Blogging Ethanol & Biodiesel

Ethanol Survivors on the Hunt for Assets

         Some of the strong remaining ethanol producers came to Washington this week to press their two-pronged cause. They registered their offense with Big Food’s argument that ethanol production drives up grocery prices. And they said they would ask EPA to issue a waiver to blend more gasoline in the nation’s fuel pool.

At a press conference announcing the kickoff of Growth Energy, the media kept hounding guys like POET’s Jeff Broin and ICM’s Dave Vander Griend about what distressed assets they may buy.

Ethanol & Biodiesel News spent some time with Wayne Hoovestol, CEO of Green Plains Renewable Energy, after the event. He shed some light on future trends in the industry.

“It’s going to be wild,” said Hoovestol, referring to what’s believed to be a pending consolidation among ethanol producers.

We asked if banks will lend specifically for that purpose. One thing Hoovestol told us that we hadn’t heard yet is that that many plants have a $1/gal of debt built into their current economics.

Still, he said bankers might favor an acquisition strategy by a company that manages its margin and has a hedging strategy that “does not go out too far.”

It also might be possible to buy someone else’s ethanol plant using your own working capital, he suggested.

Green Plains has an algae-based ethanol experiment going on in Shenandoah, Iowa. Hoovestol foresees having a lot of carbon credits to sell in the future from efforts like this.

“We think algae will be big,” he added, but algae and cellulosic ethanol will be fed through existing plants in bolt-on applications.

“They will be percentage contributions [to ethanol output],” he said. “Not the next big thing.” – David Givens 

 

How the Economic Bailout Should Work

     Henry Paulson’s plan to salvage U.S. bank assets is a good concept that had a bad sales job but may even suffer from worse execution. The reason: It is out of control.

     First Treasury was supposed to buy toxic mortgage-backed securities. Then commercial paper was added. Then equity positions in banks themselves. Now it will be equity positions in other companies. Where does it stop for the new economic czar?

     There’s no market for sub-prime mortgage backed securities. And that’s the only thing Treasury should focus on. The effort should be similar to the Resolution Trust Corp.’s handling of savings and loan assets.

     And it shouldn’t be called a bailout, because here’s how it will really work.

     Suppose the Treasury announced it will buy $50 billion of fixed rate mortgages (mortgage backed securities, or MBSs) with an average maturity of 2028 and an average term of 30 years. The term is important because it’s the basis for how much principal and interest will be generated.

     Additionally, let’s say that the only coupons that will be accepted in this batch are between 6% and 6.25%.

     After stringent prequalification, banks bid to sell their mortgage backed securities based on a discount to the coupon. Bids starts at 4.25%, and the highest that Treasury will accept is 5.75%. Only certain pricing increments are accepted, starting with the lowest bids in the Dutch auction process.

     If a holder of MBSs doesn’t like the terms, fine. They don’t bid. Ditto if they want to hold out for the least amount of discount off of the coupon. The $50 billion might fill up without some bids getting hit.

     And by the way, the next auction for similar products starts at 4% and ends at 5.5%. Announcements and results get posted on the Internet.

     What does this mean for you, Mr. Biofuels Plant Developer? These auctions would be a proxy for the cost of capital. Securitization got the U.S. into the mess, and should be used to get the country out. – David Givens

 

Why More Liquidity Is Bad

Bad money drives out good money is what was said in the days when only coins were honored, and they were shaved and the filings melted by the unscrupulous.

         The bad money today is the fiat currency of the U.S. dollar. Government borrowing to finance U.S. wars weakened the dollar in this decade. Continually lower interest rates created more bad (easy) money in circulation, so too much money chased too few goods.

         A broad swath of policy-makers ignored how the increase in non-core inflation (food and energy) would eventually dampen aggregate demand.

         It’s not just headline inflation that showed how too much money was in the system.

        The Bush Administration wanted to increase U.S. home ownership from 66% to 70%. They had plenty of tools at their disposal. Fannie Mae and Freddie Mac were a part of that plan, along with HUD schemes.

Fannie and Freddie had bought off politicians for years to avert scrutiny from accounting practices that would have caused lawsuits if they were used elsewhere.

          I remember a study in the mid-1980s by some esteemed Washington think thank that a Salomon Brothers analyst had a hand in. It said that Treasury’s implicit backing of Fannie and Freddie raised borrowing costs to everyone else by 10 basis points.

         It said nothing about a third standard deviation style market meltdown. It’s costing you and I at least 200 basis points now.

More liquidity to the current crowd of banks is only a stopgap until we know who the survivors will be. If the Fed keeps doing it, it won’t work.

What does this mean to you, Mr. Biofuels Project Developer? The government continues to crowd you out of the credit markets. Demand real-time accounting for every outstanding mortgage backed security issued by Fannie and Freddie. Make Treasury put it all on the Internet.

