How will devastating Midwestern flooding affect ethanol in the United States?

Farmers were already quietly suffering from a crisis. Falling incomes, rising debt and falling land values ​​have ravaged America’s Corn Belt in recent years without making headlines. Then came the devastating floods of mid-March.

Early estimates of livestock and crop losses in Nebraska alone exceed $ 1 billion. Some state farmers are feeding stranded cattle by boat, while the Nebraska National Guard has resorted to pushing hay bales out of helicopters. Cattle are not the only assets in the agricultural value chain that are blocked.

A number of ethanol production facilities have ceased operations after nearby rail lines were submerged. Idling could have national consequences, as Nebraska and Iowa alone account for 40% of the country’s total production. This guarantees shareholders of ethanol producers such as Archer Daniels Midland (NYSE: ADM), Valero Energy (NYSE: VLO), and Green plains (NASDAQ: GPRE) will need to prepare for an impact on the results of the first quarter – and possibly the entire year – 2019.

Image source: Getty Images.

A complicated situation

A first report from Reuters estimates that 13% of ethanol production capacity in the United States has been decommissioned as a result of flooding that cut rail lines. This includes installations that have been completely inactive and those that are operating at reduced throughput. There has been no conclusive word on the direct impact on all of the facilities owned by major Nebraska and Iowa ethanol producers, but each has a significant presence in the states based on one million gallons per year (mmg / year) capacity:

Metric

Archer Daniels Midland

Valero Energy

Green plains

Nebraska and Iowa ethanol facilities, annual capacity

5 installations, 1,191 mmg / year

6 establishments, 789 mmg / year

7 establishments, 539 mmg / year

Percentage of the company’s total ethanol production

70%

46%

49%

Data source: Renewable Fuels Association.

It is important to consider that Archer Daniels Midland and Valero Energy are much more sheltered from the volatility of the ethanol market than Green Plains, due to their primary agricultural processing and petroleum refining activities, respectively. The agricultural titan generated less than 6% of total revenue and less than 2% of total ethanol operating income in 2018, although larger parts of its business are also affected by the floods. Valero relied on ethanol for about 3% of its total sales and operating profit last year.

Meanwhile, Green Plains is completely dependent on the ethanol value chain, including sales of fuel, feed and other agricultural by-products. Although she owns 355,000 head of cattle in her burgeoning feedlot business, operations are confined to Texas, Kansas and Colorado, so they are immune to recent flooding.

The company’s ethanol logistics partnership may not be so lucky. Green Plains Partners LP (NASDAQ: GPP) works like the ethanol equivalent of a mid-size oil and gas company. It generates royalty-based revenue from the volume of ethanol delivered through its network, not the price of ethanol. While this business model has protected it from falling ethanol prices in recent years, it does not mitigate the risk of natural disasters.

Indeed, although the contracts with the parent provide minimum annual volume commitments, they also include force majeure clauses which mention flooding as an acceptable trigger. Investors will need to closely monitor the recent flooding situation in the Midwest and await updates from management at the Green Plains Partnership. Since the partnership generated 56% of Green Plains operating revenue, shareholders of the parent company will also need to remain vigilant.

Check out the latest earnings call transcripts for Archer Daniels Midland, Valero Energy, and Green plains.

An aerial view of a cornfield.

Image source: Getty Images.

Analysts expect it to take several weeks to assess the full impact of the initial supply disruption, but submerged rail tracks are just a source of uncertainty for the ethanol industry . The devastating floods in the Midwest are also expected to impact the supply of raw agricultural ingredients to ethanol plants for months to come.

There are numerous reports that grain stored by farmers awaiting higher sale prices is now completely unusable after being exposed to flood water. This will affect the national inventory. Then there is the potential impact on this year’s corn crop. A wetter than normal start to the year had already made a late planting likely, but it’s now possible that croplands in Nebraska and Iowa will be wetter than expected. This increases the risk of pests in the coming year, which could impact planting density and yield. Everything points to higher crop prices, which could increase input costs for ethanol manufacturers.

A red tractor in a field with dark clouds above.

Image source: Getty Images.

Ethanol investors will hear about flooding all year round

When the major ethanol producers release their operating results for the first quarter of 2019, they will be spending a lot of time explaining the impact of the flooding. This will likely include lost production time due to submerged rail tracks, as well as the effects on raw material costs. Valero Energy will likely be the least affected, while flooding could have a significant negative impact on Archer Daniels Midland and Green Plains’ plans for 2019.

Thinking long term, there could be a silver lining to flooding. US agriculture and ethanol have suffered from over-supply and over-inventory in recent years. This doesn’t make the initial financial impact any less devastating, but reduced production in 2019 for corn and ethanol could have the effect of increasing prices in the future. There may be a lot of unanswered questions now, but investors can count on flooding the Midwest for the foreseeable future.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.