Valero Now in the Ethanol Business

In an update to Big Oil Buys Big Ethanol, it is official:

Valero Energy, the Oil Refiner, Wins an Auction for 7 Ethanol Plants

Valero Energy, the country’s largest independent refiner, said on Wednesday that it would buy seven ethanol plants from VeraSun Energy for $477 million, giving the biofuel industry a lift at a time when it is suffering from excess production capacity and falling gasoline consumption.

VeraSun, the nation’s second-largest ethanol producer after Archer Daniels Midland, filed for Chapter 11 bankruptcy protection last fall. Valero’s purchase signals important new support for a flagging industry from an unexpected quarter. In recent years, refiners have opposed Congressional mandates for refineries to blend increasing amounts of ethanol in gasoline, arguing that it made neither economic nor environmental sense.

So, for the price of $477 million, which would be less than 5 days of profit for someone like ExxonMobil, you can be the 2nd largest ethanol producer in the country. Even for Valero, $477 million is a piece of cake. Like I say, people who think the ethanol industry is a threat to the oil industry don’t understand the difference in scale between the two. If ethanol starts to look like a good business model, the oil industry will buy up the assets without breaking a sweat. The first salvo has been fired.

Big Oil Buys Big Ethanol

Some people think that the oil industry is hostile toward the ethanol industry because they consider them a real threat. But I always point out that the oil industry dwarfs the ethanol industry by such a large amount that it could easily buy up all the available assets of the ethanol industry – if they thought there was a good business opportunity.

My speculation has turned into reality as an announcement was just released that major oil refiner Valero is buying up the assets of bankrupt ethanol producer VeraSun:

VeraSun Energy to sell assets to Valero Energy

Ethanol producer VeraSun Energy Corp. said Friday it is selling assets to Valero Energy Corp. for $280 million amid difficult industry conditions and tight credit markets.

The assets include certain VeraSun production facilities in South Dakota, Iowa, Minnesota, and Indiana. The company will sell all production facilities and operations in separate or combined transactions.

“Given current difficult industry conditions and continued constrained credit markets, we believe that commencing a sale process is in the best interest of Company stakeholders,” said Don Endres, VeraSun’s chief executive.

For a pure refiner like Valero, this seems to be a decent fit with their business model. They buy oil and turn it into gasoline. Now they will buy corn and turn it into ethanol which will then be blended into gasoline. Their risk of course is that we see a return to the high commodity prices of last summer, which is what put ethanol producers into such dire straits in the first place.

I don’t expect that this is the last we will see of this. Despite the recent write-downs of assets, the oil industry will continue to generate cash (just not as much). They may be the only viable option for some of these distressed ethanol producers. And I know for a fact that there are companies that are keeping a close eye on some of the other troubled ethanol producers.

More Ethanol Plants Going Down

I won’t say I told you so, but I will make a prediction here:

VeraSun Suspends Production at Three Distilleries

Jan. 9 (Bloomberg) — VeraSun Energy Corp., the second- largest U.S. ethanol producer, has idled three distilleries as demand falls and prices fail to cover the cost of production.

Producers have been struggling to make profits amid fluctuations in corn prices. Pacific Ethanol Inc. today said it will suspend output at its plant in Madera, California. On Jan. 7, Aventine Renewable Holdings Inc. said it halted construction of its refinery in Aurora, Nebraska, for up to 180 days.

Vinod Khosla hasn’t been immune:

Last month, AltraBiofuels Inc., which counts venture capitalist Vinod Khosla among its investors, shut production at its plants in Cloverdale, Indiana, and Coshocton, Ohio.

Aventine’s shares have plunged 99 percent since June 2006, when the company held its initial public offering. Biofuel Energy Corp., whose biggest owners are hedge funds run by David Einhorn and Daniel Loeb, has lost 96 percent since its stock began trading in June 2007.

99 percent! Holy cow. I did think this was amusing:

“Back then everyone thought this was such a great thing,” Gomes said. “Most of the publicly traded guys went into substantial debt to build these plants and capitalize on the rush. Right now you just have too much supply.”

Everyone thought that? Au contraire. Here is an essay I wrote in June of 2006 warning about the dangers to investors in the ethanol industry:

Ethanol Investing Counterpoint

That was in response to a gushing article the previous week advising everyone to stash away their life savings in this great new venture. Some of my comments in response – “many claims regarding ethanol are overblown”, “the underlying fundamentals (specifically of Pacific Ethanol) make it a very risky investment”, “ethanol companies are in the same boat (as dot-coms before their crash)”, “It is simply too easy to get into this business”, and “I don’t think the underlying fundamentals warrant the valuations placed on grain ethanol producers.” So I don’t think everyone thought this was such a great thing.

OK, I said I wouldn’t say I told you so. But here is my prediction. We have a mandated demand for ethanol, which means there will continue to be an ethanol industry. The government will not pull the mandate, because of the danger to Midwestern economies. So the producers that will remain standing in the long haul are those that are integrated. The company/coop that both raises corn and produces ethanol will outlast the others. When corn prices skyrocket, they will put non-integrated producers out of business. But the integrated guys will make money on corn in this situation.

It is analogous to the integrated oil companies. Pure refiners stopped making money when oil prices shot up way over $100 a barrel. Some were even pushed into bankruptcy. But the integrated guys, even though they saw refining margins disappear, made up for it on the oil prices.

It will be the same for the ethanol companies. The farmer’s coop that owns an ethanol plant has a better chance of surviving than the Pacific Ethanols of the world.

On a similar note, I just spotted this story:

Albuquerque Police Abandon Use of E-85

The City of Albuquerque is quietly abandoning part of its push for a greener Albuquerque after finding that E-85 powered vehicles are not all they are cracked up to be.

The city found they cost more to run and to keep running.

Enchanted with the idea of going green, the city bought a couple hundred police cars.

The problem is all the green the city is spending to keep those cars running green.

Albuquerque police Chief Ray Schultz said, “We are looking at a couple different things with the E-85. One is the cost. The fuel efficiency, and some problems with fuel pumps.”

It is going to be interesting to see what happens if the mandate by the government is greater than the demand from consumers – which is where I think we are headed. This will in fact keep ethanol prices low even if gasoline prices start to recover.