Growing Fuel

The first quarter was a tough quarter for most sectors of the market, including energy stocks. Nonetheless, there were some notable bright spots including agriculture plays leveraged to the explosion in global demand for biofuels. In fact, my plays on the group are up an average of 125 percent since my initial recommendation.

And although these stocks have performed well, I see more outperformance ahead because of two simple drivers: rapidly rising demand for food in the developing world and continued government support for biofuels in developed countries.

In This Issue

In this issue of The Energy Strategist, I’m taking a closer look at the trends that have driven the most recent rally in agriculture- and biofuels-related plays. And I’m adding a new play on burgeoning growth in agriculture in the former Soviet Union.

The long-term trend in biofuel demand is powered by two major trends: increased use of biofuels in the developed world and food upgrading in the developing world. Brazil and the US remain the two predominant sources, thanks to government mandates on increased biofuel use. See Agriculture Boom.

The US is only one of many countries with mandates toward increased biofuel use. The EU is also trying to increase biofuel use, which will likely cause price spikes for agricultural products such as rapeseed, soybean and palm oils. See Biofuel Demand.

As countries become wealthier, their citizens begin to consume more meat products. Although this may not seem relevant to energy, it is; the same food need for biofuels is also need to feed livestock. See Food Upgrading.

As demand begins to increase, supply will obviously be equally important. And supply will be tight, because in much of the developed world, most arable land has already been cultivated. But there are a few areas experiencing continued agricultural growth. See Supply Side.

I developed a biofuels field bet about 18 months ago in order to more safely play the biofuels industry. With the exception of a few hits, the bet has been widely successful. Here’s where it currently stands, as well as information on a new trade. See Playing Biofuels.

Starting this issue, I’ll be providing brief updates on portfolio companies. Here’s the rundown for this issue. See Portfolio Updates.

I’m recommending or reiterating my recommendation in the following stocks:
  • Anglo-Eastern Plantations (UK: AEP, OTC: AEPLF)
  • EOG Resources (NYSE: EOG)
  • Landkom International (UK: LKI)
  • Metabolix (NSDQ: MBLX)
  • MP Evans (UK: MPE, OTC: MPEVF)
  • Nabors Industries (NYSE: NBR)
  • Novozymes (OTC: NVZMY)
  • Sipef (Belgium: SIP, OTC: SSEFF)
  • Syngenta (NYSE: SYT)
  • Uranium One (TSX: UUU)
I’m recommending holding or standing aside in the following stocks:
  • Deutsche Bank Agriculture Fund (AMEX: DBA)
  • Earth Biofuels (OTC: EBOF)
  • Monsanto (NYSE: MON)
  • Mosaic (NYSE: MOS)
  • Potash Corp of Saskatchewan (NYSE: POT)
  • PowerShares Deutsche Bank Agriculture (AMEX: DBA)
  • Rowan Companies (NYSE: RDC)

Agriculture Boom

The biofuels field bet has been among the most successful long-term plays in TES, showing an average gain of 125 percent since the inception of the play in the Sept. 20, 2006, issue, Fueled by Food. More recently, I offered a detailed update of my rationale for recommending these stocks in the Sept. 19, 2007, issue, Down on the Farm.

For those unfamiliar with my field bet concept, it’s designed to be a diversified mini-portfolio aimed at playing major multiyear trends in the energy markets. Instead of recommending just one or two high-risk plays, I offer a list of five to 10 specific picks in each sector. I recommend that subscribers place a small amount of capital in each stock.

Although each pick may be risky on its own, as a whole, the list offers a safer, more-diversified play. This general strategy has paid off handsomely for us in the past.

For example, within the biofuels recommendations, the overall field bet is up sharply thanks to a handful of stocks that have gained more than 200 percent. These big winners have more than balanced out the two notable laggards in the field bet. I offer specifics of this field bet and an update on its performance toward the end of today’s report.

My long-term bullish outlook for the agricultural sector and biofuels demand is largely unchanged since last September. Of course, long-term fundamentals don’t always equal near-term performance, particularly during periods of stock market turmoil. However, in this case, what’s particularly impressive is just how handily these plays have outperformed the broader market averages since the Sept. 19 update. See the chart “Biofuels Filed Bet” for a closer look.

Source: Bloomberg, TES

To create the biofuels field bet index line in this chart, I simply created an equal-weighted index of all recommendations in the portfolio. In other words, the recommendations aren’t weighted by company size or price; all index components count equally.

As you can see, the field bet has held up remarkably well in the midst of an extraordinarily volatile, downward-trending broader market.

In previous discussions of the global agriculture industry, I’ve focused mainly on the long-term trends in demand. Those factors remain bullish, powered by two major trends: increased use of biofuels in the developed world and food upgrading in the developing world.

Biofuels is a catchall term used to describe any fuel made from agricultural products. The two main biofuels at use in the world today are ethanol and biodiesel.

Ethanol is an alcohol that can be blended with gasoline or used as a gasoline substitute. Almost all modern cars are capable of handling ethanol blended up to 10 to 15 percent with conventional gasoline; some cars known as flex-fuel vehicles can handle any mix up to 100 percent ethanol.

Ethanol is made primarily from corn in the US and sugar in Brazil. The US remains the world’s most important market, thanks primarily to government mandates requiring greater used of ethanol over time.

