What the Upholding of the Renewable Fuel Standard Will Mean for Businesses
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90 percent of the United States' total gasoline pool consists of ethanol-blended gasoline, according to Bloomberg. Ethanol production itself is projected to take away up to 42 percent of this year’s corn crop. Michal Rosenoer, a biofuels expert who works for the environmental group Friends of the Earth, commented on the situation to the New York Times, stating:
“If the worst U.S. drought in more than 50 years and skyrocketing food prices are not enough to make the E.P.A. act, it falls to Congress to provide relief from our senseless federal support for corn ethanol.”
Rosenoer is referencing the standards enacted during the George W. Bush administration that requires production of millions of gallons of ethanol to mix with gasoline each year. Many ethanol makers are losing money due to the ethanol requirements and hoped for a suspension of the regulation, but to no avail. The EPA recently declined requests by businesses and states to release the shackles of required production. Now that we know ethanol is here to stay, how will it translate to the market?
Valero (NYSE: VLO) for example recently closed 3 of its ethanol plants temporarily, with another 3 out of its 10 ethanol plants operating under reduced capacity. A spokesman for Valero elaborated that, "Corn prices have gone up and ethanol margins have gone down. Corn basis levels are high." Shrinking margins due to ethanol and corn prices has, and will most likely now continue to, cause plant shutdowns and reduced operations for the company. Many other producers of energy, especially those heavily concentrated on ethanol, are also feeling the pain due to lower margins.
Food Producers and Suppliers:
The drought this year has added fuel to the fire. Corn prices have been rising ever since 2007, when the Renewable Fuel Standard was enacted to require that ethanol was to be produced and integrated into gasoline. In fact, corn prices have jumped a total of 21% over the last six years.
High corn prices significantly effect soda companies, such as Coca-Cola and Pepsi directly, because they rely heavily on high fructose corn syrup as a sweetener. The same goes for companies that sell sweeteners that are corn-based, such as Sysco. High corn prices also effect fast-food companies like McDonald’s (NYSE: MCD) who serve many menu items that are made with corn-fed animals. This may be part of the reason why the company is shifting towards more chicken-centric items, because it is cheaper to feed chickens then cows- especially when the price to feed the animals is being increased intensively by rising corn prices. Also, rising corn prices due to drought are magnified intensely when an already limited supply of corn is being cut in half to be used in biofuels.
It is no doubt that the occurrence of a terrible drought is primarily to blame for high corn prices, which have caused ethanol plants to shut down and every aspect of the food markets (from fast-food to cola to livestock and cattle) to feel pain and decreased margins. Even without a small crop, however, corn prices will most likely continue to rise as a large portion of corn production will continue to be directed towards biofuels and ethanol production.
For investment purposes, it would be wise to watch corn prices if an investor is holding any securities that have significant exposure to corn. The EPA has dictated that the RFS is here to stay, at least for now. If corn continues its rise higher, one company to play the rise is Monsanto (NYSE: MON). Monsanto is the world's largest seed company, and corn is one of the company’s biggest drivers.
As seen above, the company seems to be a little expensive with a P/E ratio of 22.49, but this ratio is also on the lower side of what it has been historically over the last 5 years. The company also offers an increasing dividend of .375, which equates to a decent annual 1.8% yield.
Jharry1 owns shares of The Coca-Cola Company, McDonald's, and Valero Energy. The Motley Fool owns shares of McDonald's and PepsiCo. Motley Fool newsletter services recommend The Coca-Cola Company, McDonald's, Monsanto Company, PepsiCo, and Sysco . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!