Views on future world biofuel production are increasingly mixed – despite bright growth prospects – as the link between mounting fuel and food prices once again comes under closer scrutiny, said Standard & Poor's Ratings Services in a report 'Global Ethanol Production: Rising Output, High Capital Spending, Uncertain Earnings' published today on RatingsDirect.
"The increasing correlation between fuel and food prices that are moving ever higher has thrown the debate on biofuels' sustainability into the spotlight," said Standard & Poor's credit analyst Michael Seewald.
At the same time, biofuels, and especially the mainly grain- or sugar-based gasoline additive ethanol, have become a preferred way to diversify for global agricommodity companies. Since 2000, rising and volatile fossil fuel prices and the call for renewable energy sources as a remedy to carbon emissions have triggered widespread government support to extend biofuel production.
According to International Energy Agency estimates, global biofuel production capacity will have doubled by 2012, versus 2006 levels. The US, Brazil, and Europe are the top three producers worldwide, with respective market shares of roughly 40%, 30%, and 10%.
"The credit outlook for ethanol producers varies across regions and business models, according the local production environment," said Seewald. "Where ethanol production is just one diversification source for large agribusiness processors, the rating impact tends to be neutral to negative. Smaller pure-play ethanol producers, however, face high business and financial risks due to the volatile dynamics in this market."
Political event risk could become a risk factor for the industry, if the food versus fuel debate sways currently positive public opinion.
Brazil's sugar cane-based ethanol has retained its competitive advantages so far. This edge could widen in a scenario where sugar prices move up on increasing world market demand, improving Brazilian sugar and ethanol producers' ability to increase their feedstock but especially their profitability. Meanwhile, Europe's wheat- and sugar-beet based production is still in its infancy. Whether the European biofuel market will confront issues of overcapacity resembling those in the US remains to be seen.
High input prices and the first signs of decreasing political support have escalated the investment risk for agricommodity companies that have diversified into biofuel production. Agribusiness companies carry inherently higher-risk business profiles compared with those in other consumer goods sectors, due to their commodity orientation and resulting earnings volatility. In addition, building biofuel production capacity is capital intensive and typically entails long start-up periods. This spending temporarily weighs on companies' indebtedness, financial flexibility, and free cash flow generation
