries are in competition for scarce, high-priced corn.

The livestock and poultry industry will suffer with falling profit margins because of the soaring price of corn for animal feed. Meat prices at the grocery store will rise, hitting consumers hard. Larry Pope, CEO of meat producer Smithfield Foods (NYSE: SFD), warned that U.S. meat prices will rise by “significant double digits” in the near future if nothing is done about the high corn prices.

But at least Smithfield Foods has done a decent job of hedging corn prices into 2013. Some of their peers such as chicken producer Sanderson Farms (Nasdaq: SAFM) have not done a good job of hedging corn. And this is important since animal feed makes up 55 percent of the company's cost of goods sold. Sanderson estimates that for every 30 cent jump in corn, it raises the cost of producing a pound of chicken by a penny. Doesn't sound like much, but it is important when you're working on the thinnest of profit margins. No wonder its stock has tumbled by about a fourth over the past few months.

The key question for meat producers and other consumers of corn is whether the government will waive, at least temporarily, its mandate for ethanol fuel. The answer is almost certainly no! In an election year, no politician in either party will want to risk losing votes in key Midwestern farm states where the ethanol program is very popular.

So other users of corn have best be prepared for even higher prices (unless the weather improves) by hedging as much corn as they can. For investors, it means continuing to invest into exchange traded funds (ETFs) such as the Teucrium Corn Fund (AMEX:CORN) which is up more than 40 percent since June. The ETF offers investors unleveraged direct exposure to futures for corn without having to open a futures trading account. The fund is set up in a unique way so as to reduce the effects of contango and backwardation. For specific information on how Teucrium does this using three different futures contracts, please visit Teucrium's website at www.teucrium.com.   This article originally appeared on the Motley Fool Blog Network. Make sure to read all of my articles for the Motley Fool at http://blogs.fool.com/tdalmoe/.

Shale Oil Boom Boosting US Refiners

The shale oil and gas boom in the United States continues to reshape a wide variety of American industries. For some industries, it's a blessing (petrochemicals) while for other industries such as coal, it's a curse.

Another sector being affected greatly by the shale boom is the US oil refining industry. The good news here is that the effect looks to be a positive one. Many US refineries, particularly on the East Coast, were on the precipice of being relegated to the dustbin of history. But now shale oil from places like Texas and North Dakota may change their outlook and save them from oblivion. North Dakota has now overtaken Alaska to become the United States' second-biggest producer of oil, trailing only Texas, with an output of about 575,500 barrels of oil per day.

This boom in oil production has led to wide discrepancy between the prices of domestically produced oil and imported crude oils, giving a lifeline to refiners who could not survive paying for expensive ($100+ a barrel) oil, especially in the light of flat US gasoline demand. In fact, according to data from Reuters, the discrepancy is about $35 a barrel between Brent crude oil and that from North Dakota.

But with so much cheap shale oil coming from the Bakken in North Dakota, the amount of oil produced has exceeded the capacity of the pipelines carrying oil to east coast refineries and elsewhere. So refining companies have turned to other solutions.....

Some firms have begun to place large purchase orders for rail cars in order to ship the oil from North Dakota to their refineries. The recent spinoff from Conoco, Phillips 66 (NYSE: PSX), has ordered 2,000 rail cars (at a cost of $200 million) in order to carry up to 120,000 barrels of oil per day to refineries on both coasts. And Phillips 66 is far from alone in shipping Midwest oil to its refineries on either coast.

Another refiner, Tesoro (NYSE: TSO), initiated a $60 million rail shipping project last year capable of moving 30,000 barrels of oil a day from the Bakken to its west coast refineries. And beginning late last year, Sunoco (NYSE: SUN) has been railing about 20,000 barrels of oil per day to Albany, New York and then barged down to Philadelphia where it has a refinery. Of course, this is a drop in a bucket when one considers that Sunoco imported about 343,000 barrels of international oil a day for its Philadelphia refinery. But it is the beginning of a major trend.

Let's remember too that rail cars are not the only possible solution to refiners' problem of getting access to cheap shale crude. Canadian pipeline company Enbridge (NYSE: ENB) is in talks with Valero Energy (NYSE: VLO) to reverse the flow of a 240,000 barrels of oil (from the Canadian oil sands) per day pipeline to bring the oil to Portland, Maine. From there, the oil would be loaded onto tankers for shipment down the east coast.

The bottom line here is that oil output from US shale oil plays will top 800,000 barrels per day by 2016, according to a forecast by energy consultancy Bentek Energy. That means that the amount of shale oil produced will double over the next four years! The only problem is how to get that cheap, abundant crude to the refiners who so desperately need it to stay in business. After all, crude is 85 percent of the cost of gasoline.

As can be seen here, the refining companies are working on creative ways to get their hands on that crude. This should give hope to the companies and their shareholders. This article was originally written for the Motley Fool Blog Network. Make sure to read my daily articles for the Motley Fool at http://blogs.fool.com/tdalmoe/.