Is ethanol headed to a glut?
Rush to produce may not pay off for Gates, other investors
By JOE CARROLL
BLOOMBERG NEWS
Mark Oberle, chief financial officer of ethanol maker Corn Plus LLP, is sitting out his industry's biggest building boom in a quarter century, and Microsoft Corp. Chairman Bill Gates may wish he'd done the same.
Within two years, planned expansion by ethanol producers will push U.S. supplies past demand, according to Standard & Poor's.
"The danger of a glut is very real," said J. Stephan Dolezalek, a partner at San Bruno, Calif.-based VantagePoint Venture Partners, a venture capital firm with stakes in three Midwest distilleries.
Overproduction may sour investments such as Gates' $84 million stake in Pacific Ethanol Inc., which hasn't produced fuel yet. The same may be true for shares of VeraSun Energy Corp., which this week raised $419.8 million, more than expected, in its initial public offering.
"I just hope it turns out all right for those shareholders and that it's not a fad," Oberle said in a telephone interview from the company's distillery in Winnebago, Minn., about 100 miles southwest of Minneapolis. "They would've got better odds in Vegas."
Producers are planning to expand after ethanol prices soared to records in response to government rules requiring more of the additive in gasoline. President Bush and former Federal Reserve Chairman Alan Greenspan also have said ethanol may be an alternative to fuel made from petroleum.
"The feel-good factor in the ethanol industry is very high right now," said Venkataraman Sreekanth, manager of North American energy analysis at Frost & Sullivan Inc., a San Jose, Calif.-based consulting firm.
The average U.S. ethanol price rose 95 percent this year, touching a record $3.61 a gallon June 13. That compares with a 32 percent rise in retail gasoline prices and a 13 percent increase for crude oil.
Investors poured $14.3 billion into U.S. ethanol stocks in the past 12 months, according to data compiled by Bloomberg. An index of alternative-energy stocks rose 33 percent in the past year, compared with a 20 percent gain for the Amex Oil Index, which includes Exxon Mobil Corp. and BP PLC, the world's largest petroleum companies.
The stock market valuation of Fresno, Calif.-based Pacific Ethanol, which plans five plants on the West Coast, doubled this year. Gates' Cascade Investment LLC bought its stake in April.
VeraSun's stock offering, the largest ever by a U.S. company solely dedicated to ethanol production, will finance expansion. The company's shares fell two days in a row to close at $25.25 Friday on the New York Stock Exchange. That followed a 30 percent increase Wednesday to $30 in their first day of trading.
Pacific Ethanol shares fell 88 cents Friday, or 4 percent, to $20.65, and have fallen 43 percent in the past month.
Two other distillers -- Hawkeye Holdings Inc. and Aventine Renewable Energy Holdings Inc. -- hope to tap investors' enthusiasm later this year with their own initial share sales.
Hawkeye, which is based in Iowa Falls, Iowa, and controlled by Boston buyout firm Thomas H. Lee Partners LP, is the No. 3 U.S. ethanol maker. No. 4 is Pekin, Ill.-based Aventine, controlled by Metalmark Capital LLC, the buyout firm spun off from Morgan Stanley in 2004.
Demand for ethanol, a form of alcohol derived from grain or sugar, has soared as U.S. gasoline refiners use it to replace MTBE, an additive that at least 28 states blame for polluting groundwater. In addition, the Energy Policy Act signed by Bush in August requires refiners to nearly double ethanol use to 7.5 billion gallons a year by 2012.
Thirty-seven of the 110 U.S. ethanol companies plan to add 2.2 billion gallons of new production by the middle of 2008, a 49 percent increase, Elif Acar, an analyst at Standard & Poor's in New York, said in a June 8 note to clients.
Supply may exceed demand by as much as 1.3 billion gallons, or 24 percent, within two years as production accelerates, Acar said.
"Ethanol prices are so high that people are making a ton of money, but things this good don't last that long," said Kevin Buente, who helps oversee a $2 billion portfolio of loans at 1st Farm Credit Services. "There's a lot of New York money coming into this market now and, I'm sorry to say, they will probably overdo it."
The surplus envisioned by Acar could grow if oil prices fall, stifling demand for ethanol as a gasoline extender, or if the federal tax break for oil refiners using ethanol is allowed to expire in 2010, the analyst said.
"There is a risk of enthusiasm getting out ahead of deployment," said Dolezalek at VantagePoint.
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