Big Oil's Big Entrance

Oil companies were noticeably absent during the ethanol industry boom from 2004 to 2007. Now, as some of those first-generation ethanol plants struggle to survive, Big Oil has begun to take an interest.
By Craig A. Johnson | October 06, 2009
With the implementation of the renewable fuel standard (RFS) in 2003, a mandate to blend ethanol into gasoline was created, and the ethanol industry boomed. For the next several years, construction of ethanol plants accounted for most of the industry investment. Builders were in short supply, or booked for months in advance. Newspapers were filled with stories of ethanol plants going up across the Midwest. Many of them turned out to be just stories, but the build had begun and ethanol became a household word almost overnight.

Existing fuel producers and refiners, companies such as Royal Dutch Shell plc, BP plc and Exxon Mobil Corp., were initially caught flat-footed by the explosion of growth in the ethanol industry. "I don't know much about farming, I'm not an expert on biofuels, and there's not a lot of technology I can add to moonshine," Exxon Mobil Chairman and CEO Rex Tillerson said at a Houston energy conference in May 2007. "There is really nothing we can bring to that whole issue. We don't see a direct role for ourselves with today's technology."

Statements regarding the utility of ethanol as a gasoline additive notwithstanding, companies such as Shell have turned their focus to the next generation of biofuels—specifically cellulosic. A recent statement from Shell points to the likelihood it sees second-generation biofuels as realistic for investment. "Shell is investing in second-generation biocomponents, which can offer around 90 percent reduction in 'well-to-wheels' CO2 production (when used neat, compared with conventional gasoline/diesel); [will] use non-food feedstocks (such as straw and wood); and [notes] some types can offer better engine performance. However, second-generation biocomponents will not be available in significant commercial quantities for five to 10 years and in this time, demand for first generation biocomponents will continue to grow as a result of government policy and mandates."

The message from Shell seems clear—corn-derived ethanol is not where its interest lies. Most oil companies prefer to be vertically integrated. Owning the means of production from well-to-pump costs less and streamlines the process as companies can realize many economies of scale.

Valero's Biofuel Ambitions
In recent years, the ethanol industry has been hit hard by extreme economic challenges, from high feedstock and energy costs, to large loans and thinning margins. Everyone knows that some plants found these challenges insurmountable, which led to bankruptcies across the industry, the largest of which being VeraSun Energy Corp.'s liquidation in 2008. Its failure opened a path to ownership for any company interested in entering the ethanol industry at a greatly-reduced cost. Initial speculation that anybody could buy up these plants for pennies on the dollar was soon replaced by the conventional wisdom that an oil refiner might be the perfect buyer for these distressed facilities.

The largest oil company to enter the ethanol industry so far is Valero Energy Corp., a San Antonio-based Fortune 500 company. The company is currently the nation's largest oil refiner, processing 3 million barrels of oil per day—just shy of 1.1 billion barrels per year. In the ethanol industry, Valero made news in March when it purchased six of VeraSun's plants. At present, Valero owns seven of the former VeraSun plants, and controls an impressive 780 MMgy, making it the third largest ethanol company in the U.S. According to Bill Day, manager of corporate communications for Valero Energy, all seven of the former VeraSun plants are operating at capacity.

Valero's interest in ethanol began with the implementation of the RFS. "[Valero] looked at getting into the ethanol producing business for a couple years, prior to buying those plants," Day says. "Of course, Valero's been in the ethanol purchasing business since the renewable fuels standard [required us] to blend into our gasoline. Since we were going to be required to blend ethanol into our gasoline, we figured it might be a good idea to get into the production business."

For Valero, the timing could not have been better. "When we started looking at ethanol production, it was not an attractive time to get into the business. There was a lot of building going on and costs were pretty high." That was a few years ago, when ethanol construction boomed. According to EPM's plant construction lists, construction represented about 560 MMgy per month in 2004. Three years later, construction was almost 10 times that, representing an average month-to-month construction capacity of 5.3 billion gallons. Anyone who might have wanted to build a plant had to get in line.

"Values for ethanol plants started dropping as a lot of overcapacity was introduced into the marketplace," says Day, chronicling the events leading up to Valero's purchase. "The price of fuel got very high, the price of corn got very high and a lot of ethanol plant operators started having financial problems. Many were looking to sell their plants, or had been forced into bankruptcy, which was the case with VeraSun. We were able to pick up these seven plants out of the VeraSun bankruptcy auction for about 30 percent of what it would have cost us to build the ethanol plants from scratch."

The predator-prey analogy may seem apt at first but Day quickly points out that were it not for Valero, the cities and towns that these plants call home might have struggled even more. "The timing was great in terms of Valero getting a good deal on these plants, and it also worked out well for the employees of the plants because we've kept them on and kept them in their jobs." The employees are a part of Valero's new subsidiary Valero Renewables, which also oversees the company's wind farm in the Texas panhandle.

Second-Generation Ethanol
One question in the energy sector has been whether oil companies will invest in first-generation plants such as Valero, whose plants are all corn-fed, or wait for cellulosic ethanol to be commercialized. According to recent reports, companies such as Houston-based KBR Inc., historically an oil industry engineering/construction firm, have been evaluating emerging biofuels technologies to see if they can get beyond bench scale. All seem to be struggling with how these processes scale-up.

Valero's move constitutes the first major move towards first-generation ethanol production by an oil company, and as such has attracted the attention of many industry analysts and observers. "It's very interesting to see the oil companies—especially the independent refiners, those not tied to the upstream—dive into the biofuels space, " says Craig Moyer, co-chairman of the energy, environment and natural resources practice at law firm Manatt, Phelps & Phillips. "They're taking plants that turn feedstocks into transportation fuel, and then they will market those transportation fuels. It's not that far from their core business."

Getting into corn ethanol may be new specifically, but vertically integrating themselves in the energy industry is what oil companies have been doing for years. Just like an ethanol plant, oil companies are sometimes forced to exist in a liminal space between profit and loss. "The refining business has always been one of feast and famine," Moyer says. "Refining transportation fuel has always been a narrow margin and sometimes supply outstrips demand and those margins go negative and poorly capitalized companies go belly-up."

Valero, by purchasing plants that produce a key component of its fuel blend, realizes a savings over other fuel producers and refiners. According to Day, Valero blends about 50 percent of its ethanol into its own fuel and sells the rest on the open market. Getting the ethanol at cost is healthy for the bottom line, and gives the company a competitive edge.

For Moyer, the Valero purchase makes good sense in the short-term, and in the long-term, when cellulosic ethanol is likely to be the dominant form of fuel in the industry. "At some point in the future, cellulosic ethanol will be out there…. These plants will [use] corn, but someday, all ethanol refineries will be cellulosic running on waste." This not only improves the environmental benefits, but removes ethanol producers from arguments over food versus fuel.

"The plants that we bought from VeraSun are all very modern," Day says. "They have the ability to add on new technologies as they become available. We are interested in cellulosic technologies and are doing some investment in that area. And we would be interested [in placing] cellulosic technology onto our plants once that technology becomes commercially viable."

Inasmuch as Valero entered the ethanol industry by purchasing first-generation plants, it's clear that it doesn't expect corn ethanol to be its only investment. Clearly, Valero didn't feel it necessary to wait for second-generation fuels to be available, and commercially viable. Rather, buying VeraSun's former plants may be the direction the energy industry was headed in all along. EP

Craig A. Johnson is the contributions editor of Ethanol Producer Magazine. Reach him at (701) 738-4946 or