Bill Gates’ Ethanol Losses

About the same time I was warning last year of an ethanol bubble, Bill Gates was sinking money into Pacific Ethanol (PEIX). In the same essay in which I warned of the bubble, I took a look at Pacific Ethanol, and concluded that the underlying fundamentals of the stock – even with the ethanol mandate – were not good.

Since that time, Pacific Ethanol has fallen from $22.54 down to today’s value of $9.97. Given that Gates’ purchase price was $16.00 a share – and the stock ran up to ultimately around $40 before collapsing – it looked like a shrewd move for a while. And I lost count of how many people – when arguing with me about ethanol – pointed out that Bill Gates and Vinod Khosla were investing in it, and that was good enough for them. After all, who did I think I was to contradict a couple of billionaires on their vision of the future? (Of course, one billionaire – Mark Cuban – did listen).

But the fundamentals were not there. I believe that Gates finds himself in this position – and I don’t believe he has seen the last of his (long-term) losses in this stock – because he had to rely on others to give him direction in his case. He was outside his area of expertise. And while people seem to automatically assume that Bill Gates’ genius in the computer industry somehow translates across other industries, this is not the case. I have said the same about Vinod Khosla – expertise in one area does not transfer to a completely different industry, so you better take his ethanol claims with a very large dose of salt. I believe that he will ultimately lose out in a very big way with his ethanol investments. He may sell into some hype and make a bit of money now, but if he stays in for the long haul he will not fare very well.

Continuing on this theme, today several ethanol stocks, including Pacific Ethanol, were downgraded by a major brokerage firm:

Ahead of the Bell: Ethanol Downgraded

NEW YORK (Associated Press) – A Friedman Billings Ramsey analyst downgraded three ethanol producers Thursday, slashing his price targets and predicting the industry’s “growing pains” will continue due to small profit margins and oversupply.

Ethanol production margins have dropped to 15 cents per gallon from 75 cents in mid-May, said Eitan Bernstein, as the price of ethanol has dropped. He said prices will stay low through 2008, and reduced his ethanol price estimates for 2007 to 2010.

Bernstein cut his rating on Aventine Renewable Energy Holdings Inc. to “Underperform” from “Outperform,” reducing his price target to $9 per share from $24. The stock closed at $11.68 Wednesday. He downgraded VeraSun Energy Corp. stock to “Market Perform” from “Outperform,” halving his price target to $12 from $24. The stock finished at $12.02 on Wednesday, and was unchanged in premarket trading. The analyst now rates shares of Pacific Ethanol Inc. “Underperform,” down from “Market Perform.” He cut his price target to $8 from $15. Shares ended Wednesday trading at $11.17.

Bernstein’s downgrades come a day after Aventine President and Chief Executive Ronald Miller addressed investors at a Bank of America conference. Miller said the industry is in a very difficult time due to declining margins, and expects conditions to stay hard until 2009.

Shouldn’t that downgrade have come before the stock price crashed? Of course if you have read this blog for long, you know that I have been warning about this for a long time. Here was a warning I gave 6 months ago:

When a commodity has such incredibly low barriers to entry, it is only a matter of time before capacity is overbuilt and the price crashes. That’s why I expect ethanol producers to continue lobbying congress to increase the amount of mandated ethanol usage and to accelerate the timeline. Otherwise, a lot of ethanol producers will struggle to stay in business in the next few years as their increased demand for corn continues to increase the price, while all the new ethanol capacity is flooding the market. Profit margins will evaporate (although corn farmers should earn a windfall). What we may see is a bail out reminiscent of the Savings and Loan debacle of the 1980’s.

Looks like Wall Street is finally coming around, although a bit too late for many investors. It may not matter much in the end to a billionaire, but it will to the people who tried to emulate them by following their investment strategy.

14 thoughts on “Bill Gates’ Ethanol Losses”

  1. Well, this is why Mr. Gates has money and you don’t. He has something else that you don’t have either – the ability to see into the future. Yes, you were correct (for now) that PEIX was heading down. I bet that more of a guess than anything. Maybe you were one of the millions of Microsoft haters but if you think PEIX or any other ethanol producing company is dying or dead, then you are very very stupid. For those who are selling off your stock of PEIX, thank you very much. Please keep selling it off because I’ll get a better deal when I buy it. Thank you very much.

  2. If I want to know about computers, I will ask Bill Gates. If I want to know about energy, I will ask Robert. One has a good track record in computers. One has a good track record in energy.

  3. Robert – While I’m on board with you on your views on ethanol, Gates and Khosla should be applauded for at least recognizing the challenge and for making investments in this area. [Obviously, they have a lot of money to spread around, so it’s going to go a few places.] These are basically venture capital investments for them; some of their money will disappear entirely, some will return neglible amounts, and a small fraction may quite possibly make them a(nother) fortune. They just don’t know which is which at this point, and neither do we.

