After several years of impressive growth, the soaring expansion of the ethanol industry has been brought back to earth. As a result, ethanol producers are experiencing the strain of reduced profit margins. To weather this business cycle and come out stronger, savvy ethanol producers must take steps to assess and improve their situation. Those that do not may not make it to the industry’s next upswing.
Several options are available for ethanol producers feeling the pinch in today’s industry climate. The most basic step is to cut costs and increase revenue. The least appealing, obviously, is liquidation. Between these two extremes lie other options, such as adding new technologies, refinancing company debts or finding a buyer. An analysis of how other producers are dealing with market changes can offer important lessons for you to determine your own route.
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A Multifaceted Response
An example of an ethanol company that has developed a multifaceted response to the tightening of margins is VeraSun Energy Co., one of the largest ethanol producers in the nation. By 2008, VeraSun had the capacity to produce 870 million gallons of ethanol annually, and had ambitious plans to expand its market share significantly. According to the company’s 2007 annual report, by the end of 2008, VeraSun projected that it would be operating 16 refineries and have capacity to produce 1.64 billion gallons of ethanol annually.
However, market trends have forced a reassessment of that expansion. VeraSun cut its costs by delaying the opening of new 110 MMgy production facilities in Hankinson, N.D., Welcome, Minn., and Hartley, Iowa. After analyzing its options, the company chose to delay commencing operation at each facility until “the outlook for ethanol selling prices and overall margins improve[d].” On July 22, the Hankinson plant began production after roughly a month delay. On Aug. 14, VeraSun announced start-up of the Hartley facility. At press time, the Welcome plant was not operating. Though the company remains optimistic about the future of the ethanol production industry, short-term analysis suggested it could protect assets and shareholder value by avoiding the high cost of starting up and operating these new plants in a climate where ethanol was “being sold at a deep discount to unleaded gasoline.”
VeraSun has nonetheless continued with production at its other facilities and with the construction of other projects, such as new production facilities in Janesville, Minn., and Aurora, S.D. This continued construction reflects VeraSun’s strategy of identifying ways to increase revenue while reducing costs. The Aurora project, for example, is an oil extraction facility scheduled to be completed this fall and expected to yield 7 MMgy to 8 MMgy of corn oil annually, extracted from the distillers grains created during ethanol production. The oil will then be sold on the biodiesel market and “is expected to generate increased revenues and improved production economics,” according to Pete Atkins, VeraSun vice president of corporate development.
VeraSun’s approach to handling the changing ethanol market goes a step further. In addition to cutting costs and finding new revenue streams, the company has refinanced in order to achieve additional liquidity. According to a June 2 press release, VeraSun entered a new revolving credit facility with UBS Investment Bank allowing maximum borrowings of $125 million, up from a previous secured revolving credit facility of $30 million. Every business expansion carries some inherent risks, especially during an economic downturn, but by refinancing its credit, VeraSun is attempting to manage its risks by maximizing its available funds in order to be sure it can achieve continued expansion in the face of current market difficulties.
VeraSun’s proactive approach combined a number of strategies, but most important was VeraSun’s strategic approach to analyzing its situation and addressing potential trouble before it became a crisis.
Other Alternatives Available
Another alternative to consider is looking for a buyer. For some producers, the market downturn has raised the difficult question of whether to continue operations in the face of financial stress or merge with another producer to achieve financial stability. Millennium Ethanol LLC chose the latter when it was purchased by U.S. BioEnergy Corp. in the spring of 2007. Formed in 2005 in Marion, S.D., Millennium Ethanol was affiliated with a large South Dakota farmers’ cooperative, Fremar Farmers Co-op, and was founded with the support of hundreds of local investors. The company’s founding vision was to support the local rural community and be a low-cost ethanol producer. Nevertheless, Millennium merged with the much larger U.S. BioEnergy in 2007, before it had even completed the construction of its 100 MMgy production facility.
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