Cosan and Shell move, slowly, closer to creating the third largest ethanol (and from sugar cane not corn) producer in the world
It’s taking quite a while to get this one done. But the joint venture announced in February between Royal Dutch Shell (RDS) and Brazilian sugar and ethanol giant Cosan (CZZ) has finally moved to the signing of binding agreements.
The deal, when completed, would create the third largest ethanol producer in the world with annual production of 440 million gallons and a sales network of 4,500 stations. Estimated annual sales revenue would come to $21 billion.
The deal seems a natural: Combine Brazil’s largest processor of sugar cane (Cosan will contribute its 23 sugar cane mills, all of its co-generation plants, 1,730 retail outlets, and other ethanol assets to the deal) with 2,740 retail stations operated by Europe’s largest oil company. Throw in Shell’s 50% stake in Canadian cellulosic ethanol producer Iogen Energy and its 15% stake in U.S biocatalyst developer Codexis (CDXS) so that the joint venture can stay on top of the next generation in biofuels and you’ve got quite a package.
So why is this taking so long? Money. (What else is new?)
Cosan is transferring $2.8 billion in debt to the joint venture. That’s about $300 million more than in the initial draft agreement announced in the winter. In exchange Cosan has added its cogeneration energy business to the joint venture.
The advantages for Shell are pretty clear. The company gets a huge presence in biofuels at one stroke. Even better that biofuels business uses sugar cane rather than corn so it’s more efficient at producing fuel and doesn’t face any of the obstacles that come with diverting a food crop such as corn to fuel production.
Sell McDonald’s (MCD)
McDonald’s (MCD) has put together an extraordinary 2010—so far. But I’m not as excited about the second half of the year, especially not at current share prices.
On Monday August 9 McDonald’s announced that global comparable store sales climbed 7% in July from July 2009. Sales at restaurants open for 13 months or more rose 5.7% in the United States and 10% in Asia, Africa, and the Middle East.
McDonald’s sales are indeed hitting on all cylinders: the dollar menu, new higher priced menu offers, frozen frappes, and upgraded coffee drinks have all boosted sales since their roll outs.
However, it’s not sales that worry me but margins. In the first half of 2010 McDonald’s benefitted from falling commodity prices for wheat, corn syrup, sugar, beef, chicken and other raw materials. In its last conference call with analysts the company said that it expected commodity prices to continue to decline in the second half of the year but at a reduced rate.
With wheat and other grain prices soaring on drought, wild fires, and grain export bans, I don’t think declining commodity prices are guaranteed in the second half of 2010.
That wouldn’t be a problem except that the stock has become rather expensive given the 13% earnings growth projected by analysts for 2010 or the 8.2% growth rate projected for 2011.
Russia’s ban on wheat exports sets the commodity markets on fire
On August 5, Russia banned grain exports for the rest of the year. Drought has destroyed about 20% of the wheat crop of one of the world’s top wheat exporters. The ban will run from August 15 until December 31. At a minimum.
Wheat prices, already up 70% this summer, climbed again. Wheat was “up” another 8.3% on the Chicago Broad of trade that day.
The ban on Russian exports (Russia exported 21.4 million metric tons of wheat in 2009.) comes on top of prior forecasts for a smaller than expected U.S. corn harvest, and smaller than expected plantings of wheat in Canada due to a wet spring.
Wheat farmers in the United States, Argentina, and Australia will pick up part of the slack—as well as the benefit of higher prices. The wheat harvests in Canada and the European Union are not forecast to be particularly abundant this year.
But the ban on Russian exports isn’t the end of the story. On August 6 Russian Prime Minister Vladimir Putin fueled the speculation that other countries would also end exports when he said that Kazakhstan and Belarus should join Russia’s ban. Kazakhstan exported 7.5 million tons in the 12 months that ended on June 30 and Belarus shipped 400,000 tons, according to the U.S. Department of Agriculture. Another wheat exporter in the area, Ukraine, could well refuse to follow Russia’s lead because of political tensions between the two countries. But formal ban or not, the drought and wildfires that have devastated Russia’s grain crop are likely to reduce supplies from the Ukraine too. That country exported 9.2 million tons of wheat in the 12 months that ended in June.
Global wheat stockpiles aren’t anywhere near danger levels. The forecast now is for the bad weather and the export bans to cut world wheat stockpiles by 2.5% to 192 million tons, according to the International Grains Council.
But the bans on exports by individual countries have more to do with internal domestic politics than any fear that the world is running out of wheat. Individual countries are trying to head off a surge in food prices that would create a wave of domestic political protest. Peak wheat prices of 13.50 a bushel in February 2008 set off food riots in Egypt, for example. Domestic wheat prices in Russia climbed 19% in the week before the country imposed its export ban.
And the bans have set off a scramble for supply and that has led to the wild surge in wheat and other grain prices on commodity exchanges. For example, Indonesia and Japan, Asia’s two biggest wheat buyers, have started to scour the markets for alternative supplies from the United States, Australia, and Argentina
That has created a psychology of shortage among global commodity traders who are now seeing commodity disasters everywhere. For example on Wednesday August 4 agricultural stocks led the Shanghai Composite Index to a 0.4% gain on speculation that recent floods will lead to a decline in the rice harvest—and higher rice prices. Chinese vice premier Hui Liangyu called on local authorities to increase rice planting after foods damaged more than 7 million hectares of farmland, according to the Xinhua News Agency on August 4.
It’s important to recognize two things about a commodity price surge like this.
Update Potash of Saskatchewan (POT)
Listening to the Potash of Saskatchewan (POT) conference call today, July 29, I kept thinking that some one was going to yell, “Cue the plague of locusts.”
In Russia grain production will fall by 20% because of drought, the company said. Canadian wheat production is forecast to be down 20% because of flooding during planting season. In India, after a string of bad harvests from insufficient monsoon rains, too much rain is rotting crops in storage.
The company forecast that China will have to import about 75% of its soybean needs in 2010 and 1.7 million tons of corn. India could hit record levels of grain imports.
Food commodity prices are likely to rise as 2010 goes on and next year, so farmers in countries such as Brazil and the United States that did have good harvests to export should have plenty of cash to increase purchases of fertilizer.
That will make 2010-2011 a tight year for fertilizer supplies.
A disappointing corn forecast and rising demand from China add up for ag stocks
It may seem counter-intuitive but bad news on corn supply is usually good news for the stocks of companies that sell stuff to farmers. The dynamic works like this: lower supply means higher prices for the crops that farmers do harvest and that means they’ll have more profit to spend on things like tractors, seed, and fertilizer. If demand is growing as supply is falling, the dynamic can get supercharged.
And that’s what’s happening right now. On July 9, the U.S Department of Agriculture reported that farmers had planted less corn because of excess and untimely rains at the same time as demand, especially from China, is climbing.
The result is that U.S. corn inventories are projected to fall 7% by August 2011.
