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Midwest Floods Leave US Ethanol Industry Waterlogged
Friday, June 27, 2008

The floods sweeping the Midwest have extinguished investors' bright hopes for the ethanol industry.

Rising corn prices had put a dent in ethanol companies' earnings, even before devastating storms further curtailed supply of the crop. Since late May, heavy rain has caused flooding in key corn-producing states like Iowa, Illinois and Indiana. Failed levies allowed the Mississippi River to overflow into cropland, extending the destruction.

This year's bout of severe weather in the Corn Belt is the first real test for the U.S. ethanol industry since January 2007, when President George W. Bush called for a sharp increase in the fuel's production. So far, it looks like there's a risk the sector won't pass.

Even before the floods, record corn prices narrowed margins, forcing producers to shut large facilities temporarily to avoid operating at a loss. Others opted not to open plants that were due to start up. One company pulled out of the business entirely.

For some producers, the most dire fallout for the industry lies ahead, analysts say. If corn prices stay elevated, some ethanol producers could see growing debt burdens and losses. Some risk triggering debt covenants, which could impede them from securing needed loans. Ethanol producers' shares have fallen in the past month, with some sinking 50%.

Even an industry trade group, which has embraced an incredibly optimistic take on the sector, points to difficult times ahead.

"Without a doubt, it will be an uneasy summer for everyone concerned," said Matt Hartwig, a spokesman for the Renewable Fuels Association.

Depending upon farmers' ability to replant flooded fields, this year's crop could be significantly depleted, leaving corn prices high for several months. Corn futures on the Chicago Board of Trade for July set a new record overnight Thursday, opening at $7.65 a bushel Friday morning. Continued heavy rainfall in Iowa and northern Missouri this week has helped to sustain high prices.

The dream that corn-based ethanol would deliver the U.S. from surging prices of fossil fuels is waterlogged. And weighed down by its own problems, the ethanol industry isn't in a position to tap the breaks on crude-oil prices that are above $134 a barrel.

"It points out the fragility of first-generation biofuels," said Sander Cohan, an analyst with Energy Security Analysis Inc. in Wakefield, Mass.

The fuel's reliance on one particular geographic region has made it particularly vulnerable to weather swings, Cohan said.

Troubled 'Heartland'

Companies that are trying to secure financing for new plants will be the first to abandon their plans, said Ian Horowitz, an analyst with New York-based research firm Soleil Securities Group. Banks are leery of financing these start-ups, given the high price of corn and perception of low returns.

One such company, Heartland Ethanol, dissolved last week. The Tennessee-based venture had planned to build seven plants, all in Illinois. Although the announcement immediately followed the flooding, Heartland's president, Walker Filbert, blamed the Federal Reserve, not the rain, for his company's woes.

The central bank's policies led to inflationary pressures, driving up corn prices and construction costs, he said. Heartland's problems were exacerbated by the credit crisis, which led banks to cut back on loans to the ethanol sector, as well as other industries.

While a bank had initially planned to finance Heartland's first plant, the bank's demands upon the company grew, prompting Heartland to put all seven projects on hold in October last year.

"We put everything on hiatus at that time, and patiently waited for the credit crisis to blow over," Filbert said. But it hasn't abated.

Filbert believes that in a year or so, conditions will turn around as turmoil in the financial markets is resolved and corn prices ease.

Agricultural economists aren't as sure that corn prices will decline.

"We're staying in the $7s for a little while here," said Chad Hart of Iowa State University. In the past three weeks, corn prices have gone up by more than $1.40 a bushel.

"That's a pretty harsh price increase on corn to absorb if you're an ethanol producer," Hart said.

'Could Be Painful'

The spike in corn prices has damaged more-established companies as well.

Producers have already shut 1 billion gallons of the nation's 9.2 billion gallons of ethanol production capacity due to margin woes, said Ron Oster, an analyst with St. Louis-based Broadpoint Capital Inc. An additional 4.4 billion gallons of capacity are under construction, and some companies are choosing not to start up these volumes.

"In the current environment, I don't think you'll see any of those start up," Oster said. "You'd be crazy to."

The largest publicly traded pure-play ethanol company decided to put three newly constructed facilities on hold. VeraSun Energy Corp.'s (VSE) move indicates just "how ugly" things have gotten, Oster said. "You're getting to the point where you're losing money for every gallon you're producing."

Abengoa S.A. (ABG.MC) and Altra BioFuels have shut plants that were already producing, illustrating the pressures margins have put on them.

Some companies have bought corn at lower prices, through hedging, and are poised to get better returns than their competitors. Aventine Renewable Energy Inc. (AVR) has one of the industry's most aggressive hedging strategies, and has purchased 39% of its corn at only $5.11 a bushel, far below the market price that its competitors must pay. Others, who aim to buy corn for immediate delivery, must pay the market price, above $7 a bushel. Such hedges could protect Aventine from the pressures its competitors feel, for at least the next six to eight months.

VeraSun and privately held POET Energy have large networks of plants that allow them leeway to pick and choose which plants to operate, so they may run only plants that can turn a profit.

Other companies face more-significant obstacles, including high debt, said Soleil's Horowitz.

"Those that have significant debt burdens are likely carefully going over their financials figuring out the degree of negative economics they can endure," Horowitz said in a recent report.

Source: Dow Jones Newswires

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