“Across California, profit margins [of ethanol plants] are vanishing”

This article in the Sacramento Bee reveals the high risk of “sure thing” investments based on political interventions in the market place.

“There was a point in time when you had $3 corn and $4 ethanol; now you have $6 corn and $2 ethanol,” said Rick Eastman, who built the state’s first big ethanol plant in Goshen and is now a consultant to Pacific Ethanol.

Ethanol: How the promise dwindled
By Dale Kasler

Sacramento Bee

March 20, 2008

The cash crunch at Sacramento’s Pacific Ethanol Inc. spotlights the swift decline of an industry battered by too much supply, too-expensive corn and too many increases in plant construction costs.

Ethanol — hailed by some as a “green” fuel that would reduce America’s dependence on foreign oil — is in a major slump here and nationwide.

Across California, profit margins are vanishing, new plants are being canceled and some existing facilities are struggling. The state’s first major plant, opened in Tulare County in 2005, has suspended operations.

And now Pacific Ethanol, in a bombshell filing Tuesday with the Securities and Exchange Commission, has revealed big quarterly losses, major construction-cost overruns, defaults on its bank loans and a liquidity squeeze. The company is relying heavily on a $40 million cash infusion from an affiliate of its construction contractor, but that deal hasn’t been completed yet.

“There is much less room for error than there was in the past,” said Todd Alexander, a New York lawyer who has represented lenders and developers in the ethanol industry, including Pacific Ethanol’s banks. “Some of the marginal facilities … are running into liquidity issues.”

Investment analyst Eitan Bernstein, who follows Pacific Ethanol and other producers, said demand is increasing but not quickly enough to justify the glut of new facilities. In a business where new plants cost $100 million apiece, smaller companies such as Pacific Ethanol will suffer the most until the industry stabilizes, he said.

Deep-pocket producers such as Cargill and Archer Daniels Midland “all say they have their antennae up,” said Neil Harl, economics professor emeritus at Iowa State University. “I think what that means is if they can find a distressed plant, they’ll pick it up. But they’re not going to rush out to save these struggling companies.”

Many experts insist that ethanol’s long-term future is bright. California and the U.S. government are mandating ever-greater use of renewable fuels, putting upward pressure on demand.

But ethanol has been a victim of its own success. Increasing demand brought a flood of new supply to market while causing a spike in corn prices.

“As ethanol prospers, it demands more corn, which runs up the price of corn, which diminishes (ethanol’s) profitability,” Harl said.

Pacific Ethanol says it is optimistic about its future as well as the industry’s.
“It’s all coming together, and it’s a very positive story because of the $40 million in new money coming into the company,” said President and Chief Executive Neil Koehler in an interview.

Pacific Ethanol stock, which traded above $40 during the industry’s boom two years ago, lost 12 percent of its value Wednesday to close at $4.33 on the Nasdaq market. Wednesday was the first day of trading since the SEC filing.

The filing said Pacific Ethanol lost an estimated $14.7 million in the fourth quarter, although it has delayed the final release of those results because of its financial problems. Multimillion-dollar bookkeeping and internal-controls errors created a default on its bank loans. The company also was a victim of cost overruns — which aren’t unusual in this industry, experts say — totalling $27 million.

The overruns have contributed to Pacific Ethanol’s “extremely limited liquidity” and left the company dependent on a proposed $40 million infusion from an affiliate of its building contractor, W.M. Lyles Co. of Fresno, the SEC filing said.

Without new money, Pacific Ethanol “will be unable to achieve its business objectives,” it said.
The company was founded by former California Secretary of State Bill Jones on a couple of fairly novel ideas: First, that California would finally embrace ethanol after years of resistance, and second, that ethanol plants didn’t have to be built in the Corn Belt. Instead, the corn could be shipped in from the Midwest and the ethanol could be manufactured close to where the cars are.

Bolstered by an $84 million investment by Bill Gates, Pacific Ethanol built its first plant in Madera in 2006 and lined up $325 million in bank financing to build more. The company acknowledged that a glut might be coming, but its strategy was to build a slew of plants quickly, establish its footprint and outlast any shakeout that might occur.

That strategy appears to be faltering. Although fourth-quarter sales jumped 60 percent, to $130.4 million, margins shrank. The average price of ethanol fell 13 percent, to $1.97 a gallon, from the year before, while corn prices soared to more than $5 a bushel.

“There was a point in time when you had $3 corn and $4 ethanol; now you have $6 corn and $2 ethanol,” said Rick Eastman, who built the state’s first big ethanol plant in Goshen and is now a consultant to Pacific Ethanol.

Reality began to set in last fall, when Pacific Ethanol suspended construction of a plant in the Imperial Valley.
Other California projects have faltered. The plant in Goshen halted production two years after opening, according to several industry officials. Officials with its owner, Altra BioFuels, couldn’t be reached for comment.

A New York investment firm’s plans to build facilities in Colusa County and Wasco, near Bakersfield, are in limbo.
Some projects are going forward, though. Pacific Ethanol’s plant at the Port of Stockton, which received tax-exempt bond financing from the state, is making progress, port officials said. A plant in Pixley developed by Calgren Renewable Fuels of Southern California opens in May. Cilion Inc., a startup backed by renowned Silicon Valley venture capitalist Vinod Khosla, expects to open its first plant later this year near Modesto.