Corn-to-Ethanol: Credit Crisis Adds to Litany of Woes for Ethanol Producers
RENEWED ENERGY: Credit Crisis Adds To Litany Of Ethanol Woes
NEW YORK (Dow Jones)–VeraSun Energy Corp. (VSE), once seen as the ethanol industry’s most promising acquisitor, was already struggling with surging corn prices when the credit crisis shifted into high gear.
Record-high corn prices in June sent VeraSun and other ethanol producers into panic mode, as they changed their risk-management strategies, and tried to lock in corn contracts. But when prices sank, the ethanol companies were forced to continue to buy corn above market value.
Companies tested the limits of their working capital loans as they struggled to buy corn at elevated prices. But when the credit markets faltered in mid-September, banks clamped down on ethanol producers, limiting their borrowing ability.
“It goes to show that they stretched themselves too thin in this kind of commodity business, which can be very volatile,” said Ron Oster, a St. Louis-based analyst with Broadpoint Capital Co., an investment bank.
Although corn prices have continued to decline, producers are unlikely to get immediate relief, because ethanol prices have also tumbled. Ethanol is widely blended with gasoline, and as U.S. gasoline demand has fallen over the past year, so has demand for the corn-based component, pushing prices downward.
The price decline has exposed the weaknesses of these companies, which are caught between the cost of corn and ethanol. Like the independent refiners, who must contend with shifting prices for crude oil and gasoline, independent ethanol producers are at the mercy of volatile commodities markets. VeraSun declined to comment for this article.
“These players do not have bargaining power on either end of the supply chain,” said JinMing Liu, an analyst with Ardour Capital Investments LLC, a New York-based bank. “They are price takers.”
The exception among the ethanol producers is agribusiness giant Archer Daniels Midland Co. (ADM), which has extensive trading experience and corn-processing facilities, which allows them to direct their feedstock toward producing the most-valuable products at any given time.
Still, a federal mandate ensures that ethanol blending won’t disappear completely. The Energy Independence and Security Act of 2007 requires U.S. gasoline producers to blend 9 billion gallons of ethanol into their fuel this year, and 10.5 billion gallons next year, as they ramp up the volumes until 2022.
In A Rut Between The Rows
When the legislation was first passed, VeraSun was expected to be a major benefactor. The company, based in Sioux Falls, S.D., quickly acquired plants spanning the U.S. Midwest. For the quarter ending in June, VeraSun continued to be profitable.
But in mid-September, the company said it expected major losses in the third quarter, due to its risk-management strategy. Following that announcement, VeraSun’s shares fell 73% in a single day. Standard & Poor’s downgraded the company’s credit rating by two notches. VeraSun retained Morgan Stanley (MS) to evaluate strategic alternatives, including a possible sale.
The losses were due to hedging. Fearing skyrocketing feedstock costs, VeraSun reshuffled its position in corn futures. But when corn prices sharply declined to less than $5 a bushel, VeraSun remained saddled with contracts requiring it to pay $6.75 to $7 a bushel throughout the third quarter. As a result, VeraSun, which had a market capitalization of $293.86 million on Tuesday, expects a to report loss of $63 million to $103 million for the third quarter.
The weakness in the credit markets may make it particularly difficult for VeraSun to secure financing to offset its recent losses and continue to build projects. The company is stuck in a bit of a rut, according to Ian Horowitz, an analyst with New York-based research firm Soleil Securities Group.
“How much can that equity be worth, with a $100 million loss hanging over it?” he asked. The company’s shares traded at $1.87 Tuesday, down from a high of $30.75 in June 2006.
While VeraSun’s problems were exacerbated by a poorly executed hedging strategy, the consecutive blows of high corn prices and severe problems in the credit markets have forced companies across the sector to scale back once lofty ambitions.
Aventine Renewable Energy Inc. (AVR), based in Pekin, Ill., has delayed one plant and canceled plans to open another, after JPMorgan cut its credit facility by $50 million. Denver-based Biofuel Energy Corp. (BIOF) has also amended its bank credit lines, in an effort to continue to operate two ethanol plants.
The industry, stagnant since the 1980s, regained momentum in 2005, propelled by federal legislation that increased ethanol’s importance as a component of gasoline. The 2007 legislation increased interest in ethanol plants.
Through 2007, ethanol producers saw massive returns, but the high corn prices of 2008 bore down upon them. Profitability margins for ethanol producers have dropped from about 40% in 2006 to just 10% in the current quarter, according to Liu.
The result is that companies are barely able to pay off their interest expenses, he said.
“It’s going to take one or two quarters for the industry to turn back to significant profitability,” Liu said. But as margins grow, he said, they won’t be as robust as those seen in 2006.
The opportunity for real change in the industry could come in the form of consolidation, he said. Because the final product being manufactured by ethanol companies is essentially the same, the lowest-cost producers will thrive, he said.
“The next few years are going to have a fair amount of shakeout unless something unforeseen happens,” said Dan Newell, a portfolio manager with the Harmony Equity Income Fund, a South Dakota-based hedge fund that previously included ethanol companies in its portfolio.
But the credit markets may be reluctant to extend large loans needed for consolidating these debt-laden companies. Due to the collapse of high-profile banks like Lehman Brothers in September, the availability of credit for ethanol projects may be limited, at best.
(Jessica Resnick-Ault covers ethanol and biofuels in addition to traditional crude-oil refining for Dow Jones Newswires. She can be reached at 201-938-4435 or by email at email@example.com.)
Renergie was formed by Ms. Meaghan M. Donovan on March 22, 2006 for the purpose of raising capital to develop, construct, own and operate a network of ten ethanol plants in the parishes of the State of Louisiana which were devastated by hurricanes Katrina and Rita. Each ethanol plant will have a production capacity of five million gallons per year (5 MGY) of fuel-grade ethanol. Renergie’s “field-to-pump” strategy is to produce non-corn ethanol locally and directly market non-corn ethanol locally. On February 26, 2008, Renergie was one of 8 recipients, selected from 139 grant applicants, to share $12.5 million from the Florida Department of Environmental Protection’s Renewable Energy Technologies Grants Program. Renergie received $1,500,483 (partial funding) in grant money to design and build Florida’s first ethanol plant capable of producing fuel-grade ethanol solely from sweet sorghum juice. On April 2, 2008, Enterprise Florida, Inc., the state’s economic development organization, selected Renergie as one of Florida’s most innovative technology companies in the alternative energy sector. By blending fuel-grade ethanol with gasoline at the gas station pump, Renergie will offer the consumer a fuel that is more economical, cleaner, renewable, and more efficient than unleaded gasoline. Moreover, the Renergie project will mark the first time that Louisiana farmers will share in the profits realized from the sale of value-added products made from their crops.