Don’t Get Trumped in Ethanol
The energy sector has enjoyed a broad-based rally over the past two months. Since the presidential election, the Energy Select Sector SPDR ETF (NYSE: XLE), a proxy for the largest energy companies in the S&P 500, has risen 7%. The S&P Oil & Gas Exploration & Production SPDR ETF (NYSE: XOP), more representative of the small-cap drillers, has rallied 14%.
The Alerian MLP Index (AMZ) accounting for most of the midstream sector’s market capitalization, is up 9.5%. Major refiners like Valero (NYSE: VLO) and Marathon Petroleum (NYSE: MPC) are up 14% and 17% respectively. The fossil fuel supply chain is up across the board, with major natural gas and coal producers rallying as well.
Renewable power producers haven’t fared as well. The Guggenheim Solar ETF (NYSE: TAN) is down nearly 7% since the election, while the First Trust ISE Global Wind Energy Index Fund (NYSE: FAN) has dropped nearly 8%. The fear is that Donald Trump and Congress will pare back support for renewable energy by reducing subsidies or by eliminating rules aimed at phasing out coal from power production.
One renewable fuel sector that is bucking that trend is ethanol producers. While wind and solar power producers have fallen, shares of ethanol suppliers Green Plains (NASDAQ: GPRE), REX American Resources (NYSE: REX) and Pacific Ethanol (NASDAQ: PEIX) have surged by 6%, 18% and 27.5%, respectively.
Why the rally for ethanol producers? They received some good news after the election, when EPA finalized the 2017 quota under the Renewable Fuel Standard (RFS). The announced volumes are 6% above the 2016 quota, and were above the 4% boost that had been previously announced.
However, investors should exercise caution on ethanol stocks given the likely direction of energy policy under President Trump. Here is what I think is going to happen.
There is a lot of bipartisan support for the RFS given its popularity with farmers across the Midwest. Plus, Trump spoke out in favor of the RFS during the campaign. I think it is unlikely that the RFS will be repealed.
However, Trump is surrounded by advisors with ties to the oil and gas industry, and they are going to come down strongly against the RFS as currently written. Further, Trump’s pick to head the EPA — Scott Pruitt — has repeatedly fought against the RFS. As EPA administrator Pruitt would have the authority to invoke a waiver to lower the volume of ethanol that must be blended into the fuel supply — a move he has advocated in the past.
Such a move is likely, in my opinion, and this would have a chilling effect on the ethanol industry while benefiting the refiners penalized under the current rules. As a result, I would urge caution with the ethanol sector in 2017, at least until the policy direction becomes clear. Aggressive investors might even consider shorting the sector given the recent run-up, as the downside seems relatively high given the risks ahead.
As the nation prepares for President Trump, we are busy tweaking our portfolios to benefit from the policy changes we deem likely and, conversely, minimizing the risks. Consider joining us at The Energy Strategist and MLP Profits to make sure your portfolio is properly positioned as well.