What's an ethanol producer to do?

As corn-based ethanol swung from a golden energy panacea to a villain driving food prices up and exacerbating world food shortages, Aventine Renewable Energy Inc. in Pekin, Ill., saw its stock plummet from a 52-week high of $18.52 last July to a 52-week low of $3.66 on April 23, an 80 percent decline. It's now selling around $5.50.

Shares of Sacramento, Calif.-based Pacific Ethanol Inc. fell from a 52-week high of $15.10 in July to $3.09 on April 24, also an 80 percent decrease.

The industry at large has not fared much better. William Caesar of consultancy McKinsey & Company Inc. notes that ethanol producers' stocks have tumbled an average of 40 percent to 60 percent since January.

“We went from irrational exuberance to despair in about 18 months,” Caesar said at a recent meeting about ethanol profitability.

Ethanol contracts on the Chicago Board of Trade, which peaked at $3.83 per gallon in June 2006, sank to $1.55 in September 2007 before rebounding to $2.41 at the end of May.

Ethanol boosters insist the declines are an overreaction. “I think the stock price doesn’t reflect the money that’s being made by ethanol companies over the last year,” declared Les Nelson, director of external reporting and investor relations for Aventine. “They are being weighted down by negative sentiment in the sector,” he surmised.

He insists that so long as the government mandates the blending of ethanol into gasoline, there will be demand for it.

Aventine’s bottom line suggests that it has navigated well the rising costs of fuel and corn--corn outlays up only 25 percent in 12 months thanks to effective hedging, while corn futures have risen since September by 64 percent at the Chicago Board of Trade to $6.11 per bushel. The company's sales for the quarter ended March 31 jumped to $510 million, a 16 percent increase from the year-earlier $436.7 million.  Although Aventine swung to a loss of $10.8 million from a profit of $14.9 million, it was caused by a $22-million impairment of investment securities; without it, Aventine earned 26 cents per diluted share, well above analysts' consensus estimate of 8 cents per diluted share.

For this year the analysts polled by Zacks Investment Research forecast earnings of 26 cents per diluted share, still hampered by the first-quarter impairment.  Last year Aventine earned 71 cents per diluted share on revenues of $1.57 billion.

Though Aventine is primarily an ethanol producer, it gets a boost from corn co-products. “Co-products is essential,” remarked Morningstar Inc. analyst Michael Tian., “It defrays a large percentage of corn costs. Aventine has more wet mills than competitors which increases their co-products at the expense of lower efficiency.”

Co-products are byproducts of ethanol production that can be used for both human and animal consumption.  This sideline is made possible, Nelson explained, by Aventine's use of wet mill technology. Though capital costs for a wet mill are higher than for a dry mill, the wet mill allows the corn germ, used for ethanol, to be separated from the kernel, which is sold for corn gluten feed and cornmeal. Aventine’s total co-product revenue in the first quarter was $33.3 million, up from $23.1 million in first quarter 2007. This gives the company more security as ethanol prices become more volatile.

Tian attributed the big difference between estimated and actual first-quarter earnings to the fact that the market is so volatile, and a “couple cents off co-products can be five or 10 cents in the earnings per share for each quarter.” He also said there is “little insight for each quarter,” as it is difficult to gauge how well an ethanol company is hedging its input commodities, like corn and oil.

Aventine, in fact, hedged well, spending an average of $4.50 per bushel in the latest quarter, though that was up 26 percent year-over-year from $3.58 per bushel.

While the company’s day-to-day operations remain largely favorable, investors are still left wondering what the future for the industry holds, particularly as support for cornstarch-based ethanol wanes.

Ethanol critics would like to see the government's Renewable Fuel Standard (RFS), which mandates and subsidizes ethanol production, requiring it to increase to 36 billion gallons by 2022, up from current production of about 7 billion gallons.  But Nelson insists that even without RFS, gasoline blenders would elect to incorporate ethanol because, given the current 51-cents-per gallon federal subsidy paid to the blenders, it's cheaper than oil.

Most industry observers are confident that cellulosic ethanol—ethanol fermented from the cell walls of corn stalks or inedible plants like switchgrass—will be the future. Some ethanol companies, like Irvine, Calif.-based BlueFire Ethanol Inc., have begun building cellulosic ethanol refineries. Cornstarch-based ethanol refineries can choose to retrofit existing plants to refine cellulosic ethanol, or they may choose to build a new facility.

Nelson said Aventine has had a cellulosic project underway since 1990, but, “when people talk about cellulosic ethanol it’s always right around the corner. It’s always five years down the road. Eventually people are going to get there, and with some money being spent today, it’ll probably be sooner rather than later.”

Tian of Morningstar echoes Nelson’s caution. “The critical issue is: what does it take to convert these plants, and what happens to corn prices and ethanol prices as some firms exit the market?” he posits. “If it comes to the point where it’s extremely difficult to convert plants and cellulosic ethanol becomes competitive, it will be catastrophic to Aventine,” but, Tian said, “that’s many, many years away.” He said cellulosic is probably an eventuality but first that industry must make feedstock production, transportation and fermentation economically competitive.

Cellulosic ethanol is getting a push from the recently passed Farm Bill, which allocates approximately $1 billion to ease the financial burdens of building biorefineries and by subsidizing farmers to begin growing cellulosic biomass like switchgrass and miscanthus grass.

But the industry still has to surpass technological and logistical hurdles to make cellulosic ethanol production both economically and environmentally efficient.

Aventine has taken a cautious approach to cellulosic ethanol. According to spokesman Nelson, “The pioneer gets the arrow and the settler gets the land. We’re going to wait until the technology is proven, and then most likely license that technology from someone else.”