Ethanol Recovery Faces Oversupply Repeat

By MARA LEMOS STEIN
With ethanol margins staging a recovery this year, it was only a matter of time before producers were encouraged to restart idled facilities and expand output to join the bonanza.
The latest addition to the supply flow—Valero Energy, which announced last week that it will bring three facilities back online—adds to concerns that if too many people come to the party some of them will find the punch bowl emptying out fast.

"There are significant volumes of both idled and under-construction assets, and if operators are emboldened by the recent ethanol margins, we could see less-than-optimal assets begin to be reintroduced to production," Ian Horowitz, an analyst at New York-based securities brokerage firm Rafferty Capital Markets, said in a recent report. "Bottom line: we are concerned that we could possibly see oversupply of ethanol in the second half of 2010."
Steady ethanol prices and relatively low corn and natural-gas prices are putting producers in the black for the first time since mid-2008. The fact that various producers in financial distress suspended production since then has supported ethanol prices even as demand for gasoline, in which ethanol is blended at a 10% rate in the U.S., dropped during the economic slowdown.
However, some analysts are wary of a repeat of the excess supplies that decimated profit margins in 2008 and put at least a dozen producers into bankruptcy.
In recent weeks, producers announced intentions to restart plants with about 400 million gallons in production capacity. Corn ethanol installed capacity is roughly 13.1 billion gallons a year, with about 1.2 billion gallons of capacity idled, according to the Renewable Fuels Association, or RFA, a trade group. Expansion projects point to an additional 1.4 billion gallons of supply on the way.

"Margins have been good, but how long will it last … unless demand picks up?," asked Jinming Liu, analyst at New York-based research firm Ardour Capital Partners.
Another factor underpinning expansion is the Renewable Fuel Standard program, which requires that refiners blend 12 billion gallons of corn ethanol in 2010, up from 10.5 billion gallons this year. In addition, there is a potential increase in the blend rate to 15%, which the Environment Protection Agency is considering at the request of producers.
The largest in the parade of new production is Valero. Its subsidiary, Valero Renewable Fuels, agreed to purchase three plants with a combined 330 million gallons of capacity that had been idled. This adds to Valero's ethanol portfolio and makes it one of the largest producers in the country, with an installed capacity of 1.1 billion gallons. Valero's growth in ethanol started in March, when it acquired seven facilities from bankrupt VeraSun Energy.
Archer Daniels Midland, another large ethanol producer with 1.1 billion gallons of capacity, is starting a new 275-million-gallon plant in Columbus, Neb. An ADM spokesman said the company's other 275-million-gallon plant, in Cedar Rapids, Iowa, will start operations later in 2010. He said the company doesn't discuss details of operational capacity
Another producer considering firing a facility back up is Pacific Ethanol, whose four operating subsidiaries have been under bankruptcy protection since May. The company last week received court approval to get its 60-million-gallon Magic Valley plant, in Burley, Idaho, back on line. The facility was shut in February as poor ethanol production margins took their toll.
If excess supplies materialize, one potential outcome will be that the most efficient producers waddle through depressed margins until the smaller producers are flushed out, which will help keep production output close to the mandated levels, Rafferty Capital's Mr. Horowitz said in his report.
Write to Mara Lemos Stein at mara.lemos-stein@dowjones.com