If you are involved in commodities brokerage at any level you would have noticed the recent interest in bio-fuels. Indeed, an entire bio-fuel strategy has emerged. For example, the traders on the front lines of this new area have cash ethanol risk management programs, covering everything from risk-aversion hedging to market research info to technical analysis. It even includes software to link it all to many data platforms with a feature to drop data into Excel spreadsheets for bookkeeping.
Bio-fuels are now serious business.
Many ethanol producers are coming online this year, and they all need risk management services. Crunching the numbers on demand for ethanol and bio-diesel is required and will affect the underlying commodities and traditional energy commodity markets.
The current global demand growth for crude oil is running equivalent to the maximum global production rate. In the middle of this ongoing shortfall, there are overages of corn and sugar to create ethanol to fill the current void that now exists. Like Brazil, we will have to up the level of ethanol to blend in with the existing stocks of gasoline to stretch out existing supplies. These two markets, along with bean oil, are the new energy market.
And this isn’t just a trend in the Western Hemisphere. The spreading so-called “brown cloud” of air pollution in China will have to be dealt with by running cleaner fuel. It is likely that China already has started its own ethanol program. Looking at the sugar purchases China has made in London, it seems China is a big buyer (see “Some sweet tooth,” below). It is just a matter of time before the news hits the wire of the Chinese using ethanol. This will have a great impact on the commodity complex.
Brazil is an important player in the bio-fuels market, and monitoring press releases from San Paulo is as important as keeping tabs on the U.S. Department of Agriculture’s projection for world sugar consumption. Brazil announced last year it was energy self-sufficient by the end of 2005. In Brazil cars run completely on ethanol or gasohol, a fuel blend consisting of 90% ethanol 10% gasoline. Increased bio-fuel consumption has meant that due to driving demands of its motorists at home, Brazil would go to the market a little lighter than planned with its refined world sugar.
The 50-year plan the country laid out to become self sufficient by using renewable resources was completed 18 years early. The only hitch is the need to plant 1 million hectares of new cane, which equates to Brazil being short 2.5 million acres of sugar-producing farmland.
Whereas in the United States we do not have spare crude oil, Brazil comes to the table light and demand for energy in China and India going through the roof. Now is the time to review consumption in the biodiesel market, particularly because the smart money has taken notice.
Microsoft co-founder Paul Allen is backing a large bio-fuel project with venture capitalist Martin Tobias in Seattle. According to Tobias, initial demand for biodiesel is strong. Support for this claim can be seen in the pricing of his vegetable-based product, which is even money with diesel at the pump. Tobias makes money whenever the pump-price of diesel hits $3 per gallon. That’s not a bad bet these days, and it could be the wave of the future.
The idea of a renewable resource is not just good business but it’s good for the environment. As long as diesel and biodiesel stay even in price, Tobias says the people of Seattle are “very hungry” for his renewable resource. Viewing his refinery reveals this is not some home garage setup begging for waste product from a fast food joint. It is a high-tech, modern refinery with large production output as its goal and an eye toward the future. The bio-fuel consumption numbers were 75 million gallons in the United States for 2005 and all numbers point to 150 million gallons of consumption for 2006.
As the applications for bio-fuel expand, that consumption will only increase. According to Tobias, his bio-fuel can run natural gas turbine engines that in turn can be used to create electricity.
What’s better is they can run on bio-fuel with little modification. This is particularly exciting in an era of shortages in natural gas supplies, where we have seen prices shoot up as much as 300%. Now we have the opportunity to use a renewable resource to create electricity for our homes and also create jobs in the United States.
This underpinning of electricity, gasohol and biodiesel should keep moving grain prices along to the upside as crude oil remains in short supply (see “Hooked on crude,” below).
Just what could happen if we get a summer of bad weather? It’s becoming clear that America can’t get enough of the black goo, and the current administration has heard the drum beat. Even Willie Nelson is selling biodiesel (known as Bio-Willie). Consequently, brokers were buying number #11 sugar for clients in the fall of 2005 and sending out additional buy recommendations in October. In early 2006, buys were issued for bean oil.
It should be evident that corn, sugar and bean oil could have a big move higher in the long term, between 2007 and 2008. Consider this statistic: 1.26 billion bushels of corn were used for ethanol in 2004, for 2008 is double that.
The idea that this America’s farmers, with all of their high-tech alternates and genetically modified seeds, will continue to bring in bumper crop after bumper crop is too big of an assumption. Statistically, we have never had four bumper crops in a row and it’s unreasonable to expect that now.
With the weather patterns we have had and the forecasters having to switch to the Greek alphabet to name storms, we might be in the beginning of a new seven-year cycle of bad weather. The drought in Illinois last year could have just been the tip of the iceberg for severe weather in the corn and soybean belt. This year, La Niña is expected to settle in and we could be in for some very nasty weather.
All of these factors could combine to create a strong market. One wild card is if, or when, the bird flu makes its way West, and how severe it will be. A large bird kill could destroy the grain market and the beans would take the brunt of the hit. If they end up dumping meal, the price of biodiesel, made from the bean oil, will be extremely cheap and the only way to trade this will be spread up, short the meal and long the bean oil. The sugar will pull back. Corn will bow to the pressure but won’t be hit as badly as it is mostly used for hogs and cattle.
But if we don’t take the hit from bird-flu, we could have a fantastic market this summer trading the bio-energy markets from the long side.
Pete Thomas is a senior broker and market analyst for RJOFutures, the retail division of
R.J. O’Brien, and has been actively involved in the markets for more than 30 years.