And by the way, your peer companies wonder if their deposits are safe. Maybe you should move your operating funds. – David Givens

True financial conservatism

The Fed should let more banks fail and provide liquidity later.

The cause of the liquidity crisis is that banks are skeptical about being repaid by other banks, and some borrowers.

          Some banks remain bad credit risks because their assets cannot be adequately valued.

          It’s unclear who the riskiest borrowers are.

          Lowering the Fed funds rate looks good now, but it may be like pushing on a string.

          If every borrower can come to the Fed window regardless of credit quality, the U.S. may be rewarding moral hazard.

          The new president should push through new bank capital standards, sending the message to banks that this is the price for liquidity.

          Otherwise, FDIC payments to depositors of failed institutions might be cheaper than expanded Fed Open Market operations.

          What does this mean for the biofuels industry?

           Take a lot of bankers to lunch. You never know where they will end up, or when you might need them. – David Givens

Lightweights at the Top of the Tickets

There’s a wave of bank consolidation coming, and both major presidential candidates are financial lightweights.

John McCain has tried to get mileage from criticizing “investment bankers and their mortgage-backed securities.”

What he doesn’t realize is that if he has mortgages on any of his seven homes, there are probably in these securities.

Wall Street has used the MBS for at least a generation, and they are integral to housing finance.

McCain went around the bend Oct. 7 when he suggested that the federal government buy individual mortgages that were under water. It’s apparent he doesn’t understand what the Emergency Economic Stabilization Act of 2008 is supposed to do, namely buy packages of distressed assets.

McCain wants the government to do double the work.

Barack Obama wants Christopher Cox, chairman of the Securities and Exchange Commission, to suspend mark to market accounting. This simply delays the reckoning, like Japanese banks did with their bad loans in the 1990s.

There needs to be some stick with the carrot of regulatory relief, and that’s the point of the EESA. If banks get to buy time with loose accounting standards, why sell your bad loan packages to Uncle Sam?

As a potential builder of a biofuels plant, you might want more banks around, since one might lend to you. But do you want more weak banks simply going through the motions, like they are today?

But Is It Really a Deathwatch?

The rate of ethanol production project development is declining fast. We looked at articles from Ethanol & Biodiesel News since January 1, and we found only four plant openings.

 Nine other articles cited projects that were proceeding with construction. Nine projects got financing, but six of those were from DOE. Eleven projects were delayed or shut down altogather.

 Companies like Mascoma, GreenHunter Energy, Glacial Lakes Energy are moving forward. Xethanol had a setback. POET is on both sides of the ledger.

Of all the articles mentioned above, only two are about biodiesel – the rest are about ethanol.

This blog post is not a comprehensive list and is not intended as investment advice. -- David Givens

We Admit It -- We Are Biased

How does Ethanol & Biodiesel News compare to other news media? We ask ourselves that a lot.

    In 2007, I calculated that fully 78% of the coverage in the newsletter was positive for biofuels. Let me repeat that: our paying clients saw information with a positive bias more than three-quarters of the time.

    In 2008, I doubt our coverage will be that glowing. Editor Peter Ngo has fully chronicled the industry’s troubles without scapegoating biofuels for the world’s problems. It’s not a secret that overproduction, higher feedstock costs and lower margins are crushing the earnings of most biofuels producers.

    If you want to say that filling our gas tanks with corn-based ethyl alcohol is causing children in third world countries to go to sleep hungry at night, this blog might not reflect your views going forward. But you might be one of those people who works in an office all day and has never planted as much as a backyard vegetable garden. 

    By the way, here’s how the other guys are covering the field. Of the first 50 news items for “ethanol” pulled from Google at 4 p.m. EDT on July 21, 2008, 42% were negative in the article’s opening line, 38% were positive and 20% were factual.

    If you think we are missing a big story, contact me at 1-703-891-4811.

 

Biofuels to Blame for 75% of Food Price Increase

A soon-to-be released World Bank study argues that biofuels are to blame for 75% of the rise in food costs, a far higher number than the 10-25% estimate in  many earlier calculations.

Even the U.N. Food and Agriculture Organization and the International Food Policy Research Institute have estimated that biofuel production has accounted for only 30% of the price rise. The combination of higher energy prices and related increases in fertilizer prices, as well as the weakness in the U.S. dollar, was directly attributable to the 35% jump in food prices from January 2002 until February 2008, said Donald Mitchell, lead for Commodity Studies at the Bank and the author of the internal report.

"Without the increase in biofuels, global wheat and maize stocks would not have declined appreciably, and price increases due to other factors would have been moderate," says the report.

The report goes onto approximate that higher energy and fertilizer prices accounted for an increase of only 15%, while biofuels have been responsible for a 75% increase over that period.

With food prices steadily increasing due to gasoline and diesel prices, and recent tornadoes and flooding, this isn't good news for the biofuels industry. Furthermore, World Bank President Robert Zoellick has estimated that the surging prices could push 100 million more people deeper into poverty.

