If President George Bush thought he had the remedy for America's oil woes when he proposed an increase in ethanol production, he's getting no support in the boardroom of the world's biggest energy company and no respect in the stock market, where producers of the corn-based fuel are among the biggest losers.
The State of the Union address January 23 made ethanol the centerpiece of a plan to reduce gasoline consumption 20% in 10 years by raising the federal mandate for renewable-fuel use almost fivefold to 35 billion gallons a year by 2017. Shares of ethanol producers Archer Daniels Midland Co., Pacific Ethanol Inc. and Xethanol Corp. have lost between 25% and 63% of their value since July 14, when oil peaked at $78.40 a barrel. Pacific Ethanol fell another 3% since Bush addressed the nation last week. Exxon Mobil Corp., the world's largest publicly traded energy company, considers ethanol irrelevant as a solution to an addiction that forces the US to import two-thirds of its oil. No „viable, meaningful business proposition” exists for Exxon in ethanol, Senior Vice President Stuart McGill told investors at a January 17 conference arranged by Goldman Sachs Group Inc. „The nature of the science as it stands today and the technology involved requires significant forms of subsidies and mandates to make a lot of sense,” McGill said in New York, dismissing an industry that counts Microsoft founder Bill Gates and David Rubenstein, co-founder of the Carlyle Group, the private equity firm, among its biggest enthusiasts.
Ethanol, after almost doubling in price in five years, is falling as prices for corn, the main raw material for the fuel in the US, reach the highest in a decade. Crude oil has tumbled 29% from its July record to $55.06 a barrel, as of 2:49 p.m. London time, cutting gasoline prices. Oil must be above $70 for ethanol to be profitable, according to research by Sanford C. Bernstein & Co. „The gold rush is over,” said Michael Liebreich, CEO of London-based New Energy Finance Ltd., which advises investors in clean energy. „Many of the new plants that have been announced will never see the light of the day.” Ethanol cost $2.04 a gallon in the US on January 17, based on data from wholesale distributors in Des Moines, Iowa, and other Midwest locations, 41% more than unleaded gasoline, before taxes. What's more, ethanol produces only 70% as much energy as petroleum.
Ethanol is distilled from crops and used as a substitute or additive to gasoline. In the US, ethanol comes from corn, while Brazil, the world's biggest producer and consumer of the fuel, makes it from sugarcane. More than half the cars in Brazil can burn ethanol. Corn-based ethanol „is not a good thing,” Jose Sergio Gabrielli, CEO of Petroleo Brasileiro SA, Brazil's state-controlled oil company, said in an interview last week at the annual World Economic Forum in Davos, Switzerland. „It's not as energy-efficient as sugar and there's big protection for corn in the US” The US government gives refiners and wholesalers a 51-cent tax break for every gallon of ethanol that's blended with gasoline. To limit supplies and bolster prices, a 54 cent-a-gallon US tariff on imports blocks shipments from countries outside the Caribbean and Central America. Ethanol's backers, who include Gates, the world's richest man, and the Carlyle Group, point to price gains and the more than doubling of US ethanol use between 2000 and 2005. Even after the seven-month plunge, prices have jumped 93% in the past five years.
„Alternative energy is necessary,” said Carlyle's Rubenstein in an interview in Davos last week. „It's a pretty good area to invest in.” Carlyle and Riverstone Holdings LLC in September unveiled plans to produce „hundreds of millions” of gallons of ethanol in a venture with White Plains, New York-based Bunge Ltd., the world's largest oilseed processor. Reviving ethanol requires a breakthrough in technology that would make current processes more efficient or cut the cost of so-called cellulosic ethanol, made from corn stalks, wood chips and wild grasses. Switch grass, for example, could yield 1,000 gallons an acre, more than double that of corn, Bernstein said. Exxon Mobil helps fund research into cellulosic ethanol at Stanford University in California. „We believe for ethanol to play a more significant role on a larger scale that technological advances are needed on cellulosic,” said Exxon Mobil spokesman Mark Boudreaux.