Brazil is another major market for ethanol because of a longstanding policy to promote the use of flex-fuel cars. In addition, sugarcane is a cheaper, more efficient feedstock for ethanol plants than corn; Brazil’s long growing season and ideal sugarcane-growing climate allow greater yields of ethanol per acre of land.

Ethanol has a large percentage share of the Brazilian market, although the Brazilian gasoline market is clearly much smaller than that of the US. And although Brazilian exports of ethanol to the US have been rising in recent years, there’s a limit to the growth potential because the US imposes significant per-gallon tariffs on ethanol imports.

Biodiesel is a diesel-like fuel made from oils such as soybean and palm. Biodiesel is the primary biofuel used in the European Union (EU), accounting for two-thirds of EU biofuel use.

As in the US, biofuels demand in Europe is supported by government regulations designed to encourage greater use. Biodiesel is made primarily from rapeseed oil (basically canola oil) in the EU, though palm oil is becoming an increasingly important biodiesel commodity. The EU imports palm oil-derived diesel main from Malaysia and Indonesia, the world’s major palm oil producers.

Back to In This Issue

Biofuel Demand

The first push for ethanol demand in the US came from the phase-out of a key fuel additive, methyl tert-butyl ether (MTBE). MTBE had been added to fuel for many years as an oxygenate. This means the additive reduces the output of carbon monoxide from cars and trucks. MTBE is also an octane booster; it helps reduce engine knocking and other performance issues.

The problem with MTBE is that it can pollute groundwater supplies and is thought to be a carcinogen. Therefore, the US government effectively banned MTBE as a fuel additive.

One of the only economical substitutes is ethanol. Because ethanol is among the only MTBE alternatives available in large quantities, it’s effectively replaced MTBE.

But ethanol demand is now powered by far more than simple MTBE replacement. The US has also enacted several direct ethanol mandates in recent years, the most recent being The Energy Independence and Security Act of 2007, signed into law on Dec. 19, 2007. The 2007 act replaced and extended renewable fuel mandates already in place from a similar law enacted in 2005.

The 2005 act required that the US use some 7.5 billion gallons of ethanol by 2012; for reference, in 2007 the US consumed some 6 billion gallons of the fuel. The new bill more than doubles the total mandate to 15.2 billion gallons by 2012. In addition, the new renewable fuel standard extends the mandates for another 10 years, requiring that the nation boost biofuels consumption to 36 billion gallons by 2022.

Apart from just increasing the standard, there are other key provisions of the new mandate. Out of the 36 billion gallons of biofuel use required in 2022, 21 billion gallons must come from advanced biofuels. The term advanced biofuels refers to ethanol (or biodiesel) derived from sources other than cornstarch. The leading form of advanced biofuel in the US is cellulosic ethanol, which is derived from products such as corn stalk waste or a prolific prairie grass known as switchgrass.

The problem with cellulosic ethanol is that producing biofuels from such woody materials is more expensive and technically complex than producing the alcohol from corn. Although current technology certainly makes it possible, meeting this mandate for advanced biofuels would be difficult at this time. There are provisions of the bill designed to allow for delays or temporary suspensions of the advanced biofuels segment if they prove unworkable.

But leaving aside these complications for a moment, two facts are clear from the 2007 energy bill: It will drive a significant increase in corn demand compared to the 2005 act and encourage development of advanced biofuels at least to some degree. Although I do recommend one play on the growth of cellulosic ethanol in my field bet—see the Novozymes writeup below—the trend toward greater corn demand is more immediately playable from an investor’s perspective. Consider the chart “US Corn Consumption.”

Source: US Dept of Agriculture

This chart uses historical data for the 2006-07 corn planting season and US Dept of Agriculture (USDA) estimates for future consumption. These estimates are taken from USDA’s long-term projections published in February.  

Note that, of the 10.25 billion bushels of corn consumed in the 2007-08 corn season, 3.2 billion were used in ethanol production. More than a third of all corn used in the US is directed toward ethanol production—a staggering figure. And that trend is expected to continue in future years because ethanol production is the fastest-growing use for corn. Consider that by 2017-18 total US corn consumption will grow to more than 12.22 billion bushels and ethanol will account for more than 40 percent of that demand.

But there’s a problem with the figures depicted in the chart above. Although the USDA long-term projections were published in February 2008, the estimates were based on data finalized in late 2007, before the Energy Independence Act of 2007 was passed into law. Therefore, these estimates are based on the much-lower mandates from the 2005 act.

The USDA makes this point very clear in the text of the report. The organization simply says that the new act will increase corn prices, reduce America’s ability to export corn and push up the prices of livestock feed. Even more important, shifts in corn consumption affect far more than the corn market alone; the prices of all agricultural commodities are, to an extent, related.

Consider that, if the mandate for corn use rises, it will tend to boost corn prices and tempt farmers to plant more corn. But there’s a relatively fixed supply of arable land in the US, so more corn acres likely mean fewer acres dedicated to the production of other key crops such as soybeans and wheat. Lower planted acres means a smaller supply and, therefore, rising prices.

Updated projections for corn used in ethanol production won’t be available until the USDA releases its next long-term projection that includes consideration of the 2007 Energy Act. However, the new Energy Act mandates corn-based ethanol consumption roughly 65 to 75 percent above what the 2005 act required out to 2012. On that basis, the Energy Act of 2007 could push required corn consumption above 7 billion bushels by 2012. As you can imagine, the impact on the US corn market would be dramatic.

