Potash overview: Expanding on indicators driving stocks like POT

Part 4
Potash overview: Expanding on indicators driving stocks like POT (Part 4 of 13)

Why the ethanol-to-corn price ratio is the highest since 2007

Corn and ethanol prices

If the relationship between the energy market has strengthened, would ethanol prices be a good predictor of corn prices? Ethanol prices have seen a pretty large rally over the last few weeks, jumping from just $1.75 a gallon to ~$2.80 a gallon. This is a reversal from last year, when ethanol prices fell as expectations of record corn output sent corn prices down from around $8.00 a bushel to ~$4.50 per bushel.

Why the ethanol-to-corn price ratio is the highest since 2007Enlarge Graph

Production cuts push ethanol

We can largely attribute the 50%-plus rally we’ve seen in ethanol to weather. As one of the worst winters hit the United States, snowstorms have caused rail shipment capacity to fall. Consequently, ethanol producers decided to cut production, which drove prices higher. Most ethanol is produced in the Corn Belt, but it’s mostly consumed on the East Coast. According to a Wall Street Journal article, capacity for ethanol shipments also fell, as some trains were diverted to carry more lucrative goods such as crude oil.

Energy and Agriculture Price RatioEnlarge Graph

Ethanol prices are unlikely to rise more

As the winter comes to an end, ethanol prices will likely come down as production resumes—although several analysts say this could take a while. Further upside for ethanol is unlikely, since gasoline prices have historically set the cap for ethanol prices. On March 21, the price ratio between gasoline and ethanol stood at a low of 1.25.

So although corn and ethanol prices have historically followed each other closely, and ethanol prices have risen, production cuts could have resulted in lower demand for corn. However, if ethanol production rises over the year—and the EIA (Energy Information Agency) recently increased its forecast for ethanol production by 2,000 to 910,000 barrels a day for 2014—corn prices and the PowerShares DB Agriculture Fund ETF (DBA) should benefit.

This in turn would be positive for fertilizer stocks such as Potash Corp. (POT), Mosaic Co. (MOS), Intrepid Potash Inc. (IPI), and the Market Vectors Agribusiness ETF (MOO) as farmers plant more than expected. In 2013, the U.S. produced an average of 875,000 barrels a day.

The Realist Discussions