Investors await key vote on biofuels

Healthy skepticism toward the ethanol fad is prompting Canadian parliamentarians to take a second look at Bill C-33 — the bill that would set minimum levels of biofuels to be blended with gasoline, diesel and heating oil. Any decision could subsequently affect related commodity prices, which have soared due to biofuel demand over the past 12 months.

Once again scheduled for a vote on Monday, May 26 (and with only three weeks left before summer recess), Bill C-33 originally enjoyed the support of all four parties, but recent public criticism of the biofuel industry prompted an about-face by some members of Parliament and at least two parties (NDP and Bloc Québécois).

“There are two sides to biofuels: social and environmental,” explains Bob Mann, senior product development with Jantzi Research. Yet, no matter what side of the fence a person sits on, the industry is reliant upon regulatory environment. “In Bush’s last State of the Nation address, he indicated that biofuel is one solution to the energy crisis. This was an indication [and the start] of implemented quotas,” explains Mann. “In itself, the [U.S.] government is creating the [domestic] market. Without subsidies or quotas the [biofuel] market would not be viable.”

Considering the reliance biofuels — and their affiliated commodities — have on the regulatory environment, many advisors and portfolio managers are closely watching how the Canadian government will respond to the recent criticism and flagging support for this fledgling industry.

“The single largest risk is if the government changes,” says Mann. “If a new government decides that biofuels are not good, and they take the subsidies of the table, the industry will crash.”

At present, the bill mandates 5% ethanol content in gasoline by 2010 and 2.5% biodiesel content in diesel and home heating fuel by 2012. Yet, in previous debate, many MPs cited recent media reports that condemned the sustainable nature of biofuels.

Articles in Time Magazine, National Geographic and a host of other publications were cited by MPs as evidence that biofuels were not the social and environmental panacea the current government had hoped for when dealing with soaring oil prices and increasing greenhouse gas emissions.

For Mann, the issue is not whether the industry should or should not be supported by government subsidies (which, he admits, is a tenuous way to build a market) but whether investors should consider buying into such a fledgling industry — particularly when the industry is marred with such uncertainty.

“Even if [the industry] does take off, from a strategic sense, as the first movers, the only advantage will be in building partnerships and locking up supply chains,” says Mann. “Even those companies that are able to enter into competitive agreements, like any typical commodities-based industry — there really will be little advantage in being the first.” He cites the steel industry as an example. While Western countries initially produced and nurtured steel production, it was Korea, India and Japan that would build factories with the latest technologies and quickly assume the role of primary steel producers.

Social and environmental factors aside, Mann believes it is “better to wait for an industry to mature and then pick a winner.”

He adds that if advisors and portfolio managers do take a chance on picking emerging companies, they “need to take into account that, while they think they can pick the winner, there will be a shake-out [in this industry].”

Originally published in Advisor’s Edge Report in May 2008