As I noted earlier, the US is only one of many countries that encourages biofuels production and consumption. The EU has a soft target to obtain 5.75 percent of its transportation fuels use from biofuels by 2010 and a mandate of 10 percent of total fuels by 2020. The EU also offers a production subsidy for farmers planting crops like rapeseed that can be used for biofuels consumption.

EU mandates and targets typically aren’t directly enforceable but require individual member states to pass laws to encourage progress toward those targets. Without delving into specifics, suffice it to say that EU member states also don’t always see eye-to-eye on how targets should be enforced. At any rate, the USDA projects a considerable increase in biofuels use in the EU and a consequent jump in demand for crops. However, the USDA also projects that the EU won’t actually attain its stated targets.

Nonetheless, EU directives will directionally have an important impact on agricultural demand. The most obvious manifestation of this in the USDA projections is soybean oil imports.

Most biodiesel in the EU is made from rapeseed oil; however, soybean oil is another key feedstock for biodiesel plants globally. Soybean oil is more heavily used for this purpose in the US and elsewhere. It’s also more heavily traded on an international basis than rapeseed. Check out the chart below.

Source: USDA

This chart shows total EU imports of soybean oil across all 27 member states. Total imports this year of 1.1 million metric tons may not seem like a great deal in the context of an 11-million-metric-ton-per-year global import market. But remember that soybean oil isn’t the primary source of biodiesel for the EU.

The region is projected to import soybean oil to supplement locally produced rapeseed oil. In other words, domestic rapeseed production won’t be sufficient to meet demand for biodiesel, so that demand will fall on other commodities such as soybean and palm oils.

It’s clear from this chart that EU soybean oil imports are projected to soar over the next few years.

Back to In This Issue

Food Upgrading

The second pillar of the global agriculture boom is food upgrading. All too often, pundits make the argument that greater food consumption in the developing world is the primary driver of agricultural demand. This is partly true; the more important effect is a shift in consumption patterns. I outlined the basic theory of food upgrading in the Sept. 20, 2006, issue, but here’s a quite review and update.

Suffice it to say that, in the world’s least-developed countries, the primary component of the average consumer’s diet is basic cereals; wheat and rice are two common examples. Consumers in these countries east very little meat, dairy or other processed foods.  

As a nation becomes wealthier, however, the average consumer’s diet changes and diversifies away from basic cereal consumption. Consider the charts below.

Source: Food and Agriculture Organization of the United Nations

Source: Food and Agriculture Organization of the United Nations

These two charts sum up the process of food upgrading rather succinctly. The Food and Agriculture Organization (FAO) of the United Nations releases a data set known as the Food Balance Sheet for about 99 countries around the world. This data set is the basis for both charts above. The latest data publicly available for each country are from 2003.

The first chart shows the percentage of the average Chinese consumer’s diet that comes from animal products; meat, animal fats and milk are three primary examples. As you can see, as recently as 1970, animal products only accounted for about 5 percent of the Chinese diet. By 2003, that figure was closer to 24 percent.  

Although that’s amazing growth, there’s still more room for upside. Consider that in 2003 animal products accounted for about 28 percent of US calorie intake, and in Germany, that figure was closer to 33 percent.

In the second chart, I offer a breakdown of consumers’ diets from a handful of countries around the world. Note the distinctions between the diets of consumers in the poorer countries on the chart—Ghana and Bangladesh—and the US and Germany. Not only do Americans and Germans consume more total calories, but diets are far more diversified.

In Ghana and Bangladesh, the diets of average consumers are based on basic agricultural commodities. In Bangladesh, this means primarily rice, a staple cereal. In Ghana, the base commodity is cassava, a locally grown starchy vegetable that’s readily available there.

Just looking at the bars representing Ghanaian and Bangladeshi diets you can see that these bars are primarily of one color; in other words, one particular food type dominates. In Germany and the US, in contrast, the bars are a veritable rainbow of colors, each representing a different food type. The diets in these richer countries are far more varied.

China is currently somewhere in between these two camps, reflecting its economic development, which is somewhere in between a nation like Bangladesh and the US. I also included China’s food breakdown from the year 1990 to make the incredible transition underway even more obvious.

Note just how much the Chinese diet has already changed. Rice consumption (China’s main cereal) has actual decline markedly since 1990, while meat and animal products consumption has ballooned.

These figures also distort China’s meat consumption considerably. Consider that, on a calorie basis, meat consumption in China is skewed upward because consumers tend to eat lower-quality, higher-calorie-content meat than in the developed world. On a kilograms-per-year basis, however, the picture looks far different.

The average American consumes nearly 124 kilograms of meat per year (275 pounds of direct meat consumption) compared to less than 55 kilograms per year (121 pounds) in China. On this basis, there looks to be even more upside to Chinese meat consumption.

I suspect that ultimately the Chinese diet will grow to look much like the diets in the western world. This implies lower consumption of cereals and an even greater consumption of meat and other animal products.

I also wouldn’t be surprised to see Chinese meat consumption exceed that of either the US or Germany in percentage terms, given the rapid growth in consumption over just the past decade. In fact, this process is already well underway. And remember all these figures are in per-capita terms; when the effects of consumers’ shifting tastes by a population of a billion people are multiplied, the effects on overall demand are dramatic.

