Ethanol Margins Suffer

VeraSun suspends construction of an Indiana refinery, the latest in a series of ethanol-production delays.

VeraSun is the latest ethanol company to postpone plans to grow its production capacity.

The company on Monday evening announced it is suspending construction of a 100-million-gallon ethanol refinery in Indiana.

VeraSun (NYSE: VSE) shares fell 5.6 percent to $10.28 on the news.

The company, which originally announced it would build the refinery in April, had already completed preparation work on the site when it called off the project. VeraSun cited unfavorable market conditions and said it expects to resume construction next year if conditions change.

It's not the first company to pull back on expected projects.

In August, Little Sioux Corn Processors' subsidiary Akron Riverview Corn Processors halted work on a proposed ethanol plant in Iowa, also citing unfavorable market conditions. In June and July, Seattle-based E85 cancelled plans for two 100-million-gallon plants.

Among other examples, Cupertino, Calif.-based American Ethanol delayed completion of a 110-million-gallon plant and Watertown, S.D.-based Glacial Lakes Energy delayed construction of a 60-million-gallon plant, according to research firm DTN.

The delays are evidence that higher corn prices and lower ethanol prices are crunching margins for ethanol companies.

"This recent decline in ethanol prices has really caused overall profitability to struggle at many of these plants," said Rick Kment, biofuels analyst at DTN. "A lot are trying to wait until the time is right."

Two years ago, corn prices were at $2 per bushel; now they are above $3 per bushel, said John Quealy, a managing director at Canaccord Adams. And big growth in ethanol production - the U.S. made 4.86 billion gallons in 2006, about 1 billion more than in 2005, according to the U.S. Department of Agriculture - has pushed ethanol prices down.

Some environmentalists have blamed ethanol for high corn and grain prices, while others say the prices are due to speculation from traderswho expect those commodities will be worth more when ethanol takes off. Likewise, some financiers expect corn prices will come back down, while others think they will remain high.

In any case, Quealy called VeraSun's decision "a prudent measure" considering the contracting margins. Companies that were making 20 cents per gallon two years ago now aren't breaking even, in some cases, he said.

And companies need to consider a 20-year outlook when deciding whether a new plant will pay off, he said. That outlook is uncertain as the industry waits to see whether corn prices will come back down and whether new legislation will help improve margins, he said.

While the U.S. Congress has been clearly in favor of ethanol, a new Congressional session - and a new president - could change that, he said.

"There are a lot of 'clean' solutions on the table that weren't on the table two years ago," he said. "While ethanol has gotten quite decent subsidies and will continue to do so, it's a question of how much to put into it, especially if it's causing inflation outside of the fuel business."

Quealy said to expect more announcements like VeraSun's - as well as sideways trading and compression - until corn prices go up or new legislation takes effect.

Kment also said he expects the market to really ebb and flow in the next several years. "I really don't see the overall economics struggling [like this] throughout the next couple of years, but I think we will see times of high profitability and times of low profitability."

Because of that instability, risk will remain a factor for new plants, he said. If market conditions improve and companies begin construction, "there's really no guarantee of where the market will be when that plant goes into production," he said.

Part of the problem has been financing, Kment said.

While some financiers have been pouring money into ethanol startups such as Amyris Biotechnologies and Cilion (see In Brief: Growing Biofuel Crops, Biofuels Gets Financing Downpour, Are Biofuels Pushing VCs Into a New Role?), Kment said money for more-established players in corn-based ethanol has "kind of dried up."

Companies trying to decide whether the margin situation is only temporary might look toward November.

That's when a number of states require "winter blending" of ethanol with gasoline to reduce emissions during lower temperatures, Kment said.

Between the winter-blending requirements, the blender's tax credit and low ethanol prices, Kment expects demand to pick up in the next couple of months.

"Right now, we're seeing buyers backing off of ethanol, but I really expect buyers to step in, in the next month or two, and buy for the winter demand," he said.

If he's right, that demand could push prices higher and help ethanol companies make their margins.