More U.S. Companies Dissolve Ethanol Plants

Weeks after a Citigroup analyst speculated that three out of four U.S. ethanol plants were in danger of closing, a Tennessee company canceled plans to build seven plants in Illinois, and a British-owned ethanol producer filed to reorganize under the bankruptcy code.

         Knoxville-based Heartland Ethanol spokesman Mike Craig said last week's decision to dissolve the company was based on the high price of corn. Also, the company was having a tough time borrowing money to build new, 55 million gallon per year plants in Illinois with local investors.

         Meanwhile, U.S. subsidiaries of U.K.-based Renova voluntarily filed for Chapter 11 bankruptcy protection last week, after agreeing to terms with lenders for $4 million in new working capital. The Heartland and Renova developments follow other producers delaying new plant openings, most citing the higher cost of corn.

         Earlier this month, VeraSun Energy, the second-largest U.S. producer, canceled plans for two Midwest ethanol plants totaling 220 million gallons per year, citing market conditions. Pacific Ethanol postponed construction of a 50 million gallon a year plant near Calipatria, Calif., following similar delays by Biofuel Energy, Agassiz Energy, Watonwan Energy and Little Sioux Corn Processors.

"Nobody" understands diversion of food to fuel cars

Tensions on government biofuel policies came to a breaking point Tuesday at the opening of the United Nations food summit in Rome as the head of the UN's Food and Agriculture Organization (FAO) asserted that "nobody" understood the diversion of food to fuel cars.

          Environmentalists and academics have cited biofuels for its part in the 60% increase in food costs since the beginning of 2007 and ensuing food shortage riots in more than 30 countries. Diversion of land from food crops to biofuels has added to about a third of the rise, Washington D.C.-based International Food Policy Research has said.

"Nobody understands how $11 to $12 billion a year on subsidies and protective tariff policies had the effect on diverting 100 million tons of cereals from human consumption, mostly to satisfy a thirst to fuel for vehicles," said Jacques Diouf, FAO director-general.

The position of the United Nations is that biofuels such as ethanol and biodiesel can help decrease global warming and create jobs for the rural poor, but the benefits may be counteracted by serious environmental problems and higher food prices. However, Brazilian President Luiz Inacio Lula da Silva soundly rejected criticism that ethanol production in Latin America's biggest nation has cut food output, blaming higher oil prices and farm subsidies instead.

It seems to be the never ending debate: one side cites all the evidence for increasing food prices, while the other side continues to reject it.

Minnesota rolling in soybeans

Last week, Minnesota Gov. Tim Pawlenty signed into law a measure that increases the state's current 2% biodiesel mandate ten-fold in less than a decade. There could have been no increase in the mandate at all, but what, or who, caused the increase?

In December 2005, Minnesota officials had to temporarily roll back the requirement in response to complaints from truckers that the fuel was becoming viscous and clogging fuel filters.

The state currently requires diesel to contain 2% biodiesel, but the new rules under set a new mandate of 5% by May 1, 2009, 10% by 2012, and 20% by 2015. Those are some of the largest increases in the nation, putting Minnesota at the forefront of biodiesel mandating.

Minnesota farmers raise 280 million bushels of soybeans annually (about 10% of the total U.S. crop) on 7 million acres, a 165% yield increase per acre. Soybeans and soybean products now account for about one-third of Minnesota's total agricultural exports.

It takes Mother Nature 250 million years to renew her fossil fuels, but for Minnesota soybean producers it takes only nine months. Thus, Minnesota is in a better position than most to produce more biodiesel from soybeans.

Senators up in arms over Renewable Fuels Standards

As Farm Bill negotiations drag on burdened by the weight of proposed spending, one facet that is unlikely to change is the $1.01/per gallon cellulosic blending tax credit introduced by Sen. Ken Salazar (D-Colo.).

As the tide continues to turn against corn-based ethanol, the perception that rising food prices are ethanol's fault has compelled two governors to request waivers from the Renewable Fuels Standard. A large group of Senate Republicans on Monday asked the EPA to suspend the RFS entirely.

Twenty-two Republican senators, including the presumptive GOP presidential nominee, sent a letter to EPA suggesting it waive, or restructure rules, that mandate a nationwide ramp-up in the use of ethanol to 15 billion gallons ethanol by 2015. On Friday, the Republican senators urged that EPA Administrator Stephen Johnson examine alternatives to "ease the severe economic and potential environmental results that are developing in America."

"We are concerned that inflationary pressure on food will only escalate in the coming months," the senators said.

We can't help but feel that the senatorial outrage with ethanol is being condensed into too narrow a beam. The nearly $300 billion Farm Bill that's on the table extends or increases many of the subsidies and special protections enacted in the 2002 version, a package that was criticized at the time for costing $250 billion. How’s that for inflation?