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High corn, soft demand beat down biofuel

By Reuters
Monday, 1 Oct 2007 | 1:48 PM ET

Record corn costs and soft ethanol prices have combined to squeeze the profitability of U.S. biofuel producers and no respite is in sight, analysts said.

Beaten-down ethanol prices should stay weak well into next year as production capacity continues to grow across the United States, threatening to pressure producers' profit margins further, the analysts added.

"We continue to hear of big supply numbers across the country," said Mike Blackford of FC Stone in Des Moines, Iowa. "As we look ahead at the rising price of corn, margins tend to look that they are in the red when we take into account $1.55 ethanol," Blackford told Reuters.

U.S. corn futures traded at $3.73-1/2 per bushel on Friday, up more than 30 percent from lows near $2.84 in September 2006.

Ethanol prices, meanwhile, are down nearly 40 percent from this year's peaks. Total U.S. ethanol production capacity has soared to near 7 billion gallons a year from about 5 billion gallons a year ago and is expected to grow further amid a building boom of "biorefineries" that churn out the clean gasoline additive made from corn.

President George W. Bush is championing ethanol to wean a gasoline-hungry America off of foreign oil.

"We expect ethanol margins to remain under pressure due to supply increases and fading summer driving demand," Banc of America Securities analyst Eric Brown said in a recent report.

Brown, who said he remains cautions on shares of ethanol producers, estimated 413 million gallons of new capacity has been added in the third quarter of 2007 alone.

PRODUCER SHARE PRICES AT NEW LOWS

Ethanol futures traded at $1.549 a gallon Thursday, down a whopping 37 percent from a year high of $2.493. Spot ethanol stood near $1.60 a gallon in U.S. cash markets like the U.S. Gulf Coast or Midwest -- down 10 percent from August.

Reflecting the erosion is a big drop in ethanol producers' share prices. On Friday, U.S. BioEnergy hit a 52-week low of $7.72 while Pacific Ethanol hit $8.45 Thursday, its low for the year. VeraSun Energy sank to a year low Tuesday at $10.41 as did Aventine Renewable Energy at $10.04.

Ethanol prices are well-below the $5 a gallon all-time peak last year, and experts wonder how much downside is left.

"We are still not ready to call a bottom in the crush spread ... but we believe the bottom is not far off," Pavel Molchanov, an analyst at Raymond James, said in a report.

Molchanov was referring to the profit margin of turning corn into ethanol. That spread is at 28 cents per gallon, down 75 percent from a 52-week high of $1.10 in May, he added.

Analysts are divided over ethanol demand growth but many see a supply overhang that will keep pressure on prices.

Last week, Friedman Billings Ramsey's analyst Eitan Bernstein downgraded ethanol producers such as VeraSun, Aventine and Pacific Ethanol saying the sharp spot price decline over the past few months is squeezing profit margins.

He said he expected ethanol prices to remain under pressure through 2008 as the industry's "growing pains" continue.

FC Stone's Blackford agreed prices would remain weak next year. Asked if he sees near-term declines, he said: "Not just yet but as you look into 2008 you'll see it. Corn prices are too high to make a profit and ethanol prices too low."

A deliberate cut in supply by producers shutting in production at plants -- similar to natural gas shut-ins by exploration and production firms -- can help the ethanol market imbalance, some analysts argued.

At current ethanol and corn prices, a producer gets 8 cents a gallon negative EBITDA (earnings before interest, taxes, depreciation and amortization), said Molchanov, a "variable cost that can be avoided by temporarily halting production."

Blackford also said he sees producer output cutbacks if corn prices keep rising. "With ethanol margins so low you're going to see corn usage cut back, that in itself is bearish to corn prices," Blackford told Reuters.

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