Vinod Khosla, the Menlo Park, California-based venture capitalist who 25 years ago helped start Sun Microsystems Inc., likens his ethanol investments to the early days of the Internet. „In the long haul, this is going to be a large market, and we should be investing in it,” he said in an interview last week. „When the dot-com bubble burst, I didn't feel like we needed to change our Internet plans, and guess what, one didn't need to.” Skeptics say ethanol will never become a significant part of energy use in the US because the country can't produce enough corn. Based on current use, reaching Bush's 2017 goal would require more than 12.5 billion bushels of the grain, more than the nation's entire harvest last year. No grain would be left for hogs, cattle or chickens, or to make corn-based sweeteners for Coca-Cola Co. and other consumers.
The growth of the US ethanol industry will lead to „a difficult couple of years” as corn prices rise, US Undersecretary of Agriculture Thomas Dorr said. „There's clearly a terrific demand on corn right now,” Dorr said at a clean fuels finance conference in London today. „There is no question that the next couple of years are going to be painful.” Corn is at the highest in a decade and may gain another 38% to a record $5.50 a bushel as inventories shrink, according to Jim Gerlach, president of AC Trading Inc. In Fowler, Indiana. By the end of August, US stockpiles may plunge to 725 million bushels, the lowest since 1996, the US Department of Agriculture forecasts. „The economics of the sector are looking pretty ropey,” said Richard Lucas, an analyst with natural resources fund Ambrian Partners Ltd. in London. „Crude oil has gone back, feedstocks such as corn have gone up.”
The six-month decline in oil has slowed demand for ethanol, leaving producers of the fuel struggling to make a profit. The margins in the biofuels industry „are really coming under pressure,” said Matthias Fawer, an energy and food analyst at Zurich-based Bank Sarasin & Cie AG. „We might see some halt in the expansion of capacity.” The price of corn at which some ethanol refiners stop making money is $4.50 a bushel and the price at which they stop producing is $5. Corn ended last week at $4.055 a bushel in Chicago. „The best investment of the time being is in farmland,” Brodie said. „This is very good news for farmers and it's bad news if you're an ethanol refiner who hasn't hedged.”
Shares of Pacific Ethanol, in which Gates is the biggest holder, have slumped 61% since their May 11 record. The stock of Aventine Renewable Energy Holdings Inc. has dropped 59% since a June 28 initial public offering. Verasun Energy, which had the biggest IPO of any US ethanol company, has lost 42% since the offering June 13. Among the losers in ethanol is Provident Investment Counsel, a Pasadena, California-based mutual and institutional fund company that manages $3.09 billion. During the 3Q, Provident unloaded its 4,600 Aventine shares, according to US Securities and Exchange Commission filings. „Capacity is coming on line a lot faster than demand is anticipated to grow,” said Ned Brines, a portfolio manager at Provident, in an interview last week. Thomas H. Lee Partners LP's Hawkeye Holdings, an ethanol producer in Iowa Falls, Iowa, put off an initial stock offering last year, as did Global Ethanol Holdings Ltd., a Brisbane, Australia-based producer of sugar-based fuel, which scrapped a $350 million IPO on the eve of the deal.
„The new ethanol mandate raises insurmountable challenges spanning all levels of the supply chain, from the corn field to the automobile,” Antoine Halff, a former analyst at the Paris-based International Energy Agency now with Fimat Inc. in New York, wrote to clients last week. Corn comprised about 45% to 50% of the cost of production for US ethanol makers during the Q4, according to Credit Suisse Group. Corn has been the second-best performing commodity of the past 12 months, behind only nickel. „Biofuels is rather like the tech bubble of the commodities,” said Christopher Wyke, who helps manage Schroders Plc's $100 million commodity fund in London. „The trick is to identify which one or two companies will have a breakthrough in the biofuels refinery technology. If the technology doesn't work, they could go bust.” (Bloomberg)