Shifting diets in the developing world have a profound impact on global demand for agricultural products. Consider that increased meat, dairy and animal products consumption spells increased demand for livestock. Feeding livestock requires large amounts of grain and meal. Simply put, it takes 8 to 10 pounds of grain and feed to produce 1 pound of meat. Of course, these figures vary depending upon the type of meat produced, but an 8-to-1 ratio is a decent rule of thumb.

Another way to look at this is the amount of land required to produce meat to feed a single consumer compared to vegetables or grains. For example, according to British consulting firm Bidwells Agribusiness, it takes more than 8,170 square meters of land to produce beef to feed one person. Producing potatoes requires just 274 square meters. Meat production is far more land intensive.

As meat consumption rises, the effect on grain and land demand rises at an even faster pace. With literally billions of consumers in the emerging markets now starting to demand more processed, meat-based foods, there’s an ever-expanding wall of demand for products such as soybeans, corn and wheat.

All of this may seem somewhat off-topic for an energy-focused newsletter, but it’s not. Increasingly, rapidly rising demand for food in the developing world is competing with biofuels production growth in the developed world. Corn that’s used to produce ethanol, for example, is also used as an animal feed. The result is a tidal wave of demand for the agriculture industry as a whole.

This wave of demand is already starting to show up in the form of accelerating imports of grains and other agricultural products into developing nations. Consider the chart below.

Source: USDA

This chart shows a clear jump in imports of corn for both China and the Middle East/North Africa over the USDA’s forecast period. These numbers are particularly striking when you consider that, as recently as the beginning of this decade, China was an important net exporter of corn. In the 2006-07 year, Chinese imports and exports became evenly balanced, and over the USDA’s forecast period, imports are likely to explode. Meanwhile, Chinese exports will remain constrained, partly because of legislation discouraging corn exports.

Even more shocking, consider that, according to USDA, the Chinese government has made the conscious decision to encourage domestic corn production to minimize import demand. This has come at a cost because land is diverted away from the production of other crops.

The most obvious symptom of this decision is a massive jump in imports of soybeans in the coming years. Check out the chart “Chinese Soybean Imports.”

Source: USDA

Note that consumption of edible oils (such as soybean oil) tends to rise as consumers in a country become wealthier. Soybean meal is also a key source of protein. Therefore, demand from soybeans is surging in China.

China is forecast to account for 80 percent of the total jump in worldwide demand for soybeans imports between now and 2017-18.

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Supply Side

With global demand for agricultural products set to rise sharply in the coming years, the obvious question is: Where’s all that supply going to come from? Just as with oil, natural gas or any of the energy commodities covered in TES, the supply side of the equation is every bit as important as total demand.

On a short-term basis, the key supply metric to watch is the global end stocks to use ratio (ESUR). This is a measure of total inventories of a particular commodity in storage dividend by total annual demand. The higher the percentage, the more adequately current inventories cover demand.

On that basis, the supply side of the agriculture industry looks tight. Check out the charts below for a closer look at the ESUR for two of the more important internationally traded commodities—corn and wheat.

Source: USDA

Source: USDA

The trends on these charts couldn’t be more obvious. The ESUR for wheat has halved from more than 35 percent in 1999-2000 to less than 18 percent in 2007-08.

The second chart shows the ESUR for coarse grains, which include corn. Corn is by far the most important coarse grain in terms of international trade, accounting for roughly 80 percent of total trade. It’s clear that the ESUR picture for corn is even tighter than for wheat; the ratio has dropped from near 30 percent in 1999-2000 to less than 12 percent today.

These charts indicate that total global inventories of grain and wheat are low relative to total demand. From a longer-term perspective, however, what really governs agricultural supply is the availability of arable land and the yield per acre of such land. Let’s examine these two key supply factors separately.

First up is arable land. Globally, there’s limited capacity for a major expansion in arable land because much of the land suitable for agriculture is already being cultivated. The two exceptions are Brazil and the former Soviet Union (FSU), including countries such as the Ukraine. Parts of Eastern Europe now in the EU also have room to expand acreage to a smaller degree.

Brazil’s agriculture industry has been growing rapidly and remains capped in the intermediate term by a lack of sufficient infrastructure. Agriculture in the FSU is also capped by infrastructure and, in some cases, a need for legal land reform that would make it easier for large-scale agribusiness to develop.

The UN estimates that there’s only about 12 percent more arable land around the world that hasn’t been degraded by desertification, isn’t currently forested or isn’t subject to erosion. Even worse, the same organization estimates that 16 percent of arable land currently in production is degraded by these same forces; in other words, this land is becoming less productive in terms of yields and may eventually become nonproductive.

A recent report by Bidwells brings up another key factor to keep in mind when it comes to potential increases in arable land—water availability. According to Bidwells, 70 percent of global fresh water supply is already used in the agriculture industry. It’s also estimated that the industry wastes more water with leaky pipes and aging infrastructure than any other industry in the world.

In the developing world, the problem is exacerbated by urbanization as more consumers move into cities and demand for clean drinking water and water infrastructure rises. Therefore, in places such as China and India, underground aquifers are tapped to supply that demand.

