Big Oil Buys Big Ethanol

Some people think that the oil industry is hostile toward the ethanol industry because they consider them a real threat. But I always point out that the oil industry dwarfs the ethanol industry by such a large amount that it could easily buy up all the available assets of the ethanol industry – if they thought there was a good business opportunity.

My speculation has turned into reality as an announcement was just released that major oil refiner Valero is buying up the assets of bankrupt ethanol producer VeraSun:

VeraSun Energy to sell assets to Valero Energy

Ethanol producer VeraSun Energy Corp. said Friday it is selling assets to Valero Energy Corp. for $280 million amid difficult industry conditions and tight credit markets.

The assets include certain VeraSun production facilities in South Dakota, Iowa, Minnesota, and Indiana. The company will sell all production facilities and operations in separate or combined transactions.

“Given current difficult industry conditions and continued constrained credit markets, we believe that commencing a sale process is in the best interest of Company stakeholders,” said Don Endres, VeraSun’s chief executive.

For a pure refiner like Valero, this seems to be a decent fit with their business model. They buy oil and turn it into gasoline. Now they will buy corn and turn it into ethanol which will then be blended into gasoline. Their risk of course is that we see a return to the high commodity prices of last summer, which is what put ethanol producers into such dire straits in the first place.

I don’t expect that this is the last we will see of this. Despite the recent write-downs of assets, the oil industry will continue to generate cash (just not as much). They may be the only viable option for some of these distressed ethanol producers. And I know for a fact that there are companies that are keeping a close eye on some of the other troubled ethanol producers.

16 thoughts on “Big Oil Buys Big Ethanol”

  1. Isn't this just another example of the corrosive effects of mandates & regulations?

    Refiners are under government order to blend ethanol into the gasoline they produce. (Actually, under many different mandates, but that is another story). For a refiner, vertical integration into ethanol supply may make sense — whether or not the production of ethanol is profitable.

    What we will not know until later are the full consequences of diverting limited investment funds from (say) refinery upgrades into purchasing ethanol plants. But we do know that the supply of investment capital is limited.

  2. I pulled the trigger on a boatload os stocks this week. Mostly energy stocks. I’ve been out of the markets for two years,because they sucked so bad,and I’m terrible at trading the short side.

    Anyway,the Baltic Dry Index started rallying last week. It’s up about 40% from its lows. Still down 85% from its highs,but it’s showing life again. Asia and Europe have rallied for the last week. Shipping companies,energy,and financials were all rallying overseas. So I pulled the trigger. I think the markets are telling us the recession will be over in about 6 months.

  3. Maury-
    Sure hope you are right.
    But be wary of oil stocks. I expect global crude oil demand to fall about 10 percent in 2009-10, similar to 1979-82.
    It may take 10 years to get back to 2007 levels of crude oil demand. Or maybe longer.
    And, somewhere in the next two calendar years, I say we hit $10 a barrel. I hope I am wrong. But this recession appears to be deepening rapidly, and globally. Already, there is no place to store oil — and 600k workers just got dumped in USA. In China, there is a threat of social unrest, as migrants return to rural areas from cities.
    All sorts of economic output figs are off by 10-40 percent. This is ugly, a human disaster for many.
    Energy stocks are certainly a better buy than in mid-2007, I guess there are off by half now. But I suspect we see them cut in half again.
    When the cover of Time magazine proclaims the world is glutted with oil for the forseeable future, then buy oil stocks.
    Man, what a world. Some people said we would see $200 oil in 2009, and instead we may see $10 oil.
    The latter sure seems more likely right now.

  4. “Some people said we would see $200 oil in 2009, and instead we may see $10 oil.”

    Isn't the point that we (as a species) are really bad at predicting discontinuities? Black Swans, if you will.

    There are a lot of potential discontinuities in our energy future — very few on them on the bullish side for supplies.

    Mexico descends into political chaos & stops exporting? Chavez starts a civil war in Venezuela, and it stops exporting? Iran has another revolution or an overdose of radiation & stops exporting? Russia decides to start demanding the respect it deserves from the EU, and changes the terms of trade?

    The list goes on & on. And any event like that would result in another 'totally unexpected' discontinuity, with a resulting impact on oil prices.

  5. Low oil prices is just what the world needs right now Benny. Energy stocks should do well even if oil goes lower. Shell and BP were each up close to 3% friday,even when oil was down $2 a barrel. I get dividends of 6.4 and 7.4% respectively,whatever the stock price does. Assuming they don’t cut the div,of course. With the wider crack spreads of late,the oil giants will be just fine. I could stay in cash and earn that whopping 1% interest,but that’s getting kind of old.

  6. One interesting stock I got is ATN,with a 16% dividend. The interesting part is the drilling they’re doing in Marcellus. They claim to have pioneered a technique that goes double horizontal with up to 8 fractures. They haven’t used it in Marcellus yet,because a vertical bit with one or two fractures is hitting paydirt. Thars a heap of oil in that shale too. And one day we’ll have the technology to get it out cheaply enough.

