Ethanol prices to stay put amid market stress in 2008

Experts predict continued consolidation among ethanol producers

By Dave Hannon -- Purchasing, 12/11/2007 10:50:00 AM

The good news for buyers is that ethanol prices will likely not go up in 2008 due to a dramatic increase in production capacity spurring more competition in the market. The bad news is that those same market dynamics may put some ethanol producers out of business next year, as their costs spiral and margins dwindle.

According to a Reuters report, ethanol capacity is up 40% this year while average weekly U.S. ethanol margins slipped recently to about 52¢/gallon, from 62¢/ the previous week. “After fuel, conversion, and overhead costs, many producers were barely breaking even,” Reuters reports.

At a National Grain and Feed Association conference in Chicago recently, Marty Ruikka, president of commodity analyst firm PRX Geographic, said that “It's not because of market prices that [ethanol producers] have a problem right now. It's because of physical, capital, structural capacity.”

That market is spurring a pullback on capacity increases as well as some major consolidations. Fitch Ratings said in a recent ethanol market outlook that if “low ethanol prices and excess supply continue, some smaller facilities or less desirable locations could be shut down. The best and most efficient locations could be acquired by the major processors.”

In late November, VeraSun announced it was acquiring U.S. BioEnergy for an estimated $700 million in stock, less than a year after U.S. BioEnergy’s initial public stock offering. The combined companies are targeting ethanol capacity of 1.6 billion gallons a year by the end of 2008, more than current market leader Archer Daniels Midland's capacity of about 1.1 billion gallons.

"This is a bigger sign of what's already been under way," said Todd Alexander, a partner at New York law firm Chadbourne & Parke in a Wall Street Journal story. His firm represents developers and lenders in connection with the financing of new ethanol-production facilities. "The pace of consolidation is increasing."

The Journal article points out that Patricia Woertz, CEO of Archer Daniels, has repeatedly said that she would consider acquisitions if they fit into the firm’s business model.

As an indication of what the ethanol market has gone through this year, MarketWatch points out that after going public at $14 a share last December, U.S. BioEnergy stock hit a high of $17.72 on Jan. 3 amid optimism over ethanol. The stock sank to a low of $6.20 a share on Oct. 24.

Also this week, Pacific Ethanol announced it has suspended construction of a new ethanol plant in California. Despite the suspension of the California project, Pacific Ethanol said it was sticking to its 2008 production target of 220 million gallons.

Fitch Ratings says, “The completion of new infrastructure and the passage of new legislation expanding ethanol usage, if it occurs, will be catalysts for further industry growth.”