November 28, 2007

 

Corn-based ethanol price drop hurt US investors

 

 

Prices for the biofuel, which have fallen 55 percent in a year, are now burning US investors who joined the ethanol bandwagon a year ago.

 

Ethanol, the centrepiece of President George W. Bush's plan to wean the US from oil, is 2007's worst energy investment, according to analysts.

 

The corn-based fuel sharply fell 55 percent from last year's record of US$4.33 a gallon and drove crop prices to a 10-year high. Production in the US tripled after Morgan Stanley, hedge fund firm D.E. Shaw & Co. and venture capitalist Vinod Khosla helped finance a building boom.

 

The price of ethanol immensely fell that it is now 25 percent cheaper than gasoline. It has created an incentive for refiners to blend in more ethanol, sending up the price by nine cents to US$1.95 per gallon in the last week. It hit a low of US$1.52 on September 26.

 

Even worse for investors and the Bush administration, energy experts contend ethanol isn't reducing oil demand. Scientists at Cornell University say making the fuel uses more energy than it creates, while the National Research Council warns ethanol production threatens scarce water supplies.

 

As oil nears US$99 a barrel, ethanol markets are so depressed that distilleries are shutting from Iowa to Germany. An investor who put US$10 million into ethanol on December 31 now only has US$7.5 million, a loss of 25 percent. Florida and Georgia have banned sales during the summer, when the fuel may evaporate and create smog.

 

Barry Frazier, president of Centre Ethanol LLC in suburban St. Louis admits there would be no immediate rebound as its going to take to take 12 to 24 months before the market is able to absorb the large amount of new capacity."

 

The biggest producer, Archer Daniels Midland Co., may resort to exporting ethanol. Pacific Ethanol Inc., backed by Microsoft Corp. co-founder Bill Gates, dropped 70 percent in New York trading this year as profits collapsed. Record oil prices, which make blending of ethanol with gasoline more profitable for refiners, haven't stemmed the declines.

 

At best, ethanol is just near break-even profits, according to Ron Oster, a principal at Broadpoint Capital Inc. in Albany, New York. The situation, he said is "not a good recipe when you have $100 oil."

 

Corn has risen to US$3.86 a bushel on the Chicago Board of Trade from less than US$2.50 in September 2006.

 

The Bush energy plan spurred more production by mandating increased use of biofuels, such as corn-based ethanol. The administration proposed raising output in the next 10 years to five times the current target amount for 2012.

 

The US Senate approved the increase and lengthened the time frame to 2022. The federal government has 20 separate laws and incentives to boost ethanol use, and 49 states offer additional subsidies and supports, according to the Energy Department in Washington.

 

Scientists in elite universities question the wisdom of using ethanol. Stanford University researchers say ethanol, originally added to gasoline in the 1970s to reduce tailpipe emissions, does nothing to improve the environment.

 

David Pimentel, a Cornell University professor who has studied production of the fuel for two decades, concluded that it takes more energy to produce ethanol than it actually gives off.

 

Ethanol is a form of alcohol indistinguishable from moonshine that's created by fermenting and distilling the starches from corn, sugar, wheat and other crops. Harvesting, crushing, fermenting and distilling corn requires 29 per cent more energy than ethanol produces, says Pimentel, who is also a professor of ecology and agriculture.

 

Michael Wang, an environmental engineer at the Argonne National Laboratory outside Chicago, counters Pimentel's findings, stating it is wrong to include energy spent on making fertilizers and pesticides. Ethanol production results in a 33 percent gain in combustible energy, Wang says.

 

US ethanol inventories swelled to a record 10.3 million barrels in August as production jumped 32 percent from a year earlier and demand growth slowed, the Energy Department said.

 

Restrictions on when ethanol can be used in Georgia, Florida and other parts of the Southeast are cutting demand by about 45 percent of national demand, says Eitan Bernstein, an analyst at Friedman Billings Ramsey & Co. in Arlington, Virginia.

 

Tennessee and Arizona are among states that waived or modified rules to permit more ethanol use. On the other hand, Georgia Agriculture Commissioner Tommy Irvin in Atlanta has scheduled hearings for this week to debate whether to relax fuel regulations. Florida is considering similar changes, says Matt Curran, chief of the state's Bureau of Petroleum Inspection.

 

Georgia and Florida may not increase ethanol use soon enough to deplete the growing supply, Bernstein says. Even with distilleries being cancelled or scaled back, so many new mills are under construction that annual US output may reach 42.8 billion litres by the end of next year, he says.

 

Indiana Governor Mitch Daniels in 2005 declared the town of Reynolds "BioTown USA," pledging to make the hamlet of 550 people a showcase for crop-based fuels. Reynolds's municipal vehicles run on gasoline that's 85-percent ethanol and diesel made from soy. Residents received incentives to buy General Motors Corp. cars that can use more ethanol than conventional vehicles.

 

Two years later, after ethanol prices tumbled to a 28-month low, VeraSun Energy Corp. of Brookings, South Dakota, suspended operations on a 416-million litre distillery in the town.

 

Five other projects have been cancelled since October 1, including an Alta, Iowa, mill for BioFuel Energy Corp., which sold shares to the public for the first time in June. The stock dropped 55 per cent since the offering, wiping out more than US$190 million in market value. Another loser was Pacific Ethanol, which fell 18 percent in Nasdaq Stock Market trading last week after announcing Bill Gates may sell his stake.

 

Lenders have cut off funds for mills that weren't already under construction when prices began to drop, says Ron Miller, chief executive officer at Pekin, Illinois-based Aventine Renewable Energy Holdings Inc,

 

As the price slump prompts more distillers to shelve new plants, production growth will slow, allowing demand to catch up with supply, says Mark Miller, an analyst at William Blair. New production will peak in May, then drop to an 18-month low by October 2008. Prices will begin to rebound in July, he said.

 

Through the first half of 2008, the weak margin environment will continue as no policy measures of easing the feedstock markets are done, according to Christoph Berg, managing director at Hamburg-based commodities researcher F.O. Licht.

 

US distillers' best hope for a recovery rests with attempts by farm-state lawmakers to increase the amount of ethanol in gasoline, Berg says.

 

Democratic leaders in the House of Representatives and Senate are negotiating on whether a final energy bill should include a Senate plan to increase the "renewable fuels mandate" to more than one trillion litres a year, more than five times the amount produced now by all 131 US mills.

 

"Long-term prospects for the industry depend very much on whether a new energy bill requires higher blending targets," says Berg. "Any increase in the mandate would give a psychological lift to the ethanol market."

 

Almost one-quarter of the US$33.8-billion corn crop is devoted to ethanol, causing food companies to raise prices for tortillas, meat and soda-pop made from corn-based ingredients. Land prices climbed 13 percent in the central US during the second quarter, the biggest increase in at least 27 years, according to the Federal Reserve Bank of Kansas City.