Over time, this has resulted in a depletion of supplies. According to Bidwells, the ground water levels in the North China Plain are dropping at an alarming rate of 1 to 3 meters (3 to 9 feet) per year. The loss of water supply is already having a deleterious effect on agricultural productivity.

In the developed world, too, water is a problem. California, southern Spain and parts of the Southeastern US, among other agricultural markets, have been hit by droughts and water restrictions in recent years. At best, lack of water resources raises costs of obtaining supplies. At worst, in some countries, loss of water volume may mean that previously productive areas become no longer arable.   

The second component of agricultural supply is yield and productivity. Back in the late 19th century, British economist Thomas Malthus published his Essay on Population. The basic argument was that, whenever the population expanded beyond some limit, the supply of agricultural commodities was insufficient to meet that demand. The result was famine, disease caused by malnutrition and likely wars over scarce resources. This theory was broadly consistent with Britain’s own experience during the Dark Ages; the population remained capped by agricultural productivity.

But what Malthus failed to adequately address was agricultural productivity—basically, the potential for an increase in yields such that volumes of food produced on a given tract of land could increase markedly. It was the Agricultural Revolution that brought innovations such as crop rotation, a better understanding of fertilizer, the development of pesticides and selectively bred plants. These trends were reinforced by the development in the 20th century of genetically modified crops that are resistant to disease or can grow in a wider variety of climate conditions.

In the latter half of the 20th century, farmers’ productivity more than doubled. According to Bidwells, the average grain farmer produced some 1.1 metric tons per hectare in 1950 and 2.7 metric tons by 2000. This was the fastest rate of productivity enhancement in history, and it will be tough to replicate over the next 50 years. However, agricultural yield gains will be a key component of feeding the world and meeting global biofuels demand.

To make a long story short, demand for agricultural foodstuffs is accelerating because of the twin pillars of developing world consumption and biofuels demand. At the same time, there are some very clear constraints on the potential supply of such commodities. The offshoot of all this: Short-term gyrations aside, agricultural commodity prices are headed higher.

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Playing Biofuels

As noted earlier in today’s report, I recommend playing the biofuels story using a field bet. Instead of just picking one or two highly leveraged plays on biofuels, I recommend casting a much wider net. In buying several biofuel plays of differing risk levels, the chances of hitting a few big winners are maximized.

The key is to buy all the plays in the field bet and account for the risk by placing a relatively small amount in each pick. Depending on your risk tolerance, I recommend placing a fifth to a third of what you’d normally put in a TES recommendation into each pick. I’m also careful to identify picks that I consider to be riskier. Remember, in order to make homeruns, as we have in a few of our fertilizer plays, you have to take some risks along the way.

Below is my current biofuels field bet, with total returns calculated since inception. The total average return currently stands at 125 percent, in large part, to strong three- and fourfold gains from my two fertilizer plays. The field bet’s diversification principle has worked like a charm, with gains from these picks more than compensating from the one absolute disaster in the portfolio, Earth Biofuels.

Also note that several of the picks are currently rated holds, meaning that new subscribers shouldn’t get in at this time. I’m also recommending that subscribers take partial profits in some of the plays to lock in gains. This is a key part of my strategy with field bets picks. Finally, I’m adding one new recommendation to the field bet portfolio as of this issue.
Biofuels Field Bet
Company Name (Exchange: Symbol)
Entry Price (USD)
Total Return Since 09/20/06 (%)
Total Return for 2008 (%)
Anglo-Eastern Plantations (UK: AEP) GBP2.99 121.8 39.3 Buy under GBP7.50
Earth Biofuels (OTC: EBOFE) 2.17 -98.1 -28.9 Hold
Landkom International (UK: LKI) GBP0.93 NEW NEW Buy under GBP1.15
Monsanto (NYSE: MON) 46.91 138.9 -0.7 Hold, SELL Half
Mosaic (NYSE: MOS) 21.89 500.6 6.0 Hold, SELL Half
Metabolix (NSDQ: MBLX) 23.94 -54.6 -54.3 Buy under 29
MP Evans (London: MPE) GBP2.82 64.8 9.1 Buy under GBP5.50
Novozymes (Copenhagen: NZYMB, Frankfurt: NZMB, OTC: NVZMY)* 103.50 -11.5 -20.3 Buy under USD130
Potash Corp (NYSE: POT) 33.30 371.1 9.0 Hold, SELL Half
PowerShares Deutsche Bank Agriculture (AMEX: DBA)+ 26.05 43.9 12.1 Hold, SELL One-Third
Sipef (Belgium: SIP) EUR187.00 194.1 18.6 Buy under EUR500
Syngenta (NYSE: SYT) 29.40 97.6 12.9 Buy under 60
* Returns from original 05/02/07 recommendation date. + Returns from original 01/24/07 recommendation date.

Here’s an update of the field bet recommendations, including my newest play:

My two fertilizer plays, Mosaic and Potash Corp of Saskatchewan, have been far and away the biggest winners is the biofuels field bet, returning 500 percent and 371 percent, respectively, since my initial recommendation.

One of the keys to boosting crop yields is proper fertilization. And with prices for agricultural commodities rising sharply in recent years, farmers have every incentive to try to maximize output.

But fertilizers aren’t produced out of thin air. Potash, for example, is a mineral containing potassium—typically potassium chloride—that’s mined from the earth. Economic mines are located in only a few places around the world.

