Boom times for two-product strategies?

Can feed markets offer relief for the challenges on the fuel side? The Digest investigates.

The energy industry continues to feel the impact of falling energy prices. In Wednesday’s Top Story, we noted that the industry conversation has shifted from long-term fundamentals to a form of “oil price watching” — not even the short-term fundamentals, but the kind of paralyzed ticker watching, waiting for the bottom, that comes during stock market crashes.

“Barron’s says oil is going to $35bbl,” writes a trusted Digesterati. “The same guy who predicted the 2004 and 2009 lows.”

Well, we haven’t seen the argument made for that low-point — perhaps there’s evidence in the options market — but it’s evidence that we’re seeing ticker-watching.

Besides behavioral change, we’ve seen three types of fallout in the hard data:

a. Layoffs and assets sales announced by major energy companies, including BP, Shell and Chevron.

b. ConocoPhillips just issued its 2015 capital budget of $13.5 billion, “a decrease of approximately 20 percent compared to 2014″. ConocoPhillips notes that the cuts strongly reflect ” the deferral of spending on North American unconventional plays…In 2015, the Lower 48 development program capital will continue to target the Eagle Ford and Bakken, and will defer significant investment in the emerging North American unconventional plays, including the Permian, Niobrara, Montney and Duvernay.”

CEO Ryan Lance said “We are setting our 2015 capital budget at a level that we believe is prudent given the current environment.”

c. Rising gasoline sales. Low prices have stimulated a modest but trackable rise in consumption, despite increases in vehicle fuel economy. EIA said in September that the “short-term forecast of gasoline consumption” has risen to “8.82 million barrels per day (135.2 billion gallons), 0.13 million barrels per day (2 billion gallons) higher than last November’s forecast.”

In the December short term forecast released this week, the 2014 forecast was revised to 8.88 million barrels per day, while actual November consumption rose to 9.04 MBD, up from 8.94 MBD in 2013 and 8.48 MBD in 2012. Overall, gasoline consumption grew 1.9 percent in 2013 and 0.5% in 2014.

The uncertainty in prices going forward.

In Wednesday’s Top Story, we discussed at length the fundamentals driving uncertainty in forward oil prices, but we’ll add here that the EIA, in the December Short-Term Energy Outlook released Tuesday, forecast “$68-per-barrel average Brent crude price in 2015 (and $63 for West Texas Intermediate) while recognizing high price uncertainty,” which you can contrast with:

EIA Forecast from December 2014

a) The $35 Barron’s forecast for the new low; or b) The EIA’s previous forecast of $102 for Brent and $95 for WTI just 3 short months ago, which as of this morning was still proudly displayed on the agency’s website front page.

EIA Forecast from September 2014

We continue to point attention to what we described as a “competition between storylines,” for those who wish to divine the oil price for 2015 at this time.

The opportunities in $60 oil

In looking at the fundamentals driving oil prices (amidst other factors), one of the Digesterati writes this week with a good reminder to focus in on the opportunities that comes with low-priced oil. Namely, in a world where unconventional plays become unprofitable, the opportunities for technologies that make a feed and a fuel product. A friend writes:

I’ve attached an index graphs [comparing the crude oil, soymeal and fish meal price] which makes crude look better than it would be if the data were through November/December 2014 (the data from indexmundi.com stopped at October 2014 at $83/bbl crude oil).

What this helps me see is that, as the price of crude oil / energy further uncouples from the price of fishmeal and soymeal, the opportunity for those companies whose primary products are feed/food/protein is great and getting even better with every dollar reduction in the price for crude oil.  

Soymeal seems to trade in more sympathy with crude oil, even now, but fishmeal hasn’t for some time, as the data indicate to me.

So this obviously plays into the strategies that focus on making Omega-3s and, later, protein/feed the primary product, but with strains that make meaningful volumes of crude oil that can be refined into biofuels.

This strategy, in particular, plays into the algae market — where proteins are aiming to compete with fishmeal. In the case of algae, the opportunity to use algae oil for the biofuels market gives the volume by which an algae operation can reach meaningful economies of scale — omega-3s and other products just can’t make the enterprise big enough to capture the potential rewards seen in the fishmeal market.

Over in the ethanol markets

The same logic applies. Although fuel ethanol prices have dropped fast, in keeping with the overall drop in petroleum prices, we are seeing RIN prices on the rise — as rising gasoline consumption obviously doesn’t square with the kind of production slow-down that low ethanol prices generally result in. At the same time, ethanol producers (and biodiesel producers) have a secondary product (dried distillers grains and glycerine, respectively) to take some of the sting out of low energy prices.

The hard data?

Here’s a chart of commodity prices, contrasting September 10, 2014 with December 10, 2014:

As you can see, a massive drop in gasoline futures, nearly 35 percent. But we don’t see the same fall in ethanol future, which are off, but by a comparatively minor 6 percent. Interestingly, ethanol spot prices are up nearly 7 percent in the same period. Though, in bad news for ethanol producers, corn prices have spiked 14 percent since the fall — though still below $4.

At the same time, some other ethanol fundamentals have modestly improved over the past few months. For one, natural gas prices have dropped 5 percent, making it less expensive to run ethanol plants and in particular to dry out distillers grains. Meanwhile, corn oil and distillers grains spot prices have risen, by 10 and 7 percent, respectively.

A two-product strategy looks pretty good — in fact, overall prices for ethanol producers would be up something around 7 percent in this period — compared to a catastrophic fall in gasoline futures. Challenges in fuel prices can be partly mitigated by prices for co-products.

Note on methodology — state data is averaged but not weighted for DDGs— so, for example, Iowa’s prices are given the same importance that Michigan’s are, which could lift DDG prices a percent or two above a true weighted average. Ethanol, corn oil, corn prices, ethanol futures, natgas futures and RBOB gasoline futures are not affected in this way.

The Bottom Line

Our friend writes:

“It would obviously be good to see crude oil prices higher, but, to the extent that fishmeal soymeal and other protein sources continue their march upward asymmetrically to crude oil, it’s not necessarily a bad thing for the price of crude oil to stay persistently under $100/bbl.  One could still get to energy scale and be competitive with the going price of crude oil (no premium to the market price), and make profits, all without a subsidy.”

A two-product strategy is no guarantee of good times during period of rapidly falling energy prices. But it is a hedge, and a solid one based on the data we’re seeing. And unexpected good news, perhaps, for those watching the falling ticker and the tumble in oil prices.