Oil Crosses Over into the Ethanol Business

By: Dirk Lammers
By: Dirk Lammers

SIOUX FALLS, S.D. (AP) -- If federal renewable fuel mandates require ethanol to be mixed into gasoline, the nation's largest independent oil refiner figures it might as well just do it itself.

The ethanol industry is under duress partly due to overcapacity and biorefineries can now be had for pennies on the dollar.

Valero Energy Corp. became the first conventional energy company to test the waters last week, bidding $280 million for five ethanol plants owned by VeraSun Energy Corp., which is now under bankruptcy protection.

It would be the largest ethanol buyout in U.S. history in terms of production capacity, according to Raymond James & Associates.

Cory Garcia, a senior research associate with Raymond James, said it was only a matter of time before the petroleum industry got into ethanol, much like agribusiness giant Archer Daniels Midland Co. did years ago.

"This is the first time we've seen a refiner get out there and do this," Garcia said. "If they're bullish long-term on the blending ability of ethanol, you can't beat this price."

The nation's renewable fuel standard ensures demand for ethanol by calling for 11.1 billion gallons of renewable fuel to be blended into gasoline this year, with that number climbing to 36 billion gallons by 2022.

"To this point, we've just been buying it, not producing it," said Bill Day, Valero's spokesman. "But once we realized that ethanol is likely to remain an important part of the fuel mix here in the United States, we decided to start looking at opportunities to produce it as well."

The ethanol industry has been hammered during the past year by volatile commodities and shrinking profit margins.

Those market conditions pummeled the stocks of many smaller publicly traded companies and landed VeraSun, the nation's second largest producer, in Chapter 11 bankruptcy protection.

Raymond James estimates that Valero is buying the plants for around 25 percent to 33 percent of book value.

"With all the plants and the capacity that they had, it was basically a fire sale at this point," Garcia said. "And Valero stepped in and got a very, very attractive price, in their opinion."

Valero during its history has taken advantage of opportunities created by distressed assets and bankruptcy filings, Day said.

"Right now, ethanol assets can be purchased at significant discount to what they would cost to build new because of the state of the industry," he said.

Valero's bid is for production facilities in Aurora, S.D.; Charles City, Fort Dodge, and Hartley, Iowa; and Welcome, Minn.; and a development site in Reynolds, Ind.

"The Valero bid suggests reports of ethanol's death are premature," said Oppenheimer Research analyst Joseph Gomes Jr.

Sioux Falls, S.D.-based VeraSun owns 16 biorefineries with the total capacity to produce 1.4 billion gallons of ethanol annually, or about 13 percent of the country's total capacity. Only four of those refineries - all ones targeted by Valero - remain operational.

VeraSun is looking to sell all of its production facilities and has set a March 13 deadline for bids.

If Valero's offer prevails, the company would group the plants under a subsidiary and use the staff already in place at the refineries.

The $280 million bid values the 560 million gallons of existing capacity at 50 cents per gallon, well below the $1.50 to $2 per gallon cost of a new facility.

That low price doesn't bode well for Aventine Renewable Energy Holdings Inc. and Pacific Ethanol Inc., ethanol companies that saw their stocks lose about 95 percent of their values during 2008, Gomes said.

"In an acquisition, the shares would appear to have little, if any, value," he said. "On the positive side, Valero is betting the industry has a future."

Gomes said more cross-industry acquisitions could be on the way.

"We would not be surprised to see additional players in the petroleum industry step up and bid on the remaining VeraSun assets," Gomes said in a research note.

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