That means ramping up production isn’t seamless and requires building new mines and processing facilities; therefore, supply can only rise slowly to meet growing demands. This classic supply/demand squeeze has pushed potash prices sharply higher during the past few years.

Consider that, in 2003, potash prices were hovering around $70 to $80 per metric ton. In late March, however, a potash export association, representing Mosaic and Potash among others, announced a deal to sell 1.3 million metric tons of potash to an Indian buyer at $625 per metric ton. That’s a near 10-fold increase in prices in a five-year period.

But with crop values rising so much, it’s economical to buy potash even at current lofty levels. Even more amazing, just one year ago, the same export association concluded a deal with the same buyer at $270 per metric ton. Since that deal, there have been rumors swirling around the industry of the potential for a $700-per-ton-plus deal later this year.

The reason for the dramatic run-up in fertilizer prices is simple: tight supply and demand. Demand, as noted earlier, is rising because of strong pricing for agricultural commodities and a desire to maximize yields. Meanwhile, supplies and inventories of the mineral are tight. In fact, Potash CEO Bill Doyle recently warned Chinese buyers to conclude price negotiations quickly if they would like to ensure adequate supplies.

Potash and Mosaic are two of the largest fertilizer producers in the world and some of the only producers with the scope to meaningfully increase capacity into a strong market. In the Sept. 19, 2007, issue, I cut both Potash and Mosaic to holds; although the fundamentals remain rock-solid, both stocks have seen huge run-ups and are “crowded trades,” meaning that the bull market in fertilizer is widely understood.

I’ll continue to recommend holding onto a stake in both Mosaic and Potash Corp of Saskatchewan if you have one, but new subscribers should steer clear for now. And if you haven’t already done so, sell half your position in both stocks to lock in partial gains. That means, if you originally bought 100 shares in each stock, consider selling 50 shares and let the remaining position ride.  

I recommend three stocks with significant exposure to edible palm oil: MP Evans, Anglo-Eastern Plantations and Sipef. All three stocks have performed well since inception, gaining 64.8 percent, 121.8 percent and 194.1 percent, respectively.

Palm oil is produced from the fruit of a particular type of palm tree. As with most palms, this tree requires a tropical climate and is normally found near or around the equator. Although this oil doesn’t get as much attention as canola, peanut or olive oil in the US, chances are you’ve consumed it at one point or another. If you care to examine the wrapper of the next candy bar you eat, you may find palm oil among the list of ingredients.

Malaysia and Indonesia dominate production of palm oil, each producing around 16 million metric tons per year. The next-highest producer is Thailand, which produces around 1 million metric tons.

China is the No. 1 consumer of palm oil in the world; palm oil is the most popular edible oil in China. As noted earlier in this issue, consumption of fats and oils also tends to rise as consumers become wealthier. India is another huge customer for Malaysian and Indonesian palm oil.

Among developed countries, the EU (taken as a whole) is the No. 2 palm oil consumer in the world. The EU imports palm oil as an edible oil and, increasingly, as a source of oil for biodiesel plants. It’s often cheaper to import palm oil than to actually buy domestically produced rapeseed oil for biodiesel production.

The primary driver for all three stocks has been rising palm oil prices. Check out the chart below for a closer look.

Source: Bloomberg

This chart shows palm oil prices quoted in Rotterdam, Netherlands. Prices surged from about $400 per metric ton in late 2006 to as high as $1,400 per metric ton earlier this year; they’ve settled to around $1,065 per metric ton more recently.

Anglo-Eastern has been an aggressive acquirer in recent months; it’s bought 50,000 hectares of palm oil producing land in Indonesia. The firm has now amassed a land position of 100,000 hectares of prime land in Indonesia. The company is proceeding with its planting program and has scope to significantly expand production over the next five to eight years. Anglo-Eastern Plantations rates a buy under GBP7.50 (USD15) per share.

Much of what I just outlined for Anglo also applies to MP Evans. But MP has been following a slightly different strategy.

The company has historically owned plantations in Malaysia and Indonesia, but it’s been gradually exiting the Malaysian market entirely and buying up additional properties in Indonesia. The company’s Malaysian plantations were relatively small, which made their profitability less than satisfactory. However, the land MP owns there is valuable; it’s realized solid prices on these sales in Malaysia.

MP is on track to put together a total of 50,000 acres of land in Indonesia and has an aggressive planting program in the works for the next few years. I like the overall strategy and recommend buying MP Evans under GBP5.50 (USD11) per share.

Finally, there’s Belgium-based Sipef. Sipef is a more diversified farmer than either MP Evans or Anglo-Eastern; the firm owns plantations in Indonesia, Papua New Guinea, Vietnam, Congo and elsewhere.

In addition to palm oil, Sipef produces tea, bananas and rubber, but palm oil remains its most important product. Like the other two picks, Sipef benefits handsomely from rising prices for oil and rates a buy under EUR500 (USD750).

Note there are no pure plays on palm oil prices traded on the US exchanges. However, palm oil remains one of my top biofuels growth themes. You can purchase all three recommendations on the over-the-counter (OTC) market, but they’re extraordinarily thinly traded.

You’re much better off buying the stock directly from the European exchanges, where they trade liquidly. Several brokers can now handle trades on foreign exchanges including Interactive Brokers and E*Trade.

