In Alternative Energy Hunt, Ethanol Under the Gun

Jeff Cox, |Special to CNBC

These aren't happy times for the ethanol industry.

First, there's the public relations problem.

Fields of corn surround the Golden Grain Energy ethanol plant, in Mason City, Iowa.
Charlie Neibergall

Corn-based ethanol has become the favorite whipping boy for people concerned about global food shortages and soaring costs for wheat, beans, rice and other food products.

Demand for corn has driven up the price of the crop to three times levels of just two years ago, pushing up not just corn itself but the myriad byproducts that come from its kernels.

Then, there's the economic problem.

Under current technology, corn ethanol is inefficient and costly to make, requiring steep investments in energy, money and natural resources. In fact, the energy used to produce ethanol and transport it from plant to marketplace—in either tractor-trailers or freight cars that run on hyper-expensive diesel fuel—is about equal or perhaps even exceeds the power within the very ethanol itself. And an average-sized ethanol power production plant requires about 400,000 gallons of water a day to operate.

Plus, ethanol fails to give consumers any breaks at the gas pump.

A gallon of regular unleaded gas costs about $3.57, while a gallon of E85 ethanol blend (85 percent ethanol) goes for $2.93. However, the adjusted price for ethanol when taking into account the fuel's lower miles-per-gallon efficiency compared to gasoline is about $3.86, according to AAA.

And then there's the issue of trying to find a station, especially in the Northeast of the United States, that actually carries E85. About 40 states have fewer than 10 E85 stations.

All in all, things could be better for those who believed in an industry that they thought would boom over the next several years.

"While it may not be the immediate death of ethanol, certainly it's been handed its hat," says Kevin Kerr, editor of online commodity newsletter Resource Trader Alert. "I would say that this is probably the peak for corn-based ethanol politically and financially."

Stock prices for many ethanol manufacturers have been under pressure this year, though it's mainly the smaller producers that have suffered.

Archer Daniels Midland , the largest ethanol producer, has seen its shares gain marginally in 2008 and nearly 15 percent over the past year. ADM, of course, is a highly diversified company that doesn't rely on ethanol as the core of its business.

But other companies that focus mainly on ethanol production haven't been as fortunate.

The Evil of Ethanol

VeraSun Energy has seen its stock tumble 56 percent in 2008. BioFuel Energy is off 41 percent. And Pacific Ethanol, in which Microsoft founder Bill Gates holds a 25 percent stake, has plummeted nearly 60 percent.

At the same time, the public's loss of favor toward corn-based ethanol doesn't bode well for the industry as it approaches the inevitable loss of one of its biggest advocates—President Bush—and faces the uncertainty of the next administration. Last year Bush signed the Renewable Fuels Standard into law, which dictates the production of 36 billion gallons of ethanol by 2012.

None of the three remaining presidential candidates has expressed much fondness for corn ethanol, and there is speculation that the new president will revisit how much alternative energy will come from corn ethanol.

"Corn-based ethanol will be another disaster for the Bush administration," Kerr says. "The new administration will be able to come to the rescue with things that are more practical."

Blame Pricey Energy for Pricey Food, Industry Says

Yet many in the industry still express faith that ethanol can forge ahead, even in the wake of bad publicity, dubious economics, questionable environmental benefits, difficulty in securing credit, and an uncertain political landscape.

Neil Kohler, CEO of Pacific Ethanol, which needed a $40 million cash infusion to shore up its balance sheet earlier this year, said the industry is being victimized by misinformation.

"I'm an optimist and I believe that over time, truth prevails," Kohler says. "The increased price of fuel has had more than twice the impact on the rising price of food than has the raw materials, the cereal grains. Whether it be the loaf of bread or gallon of milk, the oil price has been driving the price of food."

Yet the companies that have kept their heads above water have done so because the cost of ethanol has risen right along with the cost of gasoline, and sales have sustained profitability.

"The raw materials cost certainly has risen. Fortunately, the price of ethanol has moved right along with it," Kohler says. "It's all related to oil. The high price of corn is all about oil, the higher value of ethanol in the marketplace is all about oil—all of these things are interconnected. They've all been sort of keeping pace with one another in a rapidly upward trend."

PEIX CEO on Ethanol

In the meantime, ethanol production forges ahead.

Some 61 new facilities will add five billion gallons of ethanol to the fuel stream in the next few years, says Renewable Fuels Association spokesman Matt Hartwig, while more than 15 planned facilities have been scrapped.

Hartwig acknowledges that construction has slowed, due both to ethanol's inherent problems and the credit crunch gripping the banking industry.

But as things stand now, 134 ethanol plants are producing 7.2 billion gallons a year, just a shade below the 7.5 billion gallons the federal government's target for 2012.

"Certainly you have seen a little bit of a slowdown in new construction," Hartwig says. "The Renewable Fuels Standard passed in December is specific and pragmatic in its approach, recognizing that given today's technology there is a limit as to how much ethanol can be produced from corn."

The government agrees. The RFS dictates that fully 21 billion of the 36 billion gallons of ethanol produced by the 2012 target date must come from sources other than ethanol, even though no cellulosic ethanol plants—those that would process ethanol from crops other than corn—are currently in operation.

Meanwhile, finding new financing to produce all this new ethanol remains a struggle.

"It's very hard right now to get financing because of some of the restructuring of credit issues and weakening profitability estimates," says Rick Kment, biofuels analyst at DTN in Omaha, Neb. "At the same time, plants that already had financing secured continue to move forward through the construction phase and continue to plan on opening doors at or near the time when they were supposed to start operating."

Ethanol and Washington: A Relationship on the Rocks

But all that worry about financing issues could become irrelevant should ethanol lose its political support.

After a decades-long courtship, the marriage between ethanol and Washington is teetering on an ugly divorce.

At the very least, the next administration, regardless of who wins in November, is certain to mount an aggressive campaign to find alternatives to corn ethanol. That would come primarily from cellulosic ethanol, which is produced from switchgrass, wheat, oat, barley and waste products. But to some extent, such ethanol faces the same criticism from those who oppose the idea of taking products out of the foodstream and converting them into liquid fuels.

The growing discontent over ethanol could well mean that nuclear energy will emerge as a stronger alternative, especially if Republican John McCain is elected.

"He really thinks corn-based is a fine alternative, but he doesn't think it should be singled out," says McCain senior policy advisor Douglas Holtz-Eakin. "He'd like to see a world where the alternatives are on a level playing field ... without this picking of a winner."

Democratic candidates Barack Obama and Hillary Rodham Clinton did not respond to repeated requests for comment.

Obama's Web site does not mention corn ethanol in his energy plans. He does pledge to meet the current RFS number and carry it to 60 billion gallons by 2030. But he mentions only cellulosic ethanol, and pledges "tax incentives, cash prizes and government contracts" to meet his biofuels goal.

Clinton's site also calls for a 60-billion-gallon RFS by 2030. Interestingly, her energy plan does not use the word "ethanol" at all, making reference only to "biofuels" without differentiating between corn or cellulosic ethanol.

Yet even in such a climate of political, economic and social turmoil, industry insiders are still hoping for a brighter future ahead, one that includes a balance between energy and food needs.

"As long as ethanol keeps going up, we're OK. It's not a great margin in this business, and we have seen marginal plants shut down," Pacific Ethanol's Kohler says. "We believe that there is very strong bipartisan support for the growth of a vibrant renewable fuels business in this country, given the conservation and environmental value that ethanol is bringing to the economy. We're not concerned that support will change."