My weekly column for AltEnergyStocks again doubles as part of my study for the second CFA(R) exam. The Equity valuation part of the curriculum contains a chapter by Michael Porter on analyzing competitive pressures in an industry. I decided to apply it to the corn based Ethanol industry, and, as often is the case, it changed my way of thinking about the industry. I’ve never been bullish, because I worry about a classic commodity squeeze: both ethanol and the main feedstock (corn) are commodities, and are subject to forces outside the industry which effect their prices. For instance, if corn harvests were to be poor because of drought or pests, at the same time that oil prices fell, many ethanol producers would be forced out of business because their costs exceed their selling prices.
I also went on a little rant about the typical measures of Energy Payback and Energy Return on Energy Investment (ERoEI) often used in the industry. These measures are often used to criticize ethanol, but it is a weak criticism, because they do not take into account the time value of energy: namely that a kWh of electricity today is a lot more useful than a kWh produced 30 years from now. We should instead be thinking in terms not only of how much energy we have to use to get energy out, but also in terms of how soon we get that energy.
I propose a couple measures, of Energy Net Present Value (ENPV) and Energy Internal Rate of Return (EIRR) which I think would give us a clearer view of the undying energy economics (and hence the potential economic profitability) of various energy production technologies. But that is a column for another week.
This week, here are my thoughts on competition in the corn Ethanol industry, and how it might affect your investments.