When it comes to increasing the yield potential of crops, seed giant Monsanto is far and away the market leader.

The company makes genetically modified (GM) seeds that exhibit certain beneficial traits. Examples include a strain of corn that’s resistant to the herbicide Roundup (also manufactured by Monsanto). This allows farmers to treat crops with this herbicide without killing the corn.

Monsanto has also released or is developing drought-resistant and pest-resistant traits. The most exciting aspect of all of this is Monsanto’s ability to offer stacked traits—strains of corn offering more than one beneficial trait.

In late March, Monsanto saw its largest rally in seven years after releasing positive preliminary results and raising its profit forecast for 2008. The company highlighted continued strength in its triple-stacked corn that’s Roundup resistant and less susceptible to two different types of pests.

Monsanto estimates that triple-stack seeds will be planted on 27 million acres of farmland in the US this year; that’s up 50 percent from 2007 levels. This is a major boost to seed margins because triple-stack seeds carry above-average profit margins.

In addition, sales of Roundup-resistant seeds encourage greater sales of Roundup herbicide; the two products essentially go hand in hand. Profits from sales of the weed killer are expected to more than double. Monsanto indicates that supplies are tight: The company has been raising prices.

Monsanto also says that its early read on the 2008 planting season for the Northern Hemisphere is positive, suggesting its growth trends remain solid. Monsanto is way ahead of its competitors in terms of introducing even-more-advanced seeds, including those stacked with as much as eight to 10 traits. Most analysts agree the firm is roughly five years ahead of the competition technologically.

Monsanto also recently made a EUR546 million (USD847 million) acquisition of Netherlands-based De Ruiter Seeds. De Ruiter specialized in making seeds for vegetables grown in greenhouses; the purchase will fit well with Monsanto’s existing vegetable seed market.

In short, I see no sign of weakness for Monsanto, and the recent run-up in the stock has been largely supported by fundamentals. That said, after such a large run-up, Monsanto has been a big winner and is vulnerable to profit-taking; such a short-term correction could be violent. Therefore, I’m cutting Monsanto to a hold at this time; new subscribers should now avoid the stock. I also recommend selling half your position in Monsanto to book a significant 140 percent gain.

Syngenta makes crop protection products and, like Monsanto, has a GM seed unit. The crop protection unit, accounting for nearly 80 percent of Syngenta’s sales, consists of herbicides, pesticides and insecticides. Sales of these products have been surging, particularly in South America, where sales soared nearly 40 percent in the most recent quarter.

Syngenta is devoting considerable investment to growth in its seed unit. Sales of GM seeds can carry larger profit margins than the crop protection business. And although Monsanto is still far ahead, Syngenta is making some progress.

The company’s new anti-insect trait was recently approved in the EU for use as animal feed. And a recent trait licensing deal with DuPont is a positive step; DuPont is the world’s second-largest seed producer after Monsanto.

Although Syngenta is a second-tier player in the seed business, there’s enough growth in the industry to benefit both players to an extent. A bit less extended than Monsanto near term, I rate Syngenta a buy under 60.

I also recommend a direct play on commodity prices, the Deutsche Bank Agriculture Fund. This is an exchange traded fund (ETF) that tracks the performance of four key commodities: corn, wheat, soybeans and sugar. Note that the ETF tracks the price of the commodities themselves and not stocks actually leveraged to these commodity markets.

The ETF offers individual investors a convenient way to benefit from rising agricultural commodity prices. The only commodity within the fund that hasn’t performed particularly well is sugar. See the chart below.

Source: Bloomberg

However, even though sugar prices have been weak, strength in the other commodity groups in the fund has more than made up for sugar’s weakness. The overall fund is up 44 percent since my recommendation a little more than one year ago. I’m cutting Deutsche Bank Agriculture Fund to a hold and recommending you take a third of your profits off the table, if you haven’t done already so per my recommendation in the Jan. 24 Flash Alert: Panic Bottom.

The final three picks in the field bet are Novozymes, Metabolix and Earth Biofuels.

Earth Biofuels makes and sells biodiesel in the US. As I’ve been saying for some time, I see little hope for this stock because its business never really panned out and margins in biodiesel production have been squeezed by rising crop-derived oil prices.

I’ll continue to track Earth Biofuels as a hold only because I see no reason to sell it here on the off chance it does recover somewhat. If, however, it would be useful for you to generate a tax-loss on the stock, this would be a reasonable candidate for that.

Metabolix is the second-largest loser in the portfolio, down nearly 55 percent since my recommendation. I would caution that, although I like the story, this is a higher-risk play. The company makes biodegradable plastics out of crops such as soybeans, corn and sugarcane as part of a joint venture with agribusiness giant Archer Daniels Midland (ADM).

The advantages are obvious. Because plastics are typically made from oil, natural plastics would actually cut petroleum consumption. And a great deal of plastics, including plastic bottles and containers, end up clogging the world’s landfills. These products take thousands of years to degrade. But biodegradable plastics would disappear from the waste stream in a matter of months.

The stock has been hit for a few reasons. First, the prices for agricultural commodities Metabolix uses to make plastics have been rising; this pushes up the company’s costs.

Second and more important, the company recently pushed back the construction schedule for its commercial biodegradable plastics plant. The plant was scheduled to open before the end of 2008 but now won’t open until sometime in 2009. This delays significant revenue streams for Metabolix. The main reason for the delay was severe winter weather in Iowa, where the plant has been sited.

