BioFuel Energy Caught Short on Hedging Losses

You’ve heard of Black Monday. Now meet Corny Tuesday.

Ethanol producer BioFuel Energy’s share price dropped nearly 60 percent on Tuesday after it reported $46 million in losses on hedging contracts for corn, ethanol, and natural gas. The company hedged 40 percent of its corn requirements for the third quarter at $7.01 per bushel and 30 percent of its requirements for the fourth quarter at $6.90 per bushel. On June 30, when BioFuel signed the contracts, corn was trading at $7.00 following multiple quarters of sustained upward price movements with no end in sight. The average trading price for corn in the third quarter was $4.75. BioFuel Energy announced this week it lacked the liquidity to pony up for the nearly $26.1 million for its soon-to-close third quarter hedge contracts. The company will realize an additional $19.9 million in losses for contracts closing in the fourth quarter, when corn is expected to trade at $5.17. BioFuel Energy’s share price dropped to an all time low of $0.93 on Tuesday, continuing an 80 percent downward slide since the beginning of 2008.

Bad bets and lack of liquidity aside, this situation isn’t all that bad. If you’re Cargill, that is. The agribusiness giant sits on the counter side on all of BioFuel Energy’s hedge contracts. It’s also a major shareholder in the company. While BioFuel and Cargill are reportedly in talks to arrange a payment schedule, it’s likely BioFuel will need to undergo a significant restructuring - it’s market cap was only about $40 million before Tuesday’s gloomy news. Part of the restructuring may involve Cargill taking a larger piece of BioFuel, including control over one of its two (or both) 115 million gallon biorefineries. Cargill can then dismantle the plants and sell their pieces for scrap, which are surely worth more than any of the corn-based ethanol BioFuel has produced or plans to in the near future.

As the third quarter contracts come a-closing, I wouldn’t be surprised to hear about some more of the ethanol majors coming up short. It’s possible the corn and ethanol markets are slightly out of sync, which would help corn producers, like Cargill, and hurt ethanol producers. The USDA is now predicting the second largest corn crop in history following a flood-filled spring that delayed the planting season and moved prices up during the second quarter. With more supply driving prices down, ethanol producers such as BioFuel may get caught up in their contracts. If this effect is widespread enough a number of companies may shutter, restructure, or get swallowed up by their larger competitors. A wave of consolidation may be just what the domestic ethanol industry needs to improve its outlook going into 2009.