Grains Oilseeds

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Oil prices fuel ethanol boom
Share prices are up and production is on the rise, but analysts say caution is in order.

By MARK DAVIS

The Kansas City Star

Ethanol has caught fire on Wall Street. Unwary investors could get burned.

Shares of companies that make the corn-based gasoline additive are expensive. New production plants are sprouting like weeds. Scam artists circle overhead.

“We get a new business plan from an ethanol production company about once a month and have since late last year,” said Dave Schulte, managing partner of Tortoise Capital Advisors LLC in Overland Park. “There’s a tremendous amount of production capacity being built.”

Tortoise invariably rejects the groups seeking money to build ethanol plants. Its investments are focused on energy infrastructure, such as pipelines. Still, Schulte’s a believer.

As an investment banker, he helped raise $2 million in a 1993 stock offering by High Plains Corp., a Wichita company that grew to operate three ethanol plants. Now he and others see a confluence of positive factors behind the ethanol boom.

Ethanol has gotten big-money backing from investment banking giant Goldman Sachs & Co., private equity group Thomas H. Lee Partners LP and Microsoft founder Bill Gates.

Such interest is driven by persistently high oil prices and a possible shift in energy economics that could bode well for the long-term potential of alternative energy sources.

With all the attention, however, stocks of ethanol producers make gasoline at the pump look cheap. Initial public offerings by some ethanol producers have gone for the equivalent of $9 a gallon for the ethanol these companies can produce.

Some liken the situation to the Internet stock bubble of the late 1990s.

“I think there’s some irrational exuberance going on right now,” said Tim Newkirk, chief operating officer of MGP Ingredients Inc., an ingredient and ethanol producer based in Atchison, Kan.

Like Schulte, Newkirk is a veteran of High Plains and a believer in the long-term future of ethanol as a fuel source. Markets just seem a bit light-headed.

Ethanomics

Maybe that’s because ethanol is basically moonshine. Fuel-grade standards require that ethanol be cut with a “denaturant,” making it unfit for human consumption.

Make gasoline the denaturant in the right amounts and the 10 percent ethanol mixture readily runs most cars. Fewer cars can run on the richer blend of 85 percent ethanol called E85. But consumers already see and are familiar with ethanol in their tanks.

Backers say that gives ethanol a more certain future than other alternative energy sources such as fuel cells, solar and wind energy, all of which have had fits and starts.

Ethanol is made from renewable materials and with a proven technology that faces little environmental opposition to new facilities.

Gasoline refiners who blend in 10 percent ethanol save about a nickel a gallon under a federal excise tax exemption.

And refiners have turned to ethanol in a huge way this summer after Congress declined last month to grant them limits on liabilities from the MTBE additive they had been blending into gasoline to meet federal standards but which posed ground-water contamination threats.

The result has been a surge in ethanol prices and a financial bonanza for producers.

Producers essentially live off of the spread between the price of a gallon of ethanol and the cost of the corn needed to make it. The two totals are driven by different forces, and both are working in the producers’ favor.

Ethanol has followed oil and gasoline higher because it is a direct substitute in gas tanks. Corn has been plentiful and relatively cheap.

Hawkeye Holdings Inc., an Iowa ethanol producer planning a new public stock offering, said in its documents that the spread between ethanol prices and corn costs per gallon had reached $3.09 on June 30. Ethanol prices had soared over $4 a gallon and have fallen to about $2.50.

Ethanol prices certainly would suffer from a drop in oil prices. And producers’ thick margins would be squeezed by higher prices for corn or natural gas, which fuels most plants.

Gold rush

Producers also face a lot of new competition.

Hawkeye makes 205 million gallons of fuel-grade ethanol a year. Its stock offering will help finance construction of three new plants with a combined 330 million gallons of capacity by this time next year.

The Renewable Fuels Association counted 2.4 million gallons of new ethanol capacity under construction as of July 26. That counted none of Hawkeye’s plans because work had not yet begun on the plants. Nor does it count two plants planned by VeraSun Energy Corp., which went public in June.

Ethanol plant designers and builders are so busy that new plans finalized today couldn’t break ground until 2009, said Newkirk at MGP Ingredients.

That won’t stop MGP from possibly boosting its ethanol output by 15 percent or more. Its plants don’t currently operate at the volumes their permits allow, and the company is weighing the capital investment it would take to get there, Newkirk said.

A decision to build a new plant will wait.

Newkirk said the ethanol industry runs in cycles of excess and shortfalls in capacity. He said prices soared this summer in part because of the sudden switch to ethanol from MTBE additives.

“There is no shortage of ethanol in the marketplace,” he said.

Kansas City hedge fund manager Frank Sterneck was sold on the economics of ethanol last winter. But when his team at Sterneck Capital Management LLC in Kansas City started looking for investments, they suffered sticker shock.

