Bankers, investors comment on ethanol industry

By Susanne Retka Schill | March 05, 2009
Web exclusive posted March 6, 2009, at 2:00 p.m. CST

Standard and Poor's gives the ethanol industry a B rating now, according to Mark Habib, a primary credit analyst with S&P. "Crush spreads, largely driven by the market-determined commodity prices, are highly volatile and unpredictable," is one of two reasons for the B rating. The other reason - industry reliance on regulatory support which he described as "policy driven with uncertain longevity and magnitude."

Habib spoke during a March 2 seminar and webinar hosted by the law firm Chadbourne & Parke LLC.

While the industry as a whole gets a B rating, individual producers' ratings depend on the evaluation of their fixed costs and efficiency. "Look at different projects, if they have a low cost structure, they can be making profit or break even," he said. "But if they have a high fixed cost structure, they are in a loss position." The biggest factor in fixed costs is debt service, Habib said, which ranges between $1.15 per gallon to $1.75 per gallon of ethanol produced. Using current markets of corn at $3.50 per bushel, gas at $4.80 per million British thermal units, ethanol at $1.75 per gallon, S&P is calculating low crush spreads at 72 cents per gallon up to a high crush spread of 80 cents per gallon. "A low cost producer would be at a slight profit right now." He added that current ethanol market prices are tracking corn prices rather than tracking crude oil and gasoline prices as they did last year.

Habib summarized the current pressing considerations for the ethanol industry in four points:
  • Crush spread margins have compressed to historical lows

  • Future margins remain unpredictable due to volatile commodity markets

  • There currently is an oversupply of ethanol to meet the renewable fuels standard (RFS) mandate

  • Liquidity will be critical until margins improve

With the prospects for very slim margins for 2009, the bankers and investors participating in the discussion following Habib's presentation encouraged ethanol plants to work with lenders early, saying there was potential to alter payment schedules to interest-only payments. "Borrowers have been proactive in discussions with us," said Jerome Peters, senior vice president with TD Bank Project Finance. He advised ethanol producers to consider shutting down production before they've run liquidity down to zero. "Loosing a nickel a gallon and waiting until there's no money left would be a mistake," he said. "It's surprising the number of ethanol producers that sell at a price where they don't cover variable costs."

With current ethanol capacity larger than current demand, the bankers don't look for margins to turn around until the RFS increases demand in 2011 and 2012. However, Peters pointed out that a 1 percent decrease in global oil demand resulted in a drop in oil prices from $140 to $40 per barrel. "Even before we get into the increases for RFS demand, we'll see a change in the oil market," he predicted. "Right now at $40 oil the blending economics are marginal, if it gets into the $45 range, it would help a lot of companies."