Ethanol producers say that dwindling oil reserves and increasing corn yields will make ethanol more profitable in the long run, but until then how will producers like Pekin, Ill.-based Aventine Renewable Energy Inc. survive lean times?

The industry outlook is "not good.  The entire ethanol industry is suffering,” said Micheal Tian, an analyst with Morningstar Inc.  “Margins in the ethanol industry are tight at best, unprofitable at worst.”

VeraSun Energy Corp., an ethanol company of comparable size to Aventine, filed for bankruptcy Oct. 31.

It has also been a difficult year for Aventine’s stockholders, their shares sliding from $13.08 Jan. 2 to Thursday’s close at $1.30.

So far Aventine has been able to survive partly through hedging of corn in the futures market, which kept the company out of the red by contributing over $18 million to the bottom line in the third quarter, but also has done damage such as a $14 million derivatives loss in the second quarter.

“Corn and ethanol were decoupled for most of the history,” said Aventine Chief Financial Officer Ajay Sabherwal in a conference call with analysts, “and we took a view on corn, which benefited us quite a bit for a period of time.  For these next few months it doesn’t.  Going forward… the two are relatively linked so we don’t see a reason to take a view one way or the other.”

On Sept. 30 Aventine held 39 percent of the corn it needed for the rest of the year, at an average price of $5.25 per bushel, well above corn’s close at $3.79 per bushel Thursday.

“They can be a bit cavalier about their risk management,” Tian said, pointing in particular to their corn investments.  “Sometimes instead of hedging they take more risk, because they have a definite opinion of what is going to happen.”

On the output side, a massive industry-wide buildup in ethanol production has temporarily overshot increased demand.

From January 2007 to April of 2008 the industry increased its capacity by 55 percent, while demand increased by 46 percent over the same period, according the Renewable Fuels Association statistics.  By July, the total domestic capacity for plants either in operation or under construction was 13.4 billion gallons per year.

Excess ethanol production “is something we have seen impact from the last year at least,” Tian said, “since we have had such a large buildup in ethanol production.”

Ethanol prices stayed low in 2007 as producers, responding to federal production goals and subsidies, flooded the market with new production.  The yearly average ethanol spot price slid 27 percent from $2.56 in 2006 to $2.02 in 2007.  Operating cash margins were down by over half industry-wide, according to the U.S. Department of Energy.

In 2008 the outlook improved, as ethanol prices began to rally and demand for ethanol continued to rise.  Then, in the third quarter, the floor dropped out from under the commodities market.

Chicago spot prices for ethanol plummeted from a high in June of $302.50 per barrel to an Oct. 24 low of $158.50 per barrel.  December corn futures on the Chicago Board of Trade fell from $7.88 per bushel in June to a close of $3.79 per bushel Thursday.

For Aventine, the margin between the cost of corn per gallon of ethanol and the selling price of a gallon of ethanol  contracted by more than 10 percent in the last year. 

As gasoline prices slumped in the third quarter ethanol became more expensive than gas.  Now ethanol blending currently offers only a marginal savings to petroleum refiners even after a production subsidy of 51 cents per gallon.  That subsidy is slated to be reduced by 6 cents per gallon in January 2009.

Aventine spokesman Les Nelson said that as the net cost of ethanol rises closer to the cost of gasoline, blenders will become less inclined to use ethanol beyond what is mandated by law.

However, lower demand could depress ethanol prices further and hurt margins, and some competitors, such as Pacific Ethanol Inc., have already been forced to halt construction on new plants.

Meanwhile, Aventine’s own construction of new plants in Aurora, Neb. and Mt. Vernon, Ind. is stretching resources thin.  Over the next three quarters Aventine will spend $134 million on capital improvements and interest on bonds.

Right now the company appears to have only $104 million available in cash and credit.  The rest will have to be raised from operations or additional credit.

In the previous three-quarter period Aventine raised enough money in operating income, $52 million, to more than cover the $30 million dollar shortfall.  However, shifting commodity prices have led to slipping profit margins for ethanol, and the company's third quarter earnings were down to about $2.5 million from $3.0 million a year earlier, despite a two-thirds increase in sales.

Part of the liquidity tightness dates to a 2007 investment in auction-rate securities made with cash from a $300 million bond issue that raised capital for the new plant construction.  The following year the auction rate securities market froze, and Aventine’s investment was in trouble. 

In the first two quarters of 2008, Aventine absorbed $31.6 million in losses from the sale of auction-rate securities.  As a result, Aventine has posted a year-to-date loss of more than $10 million.

The company is currently involved in a lawsuit with JP Morgan Securities Inc. over the investment.

In response to tightening liquidity, Aventine announced on Oct. 6. that it would push back completion of its Aurora plant. “The easiest way to free up liquidity is to slow down or stop construction of plants,” Aventine spokesman Les Nelson said.  “Our internal models show that we have enough liquidity, not a lot of excess liquidity, but enough liquidity to continue in business and eventually finish our plants.”

Analysts concur.

"We think it would be most prudent to delay construction of both plants until the balance sheet strengthens up,” Paul Y. Cheng and Mansi Singhal, analysts with Barclay’s Capital Inc., wrote in a report Nov. 3.

The delay at the Aurora plant puts the new completion date at the contractual deadline.  If the plant is not in operation by July 2009, Aventine will be responsible for damages to the Aurora Cooperative of $138,889 per month up to $5 million.  The Mt. Vernon facility has an earlier deadline of March.

At a total capacity of 226 million gallons a year, these new plants would more than double Aventine’s current capacity of 207 million gallons a year from plants in Pekin and Aurora, though Aventine also markets and distributes ethanol for other producers, which had a combined capacity of 600 million gallons per year at the end of September.

Eventually that added capacity will help Aventine remain competitive in what should be a growing ethanol market, but for now the struggle is in getting to that future.

“There’s no question, across the industry, the difference between not shut-in and shut-in at this point is someone made the wrong hedging decision,” Sabherwal, the chief financial officer, said in the conference call.  “Across the industry there is massive economic disruption and hundreds of millions of gallons are being shut-in.”