  4. This is why RSquared should be re-vamped along investment lines. RR has way valuable info. I actually prefer a purely intellectual take on things, but an investment slant attracts more readers, and possibly income.
    The investment lense allows one to loik at all the same topics, so it is not that muich of a come-down.
    As to Gates, I am not sure he knows that much about computers – he was a great businessman, in a rapidly growing industry. His software is actually mediocre, and usually inferior to Apple.
    But being the best and making the most money are two separate items. In its day, IBM never had the best computers, but it had the best sales, marketing and service. Eventually, things changed.
    RR has made a pretty strong case against ethanol. I hold out hope for the E3 plant, or an easy way to separate ethanol from water (a key problem). RR has hinted there is a cellulosic process afoot that makes sense with waste biobulk.
    I tell you ont hting: I researched jatropha for years, as I considered planting the tree in Thailand. Recently, someone here posted about Chinese Tallow. Now that’s a tree!
    Very good oil yields per hectare, very sturdy and easy to grow tree. No annual tilling etc, very little water needed. It grow anyway all over the South, and it considered invasive (like who cares about kudzu-land anyway?).
    Back f the nevelope guess is that half-million acres provides 2 days US oil consumption, even at current profligate rates. So, we need 80 million acres for total oil needs (but likely our oil consumption could drop to half, with PHEVs and higher oil prices).
    My guess is that 40 million acres and we would be home free forever.

  5. Lose money on PEIX, James?

    I have to agree with Robert. The barriers to entry in the ethanol business are just too low; nobody can gain much of a competitive advantage, which ultimately means poor margins. So James, you may be the one that is very very stupid for not recognizing that. Robert did quote Warren Buffet in one of the linked articles, and he recognizes that. Maybe James thinks Buffet is stupid.

  6. there must be two sides to make a market–buyer/seller.

    when dealing with a commodity, it’s always best to have limited supply[a good protective moat], lowest cost production, and a rapid consumption base.

    i don’t believe ethanol[corn] meets these criteria.

    cellulosic has yet to show reasonable business case to justify this analyses.

    i wouldn’t enter either arena.

  7. Tanner said: “The barriers to entry in the ethanol business are just too low; nobody can gain much of a competitive advantage, which ultimately means poor margins.”

    You’ve got that right Tanner.

    Any smooth talker who can get 70-80 farmers to throw $100,000 into the pot can form a co-operative and build a corn ethanol plant.

    The early ones could be very profitable — not because of the great economics or thermodynamics of corn ethanol — but by taking advantage of the mandates, subsidies, tax credits, and protective tariffs Congress and state assemblies have thrown towards corn farmers and ethanol plants.

    But the market is quickly becoming saturated and all those co-op ethanol plants now have to compete for the natural gas and corn they need as foodstock, plus figure out what to do with all those co-products.

    The only real way now to profit is to come up with a proprietary process that changes the thermodynamics of ethanol (that will be tough since thermodynamics are natural laws), or somehow increases efficiency.

    The old model of being able to profit by simply grinding the corn, fermenting it, and then distilling it several times, is just about dead — unless Corn Belt politicos keep increasing the subsidies and other regulatory mechanisms necesary to make corn ethanol profitable.

    But, always remember: One man’s subsidy, is another man’s tax.


    Gary Dikkers

  8. Some very nice and intelligent comments here. I do not think Buffett is stupid, actually, if I am him right now, I have a BIG smile on my face and if he were to be interested in Ethanol, he’d be getting ready to cash in on this fire-sale that ethanol stocks are having right now. Because Mr. Buffett would be buying this stock looking 15 years into the future when this stock blooms. It’s like buying oil stock in the early 1900’s, I’m sure many people road the roller coaster then too and the ones that held on are now very wealthy. I am also sure if Mr. Buffet were to read my post that he’d completely agree with what I am thinking. Good luck to those of you that don’t agree.

  9. James, there is a reason for the fire sale. There is a fire. Buffet won’t be buying any ethanol stocks at all, even at these prices, if you read what he had to say. There are too many people jumping into the business, and that’s going to hurt margins. The fact that it is so easy to get into the business makes it a longterm poor investment prospect.

  10. Okay, Anonymous, so if you can tell that Ethanol is never going to turn a profit, maybe you’d like to share with the rest of us what you think will? Believe me, I thank you for saying how bad ethanol is and how it’s not a good investment. I am sure a lot of people reading this will either sell what they own or never buy into it. At least, I will get the stock at cheaper prices thus increasing the value of my portfolio in 10 to 15 years. So I’m with you for spreading the bad news about ethanol, even though, I don’t believe it myself.

  11. James, if your financial acumen is as impressive as your reading comprehension ans grammer, I say good luck in 10 to 15 years. You’re going to need it.

  12. I think we are getting confused here.

    Bill Gates’ fund manager invests money on his behalf. Gates doesn’t control every investment decision made on his behalf.

    Gates would be the first to say that he concentrates on his main areas of business, Microsoft and the charitable giving of the Gates Foundation, and lets others get on with running the money.


  13. You can always tell when a person in an argument has an empty tank – they start attacking off the subject things like grammar. FYI, I do not own one share of PEIX yet, but I will very soon.

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