By Ian Gilson, CFA
Pacific Ethanol (NasdaqCM:PEIX) reported its first quarter earnings on May 10, 2012. Due to the seasonal decline in volumes of gasoline sold in California, excess inventory of ethanol statewide and some ethanol pulled into 4Q11 to take advantage of the tax credit, the price of ethanol declined significantly in the start of 2012.. However, the cost of corn, the major raw material, did not decline as farmers held back on selling some of their inventory. Ethanol producers did not reduce production rates and the combined effect of excess production and declining demand continued to have a very negative impact on ethanol prices.
Due to the increase in the USDA forecast of the 2012 corn crop to a new record the price of corn has declined slightly from the highs earlier in the year. However, the USDA is also forecasting an increase in the volume of ethanol produced in the USA, despite a decline in US production of about 10% in the first quarter.
The California Low Carbon initiative that was found to discriminate against out of state ethanol and crude oil has been appealed by the State of California. As such the initiative may be enforced until the appeal is heard.
Refineries are currently blending ethanol into gasoline at below the mandated level and are using their RINs to maintain profitability. In 2013 the E15 (gasoline with 15% ethanol) blend should be introduced into the market and this should have a positive impact on ethanol demand in the second half of 2012.
The excess ethanol inventory continues into the second quarter of 2012. We expect a decline in ethanol production by Pacific Ethanol in the second quarter and then increasing sales for the rest of the year. If the excess ethanol inventory is consumed as E15 is introduced and gasoline consumption increases on a seasonal basis we would expect the company to restart the (currently idled) Madera plant.
Pacific Ethanol will probably continue to increase its ownership New PE Holdco LLC as a low cost way of adding to its owned ethanol capacity.
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