State of the Ethanol Industry-2010 and Beyond

By Gregory J. Lynch and Porter J. Martin | January 04, 2010
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What a difference a year makes. Twelve months ago the ethanol industry, like the financial markets, appeared to face a very uncertain future. Negative margins and bankruptcies were the big news. One year later, things appear to have changed. Ethanol margins have turned positive and many plants are able to show several months of positive earnings. We believe the following three major trends that were manifested during 2009 will continue in 2010 and beyond.

Oil Enters the Industry
Perhaps the biggest news of 2009 was that the oil industry jumped into ethanol in a major way. Valero Energy Corp., the nation's second largest oil refiner, is also now the third largest producer of ethanol in the United States with over one billion gallons of ethanol capacity.

Valero's entry also provides a new twist on a successful ethanol business model. Many of the most successful ethanol plants already had some type of vertical integration in the form of ownership by agricultural companies or producers. This structure created a built-in hedge against corn price fluctuations. Valero is achieving similar vertical integration on the oil refining side, helping to hedge against negative gasoline prices and provide it with a competitive advantage compared to other refiners. Valero also directly benefits from the blenders tax credit. We believe it is possible that other refiners or oil companies will become active in acquiring ethanol capacity.

Improving Margins and Plant Values
Increased ethanol margins and plant values were also experienced in 2009.Despite some challenging times in the first half of 2009, most ethanol companies were in the black for the last quarter of 2009 and look to continue to be so into 2010.

Ethanol company valuations also improved in 2009. The bottom could perhaps be traced to the VeraSun Energy Corp. bankruptcy sale to Valero in which Valero acquired 760 MMgy of production capacity for less than 63 cents per gallon. Other bankrupt plants were sold for a higher nominal amount, but many buyers did not have to put any money down and assumed only a portion of the former debt.

Unlike the housing market, valuations appear to have increased as well. In December, Valero announced the acquisition of three more plants with 330 MMgy of production capacity. Valero paid 91 cents per gallon for the two most directly comparable plants. Although this valuation is still below replacement cost, it represents approximately a 45 percent increase from comparable valuations earlier in the year.

Investment in Next-Generation Biofuels
Considering the financial factors of 2009, it is not surprising that there was not much investment in new first-generation ethanol plants. In contrast, the U.S. DOE and USDA recently announced awards of nearly $600 million to 19 next-generation biofuels projects. The renewable fuel standard calls for 2 billion gallons of advanced biofuels by 2012, which creates tremendous opportunities for companies that can cross the technical and economical commercialization hurdles within three years.

2009 proved to be a tale of two halves for the ethanol industry. The first half was a continuation of a very challenging 2008. However, the second half (and especially the last quarter) showed strong signs of positive momentum for both first- and second-generation ethanol companies, trends which will continue in 2010 and beyond.

Gregory J. Lynch is co-chair of the renewable fuels group and managing partner of the Madison office of Michael Best & Friedrich LLP. Reach him at (608) 283-2240, gjlynch@michaelbest.com or http://twitter.com/Renewable_Energ. Porter J. Martin is a partner with the law firm of Michael Best & Friedrich LLP and is a founding member of the firm's renewable energy group. Reach him at (608) 283-0116 or pjmartin@michaelbest.com.