High-risk speculative stocks such as Metabolix have been hit by market volatility this year, and investors reacted harshly to news of the plant delay. However, ADM is one of the most well-respected companies in the agribusiness industry; its involvement with Metabolix suggests that the technology is legitimate. Metabolix requires some patience and should be considered speculative; however, it remains a buy under 29.

Finally, Novozymes makes enzymes used in ethanol production. More important, the firm is developing advanced enzymes that will be a crucial step in making advanced cellulosic ethanol as mandated by the 2007 Energy Act. The company is no small fry; it’s the largest enzyme manufacturer in the world.

Novozymes released a weak overall growth forecast for 2008 in late January. One of the main problems was simply that its fastest-growing market for enzymes is the US.

Denmark-based Novozymes posted growth of 26 percent in North America last year. However, because of the weak US dollar, when translated into Danish krone, that growth looked less impressive. Also hitting Novozymes was rising energy costs and raw materials inputs at its enzyme manufacturing plants.

But the long-term growth story for Novozymes looks solid. The firm’s North American business is a solid grower, and the company has plans to open a new enzyme plant there. Novozymes could also be a big winner of the cellulosic ethanol boom. Down a little more than 11 percent since my recommendation, Novozymes continues to rate a buy under 130.

Finally, this week I’m adding one new recommendation to the biofuels field bet, Landkom International. Landkom is a relatively new issue that had its initial public offering (IPO) in November 2007 on London’s Alternative Investment Market (AIM). With a market capitalization of about GBP186 million (USD375 million), Landkom is a small stock with a limited operating history that should be considered a speculative play.

However, the company is leveraged to one of the most exciting growth markets in the agricultural industry: the Ukraine. The Ukraine was the breadbasket of the FSU and is now one of only a handful of markets around the world that could see a real increase in planted acreage in coming years.

According to the USDA, corn exports from countries in the FSU are set to double by 2017 to 7 million tons. The vast majority of that increase is to come from Ukraine. And the Ukraine is also projected to become a key player in the global wheat market, with exports jumping from 3.4 million tons in 2007 to more than 8.5 million tons in 2017.

Landkom is a direct play on this market. The company was set up solely to buy land in the Ukraine and plant and produce various crops. Landkom intends to focus primarily on planting crops used for biofuel production, such as rapeseed, as well as wheat, a crop for which Ukraine’s climate is ideally suited. Not only is farmland in the Ukraine extremely fertile, but it’s also incredibly cheap, costing roughly a fifth what equivalent land would cost in Western Europe.

As of the time of its IPO, Landkom had planted about 10,000 hectares of land; that land is scheduled for harvest in August 2008. And in early March, Landkom announced that it had 67,000 hectares of land and was on target to meet its goal of amassing a 115,000-hectare position by the end of 2008.

Landkom, like all London-traded stocks, trades in pence. So although it will appear to be trading at around GBP93, it’s actually trading at GBP0.93 (USD1.86). Landkom International rates a buy up to GBP1.15 (USD2.30).

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Portfolio Updates

Starting with this issue, we’re adding a brief new section to each issue of TES to cover news updates on a handful of portfolio recommendations. Here’s the update for this issue:

EOG ResourcesWildcatter EOG Resources jumped in early March after announcing the discovery of a potentially huge gas reserve in British Columbia. More details of this play are starting to come out, and it’s even more exciting than originally believed.

In an Oil & Gas Journal article this month, it was suggested that the play could end up being even bigger than the Barnett Shale gas play in Texas. EOG has amassed a huge acreage in this gas play, and it looks like another homerun for the producer. Buy EOG Resources under 130.

Nabors Industries—Although there was little specific news to catalyst the rally, land rig contract driller Nabors has recently been moving higher alongside several other gas-levered plays. I suspect this is the beginning of a shift in which gas-levered plays outperform crude oil-focused firms during the next few quarters. I’m raising my buy target on Gushers Portfolio holding Nabors Industries to 35.

Rowan Companies—Jackup-focused contract driller Rowan jumped sharply after the company announced the sale of its Le Tourneau rig manufacturing unit. This is a shareholder-friendly move for Rowan and one that I’ve been looking for some time. (See the Feb. 6 issue, Earnings on Tap, for a rundown of why I’ve seen this as a possible deal.)

That said, I remain concerned about the potential for a moderation in day-rates on high-specification jackup rigs such as those owned by Rowan. I’m retaining the hold rating on Rowan Companies for now.

On the downside, uranium field bet recommendation Uranium One reacted poorly to its quarterly earnings release. The company has missed several important uranium production targets in the past few months, and there are legitimate concerns that South African power shortages will crimp production at its Dominion mine.

Nonetheless, even assuming further delays to production, Uranium One is likely to become a major producer over the next few years and does have access to some high-quality mines in the US, Africa and Australia. As a field bet pick, remember to keep your position size small to reduce risk. Uranium One remains a buy.

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Speaking Engagements

It’s time: Vegas, baby! Neil, Roger and I will head to the desert paradise May 12-15, 2008, for the Las Vegas Money Show at Mandalay Bay. Go to or call 800-970-4355 with priority code 010671 to do the “what happens here stays here” thing.