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Tide could be turning for troubled US ethanol industry

Volatile corn and ethanol prices have hit industry profits, but the election of Barack Obama could bring a reversal of fortunes, writes Anne Feltus

THE ELECTION of a renewable fuels-friendly president brought a collective sigh of relief from US ethanol producers, which have been hit hard by a combination of factors that has left some in dire financial straits.

Barack Obama, a senator from the country's second-largest corn-producing state, Illinois, supported federal subsidies and other protective measures that have contributed to the industry's growth, and he favours continuing them. His opponent, John McCain, would probably have eliminated them had he won.

The election results were a bit of bright news emerging from behind the dark cloud that has lingered over the industry for well over a year. But it has not always been this way. Until mid-2006, the picture was rosy.

Legislative boost

Already the beneficiary of state and federal tax incentives, the ethanol business received a big boost from the passage of the Energy Policy Act of 2005, which required that 4bn gallons (USG) of renewable fuels be used in 2006, increasing to 7.5bn USG by 2012. The Energy Independence and Security Act of 2007 upped the quota to 10.5bn USG in 2009 and 12.0bn USG in 2010.

In response, manufacturers began boosting capacity to meet demand forecasts. In 2006 and 2007, the industry expanded from 95 facilities to 139, and production almost doubled to about 7.9bn USG/y, according to the Renewable Fuels Association (RFA).

But while government mandates were driving growth, other forces have significantly eroded manufacturers' profit margins. One is the fluctuating price of corn, the feedstock for about 95% of US ethanol production. Corn prices had already soared to about $5 a bushel in January from about $2 a bushel at the start of the ethanol industry's building boom. Then in spring, unrelenting rains and floods ravaged crops in the US Midwest, pushing corn prices up to almost $8 a bushel.

With corn prices projected to continue rising, some producers entered into futures contracts to hedge their risk exposure. Then in mid-August, prices collapsed to about $5 a bushel, leaving companies such as VeraSun Energy, BioFuel Energy and Glacial Lakes Energy with contractual obligations to purchase corn at much-higher-than-market prices.

Volatile prices for their product have also played havoc with producers' bottom lines. Ethanol prices on the Chicago Board of Trade plunged from a peak of $4.33/USG in mid-2006 to about $1.50/USG in October 2007, then began recovering by year-end as high oil prices made ethanol more attractive as a component in gasoline blends. Between mid-2007 and mid-2008, prices rose by almost 50%. But since the summer, falling gasoline demand has pushed ethanol prices down by about 40%.

The meltdown of credit markets is also affecting ethanol manufacturers' fortunes. When VeraSun, the nation's second-largest producer, filed for bankruptcy in late October, it put part of the blame on "worsening capital-market conditions and a tightening of trade credit" that "resulted in severe constraints on the company's liquidity". Also declaring bankruptcy in October were Gateway Ethanol and Greater Ohio Ethanol, which started up a 54m USG/y ethanol facility in Lima, Ohio, in April.

Cancellations and delays

As a result of all this turmoil, a number of biorefinery projects have been cancelled or delayed. VeraSun shelved plans to finish a nearly complete 110m USG/y ethanol plant in Janesville, Minnesota. When Vision Fuels could not raise $300m in financing, it was forced to scrap plans for a 110m USG/y facility in Des Moines, Iowa. Earlier this year, Heartland Ethanol cited financing difficulties and the high cost of corn as reasons for cancelling up to seven 55m USG/y plants in Illinois.

Meanwhile, Aventine Renewable Energy Holdings is to delay the opening of its 113m USG/y ethanol plant in Aurora, Nebraska, from the first quarter to the second quarter of 2009. And the company is reportedly considering postponing a 113m USG/y plant-construction project in Mount Vernon, Indiana.

Other companies have shut down plants, either permanently or until market conditions improve. In October, Abengoa Bioenergy New Technologies and Glacial Lakes Energy mothballed facilities in Portales, New Mexico, and Mina, South Dakota, respectively.

But despite cancellations, delays and closures, the industry continues to bring projects on stream – almost three dozen facilities with a combined capacity of over 2.5bn USG/y were under construction at the end of September, according to the American Coalition for Ethanol. The RFA says 68 biorefineries are being built or expanded this year, which will increase US ethanol production capacity by about 4bn USG/y.

However, capacity is nudging uncomfortably close to the "blend wall", the point at which ethanol production equals the use requirements of the Energy Independence and Security Act of 2007. Once that level has been reached, the downstream energy industry will have less incentive to increase ethanol consumption. Understandably, producers have been pushing for higher use-requirement levels to support their product.

For safety reasons, the volume of ethanol that can be blended into gasoline for use in standard gasoline-powered vehicles is limited by law to 10%. With only a small fraction of US vehicles being replaced each year, it is unlikely enough flex-fuels vehicles, which have engines modified to accept ethanol in concentrations of up to 85%, will take to the roads soon enough to have a significant effect on ethanol demand. Not surprisingly, ethanol makers welcomed October's National Biofuels Action Plan, released by the US agriculture and energy departments, which promotes the use of blends of as much as 20% ethanol.

Since mid-2007, Department of Energy laboratories have been conducting tests on the performance and emissions of engines using intermediate blends. Preliminary results, released in October, showed most regulated emissions were within accepted limits for both vehicles and small non-road engines; but catalyst temperatures increased slightly in about half the cars when they were tested under full-throttle conditions. A second report is scheduled for release in January. More than 20 additional tests to assess drivability, materials compatibility, emissions, durability and health effects are either under way or planned.

And it is likely that Obama will take steps to expand the market for ethanol. He plans to spend $150bn over the next decade to develop renewable fuels and to require that at least 60bn USG/y of advanced biofuels are produced by 2030. For members of the beleaguered ethanol industry, it is nice to know they will have a friend in the White House for at least the next four years.

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