  7. Maury-
    I like the divvie on oil stocks. Just wondering if oil stocks will be cheaper in a year.
    Kinu: Right. Making predictions is hard, especially abut the future. However, the screw has turned. Oil thugs need money now, and can’t get it by cutting production. They will have to pump more to make more. Of course, maybe the thugs don’t care. They still have food on the table, even if whole populations do poorly.

  8. Maury,

    I’d be careful with those resource plays. I was at the North American Prospect Expo last week, and saw loads of operators selling interest in plays like the Marcellus, Barnett, and Bakken. Good long term potential, but for now my sense is that costs are too high and people are dropping out. As an indicator, North Dakota (Bakken) rig count has dropped from 80 to 68 in the last quarter, and I’ll bet we see further drops as contracts expire.

  9. armchair, NG has a much higher depletion rate,especially in shale areas. Something like 30% annually I believe. At least initially. Restoring equilibrium in the NG market is much easier than with oil. 95% of American supplies are produced in the US. Still,I’m not worried if NG goes lower. ATN and CHK hedged much of their production for the next few years. ATN gets between 8 and $9 MCF until 2011 or so. I forget what CHK hedged at,but it’s almost double the spot rate too.

  10. I wonder what Benny’s view on gas is. Qatar is sitting on a QCF (that’s right, 1000 TCF) in the North Field and expanding LNG exports aggressively. They’re now the world’s #1 LNG exporter. 1 QCF. That a lot of gas to sell.

  11. armchair-
    I am flattered anyone would ask, but I don’t have a good feel for gas markets.
    But you know commodities…sustained high prices seem to inevitably to lead to gluts…..

  12. I don’t think this is the right time to be buying stocks. The bears haven’t capitulated yet. They’re getting there, but until they’re crying into their cheerios this isn’t over.

    Furthermore, since this recession is credit/real estate driven, look at a chart of mortgage resets. Subprime has already peaked but some of the higher priced exotic stuff doesn’t peak until 2011. Google “credit suisse mortgage reset chart”.

  13. Robert McCleod, this recession was kicked off by high fuel and food prices,then was exacerbated by the housing crisis,the bankruptcy of Lehman and the resulting credit crisis. The crazy food and fuel prices are at more reasonable levels today. Foreclosures seem to have peaked,at least for now. And credit markets are unthawing. To top it off,governments around the world are priming the pump with trillions of dollars.

    Markets could still capitulate,or they might do somersaults. Nobody can know short term. But,conditions are there for growth and I’ve locked in some awesome dividend rates. I bought what I could with cash,then doubled down on margin. I intend to leverage that margin all the way up. I’m pretty good at riding bulls,but I’m terrible in a bear market. I can’t bring myself to short a good company that’s valued at half what it should be,even knowing it’ll probably be chopped in half again…..LOL.

  14. Oil companies are first and foremost ENERGY AND FUEL companies.

    If they see ethanol as profitable, they will jump into the business.

  15. I have to agree with Maury. While the oil and gas commodity trade continues to be uncertain, the producers with good balance sheets and significant reserves are now selling at once-in-a-lifetime discounts. In some cases it's possible to buy long term oil reserves for under $2/barrel.

    A wave of M&A will be next, such as Robert wrote about with the recent acquisition of VeraSun's assets by Valero. Larger, better capitalized companies can now scoop up smaller companies' reserves for pennies on the dollar.

    (Robert, if you don't mind my making a plug here…)

    Investors interested in opportunities in the oil patch may want to attend The Oil and Investment Summit, March 17th in New York City where I will be moderating a panel of oil investment experts including Matthew Simmons, Robert Hirsch and others.

  16. Maury-
    From CNN 12/08
    By Joe Sterling

    (CNN) — It’s a bittersweet Christmas season for Joseph Kassab, who grew up in Iraq under Saddam Hussein’s Baathist regime and now lives in Detroit, Michigan. Tempering the season’s joy is his concern for fellow Iraqi Christians, who have endured killings, displacement and daily intimidation.

    An Iraqi policeman checks security in a Baghdad church where midnight Mass will be celebrated Wednesday.

    1 of 3 Christians in Iraq face a “bleak future,” said Kassab, executive director of the Chaldean Federation of America, a nonprofit group that helps Iraqi Christians.

    “We are heading for a demise,” he said. “It’s getting to the point where it might be an ethnic cleansing in the future.”

    A recent U.S. government report focused on the plight of Iraq’s Christian minority. U.S. diplomats and legislators are worried, too.

    “I think the Christians are caught in the middle of a horrible situation,” said U.S. Rep. Anna Eshoo, a California Democrat of Assyrian and Armenian ancestry.

    She said Iraqi Christians are suffering as a result of “religious cleansing,” and she has urged more help for minorities who have fled their homes in Iraq.”

    Maury- It is one of the great oddities that we Americans (a secular, Judeo-Christian nation)established a Shiite, Islamic government in Iraq, not a secular government. I never understod that. And Maliki is best buds with Ahmendinijad, just look up stuff on the Web.

    We spent $1 trillion to accomplish that. And now Iraq is giving the best oil contracts to commie China.

    I just don’t understand it, or why anyone regards this as a victory, even by realpolitik standards.

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