Credit crunch

By Ron Kotrba | November 03, 2008
The recent global credit crunch and financial meltdown has been especially difficult for ethanol companies and other inventory-intensive businesses that need operating capital to stay running. "Biofuels is in a particularly bad place right now," said Kevin Book, senior alternative energy and fuels analyst for Friedman, Billings, Ramsey & Co. Inc., an institutional brokerage, research and investment banking firm. "It's an expensive way of making a product that's becoming increasingly less desirable to its main market—transportation fuels."

Commodity prices are suffering, as well. "Recently, we've seen corn prices come down substantially, but the real problem is that gas demand has come down equally substantially—on a year-to-date basis between 6 [percent] and 8 percent," Book said.

VeraSun Energy Corp. was hit especially hard this year by volatile markets and a risk management strategy that locked in high-priced corn futures when it looked like corn prices would remain high earlier this year. According to an 8-K filing with the U.S. Securities and Exchange Commission, that misstep could cost VeraSun $100 million in the third quarter of 2008. Asset manager Invesco Ltd. recently purchased nearly 16 million shares of VeraSun Energy, approximately 10 percent of the company. "Large public, first-generation producers look very attractive at the current share prices," Book said.

Rick Eastman, chief executive officer of Pursuit Dynamics Inc., said what he and many in the industry may also be thinking: Consolidation is coming. "There are obvious indications with the pure-play public [companies] that some consolidation may very likely happen," he said. "Is the ethanol industry going to go away? No, I don't think so."

The financial crisis is hurting all industry players, so companies looking to acquire additional assets must still come up with adequate leverage to do so. "Any transaction now is being deterred or inhibited by the transaction costs and the credit crunch," Book said.

In early October, Aventine shares sank to an all-time low of $1.93, followed by Pacific Ethanol Inc.'s 20-cent-per-share loss, dropping its stock to $1.08 per share, and VeraSun's 12.4 percent dip to $1.84 per share. Shares of agribusiness giant Archer Daniels Midland Co. fell 87 cents, nearly 5 percent of its value, to $17.65. In contrast for example, when the ethanol industry was in its prime in 2006 and VeraSun started publicly trading, its stock was selling for just over $28 per share.

What about second-generation projects? Experts believe there's a natural investor class willing to take the risk—either corporate strategic investors or venture investors such as Vinod Khosla. "My expectation is that early-stage projects will not change much," Khosla told Reuters. "Oftentimes in a recession, we see these projects go up as big companies cut back their most advanced research projects to preserve capital, but those that are let go start new projects outside the company, so it's a healthy environment for early-stage projects."