Stocks of public companies were priced at $4, $6 and even $9 a gallon for the ethanol they could produce. Sure, the business was a good one, but the prices left little margin for error.

Instead, Sterneck has put clients in a private offering that helps finance two ethanol plants under construction in western Kansas. Sterneck figures it is costing about $1.60 a gallon to get in.

“We felt we were buying at essentially construction costs,” Sterneck said.

Politics

Investors got into High Plains’ ethanol plans with that 1993 stock offering. They sold out in 2001 at below the offering price to Abengoa SA, a Spanish company that continues to run High Plains’ three facilities.

Schulte said High Plains simply came into the game too early. Its backers had expected more political support for ethanol to develop, but it did not.

Now it has, he said.

This week, for example, an ethanol conference in Kansas City has attracted the governors of Missouri and Kansas, a Republican and a Democrat, as well as Tom Daschle, the South Dakotan who led Democrats in the Senate before 2004.

President Bush endorsed renewable fuels in his State of the Union address, which introduced a nation to switch grass, another source material for ethanol.

The economic support is not just service.

Missouri requires a 10 percent ethanol blend in all regular gas starting in 2008, and it is not alone with such requirements. Kansas pays 7 cents a gallon to new ethanol production in the state for a short time.

The federal Renewable Fuels Standard that Bush signed a year ago mandates that refineries use at least 4 billion gallons of renewable fuels such as ethanol and biodiesel this year (less than is used currently) growing to 7.5 billion in 2012. Biodiesel is made from mixing vegetable oils, fats and grease with alcohol, usually methanol rather than ethanol.

Domestic ethanol producers benefit from tariffs on imported ethanol that makes imports more expensive than local brew.

Political support can be critical to developing energy sources. It also can be their undoing if opposing lobbyists shift the political wind.

“All the solar hot-water companies went bankrupt when (then-President Ronald) Reagan ended the credits,” said David Schoenwald, manager of the New Alternatives Fund he started in 1982 with his father.

Newkirk said political support for ethanol and the fickle nature of government backing are both topics of conversation at MGP Ingredients.

“It makes you nervous about investing huge amounts of capital when things are so political,” Newkirk said.

Alternative alternatives

Investors looking for alternative energy plays have a lot of choices with varying degrees of risk.

Other ethanol producers include recently public Aventine Renewable Energy Holdings Inc. and somewhat more seasoned Pacific Ethanol Inc.

There are fuel cell companies such as FuelCell Energy Inc., Ballard Power Systems Inc., Medis Technologies Ltd. and Plug Power Inc., among others.

Solar energy is alive and well in many companies, including SunPower Corp., Evergreen Solar Inc. and Suntech Power Holdings Co. Ltd.

Covanta Holding Corp. operates waste-to-energy projects. Ormat Technologies Inc. builds and runs geothermal power plants.

“I like wind and I like hydro, small hydro,” said Schoenwald, whose fund includes shares of Canadian Hydro Developers Inc. in Canada and Trust Power Ltd. in New Zealand that fit the bill.

Private investments that aren’t on an exchange are widespread as well.

Some of these prompted Missouri officials to alert investors earlier this summer to beware of fraudulent investment schemes that play on high gasoline and ethanol prices.

Consumers should check to be sure any investment and the person offering it are registered before putting their money at risk by calling [phone] in Missouri or [phone] in Kansas.

Schoenwald said he likes to own some large companies that have exposure to alternative energy for some stability. Computer chip maker Kyocera Corp. is in his fund because it also is the third-largest maker of solar cells.

The fund has owned shares of Archer Daniels Midland Co., an agribusiness giant that is run by a former Chevron executive and that happens to be the largest producer of ethanol.

The New Alternatives Fund also holds European companies’ stocks. Companies there enjoy greater political support and are profitable, Schoenwald said.

Fund shoppers can also look into the new Guinness Atkinson Alternative Energy Fund and the Powershares WilderHill Clean Energy Fund, which is an exchange-traded fund on the American Stock Exchange.

Ethanol enthusiasts can also look for ways to tap a budding technology that makes the fuel from the corn stalk instead of the kernels. It’s called cellulosic ethanol production, and it has attracted attention from DuPont Co., Goldman Sachs and others.

Schoenwald said Canadian-based SunOptra Inc. has steam technology used in cellulosic processes and he had owned shares of an enzyme-producer that was bought out by a larger company.

Existing ethanol plants couldn’t switch to cellulosic technologies without significant investment, but each process is all right with the alternative fuel’s fans.

“I’ve been watching this for over a decade,” Schulte said. “It’s here to stay, whatever its raw material is.”

To reach Mark Davis, call [phone] or send e-mail to [e-mail].

http://www.kansascity.com/mld/kansascitystar/business/personal_finance/15218358.htm