by Ken Silverstein
Despite the promise of ethanol, owners of such plants are likely to receive "deep speculative" ratings from ratings agencies. That's what Standard & Poor's says about the fuel additive, which is "booming" because of favorable market conditions as well as supportive government regulations.
Ethanol has been experiencing positive growth. That's because some states have banned MTBE as an octane booster since it has been shown to pollute the groundwater. At the same time, ethanol producers have had the benefit of low corn prices in the last few years, which is the main feedstock for making ethanol. They have furthermore been the beneficiaries of high gasoline prices, which have meant better than anticipated margins. Finally, the fuel additive has received lucrative tax subsidies?something that is expected to continue at least until 2010. "As the industry grows in capacity and tries to find access to capital markets, Standard and Poor's is witnessing an increasing number of developers eager to fund construction of new facilities or expansion of capacity with long-term financing," of 20 years or more, says the report "U.S. Ethanol Industry is Booming, But Risky." The credit ratings agency, however, concludes "that industry dynamics will not allow these developers to structure their deals fit for long-term project financing with investment-grade quality."
Ethanol is a promising fuel additive. While it has less energy content than gasoline, experts say that it has a cleaner and more complete burn than gasoline. As a result, fewer emissions are leaving the car's tailpipe?meaning that fewer greenhouse gases are entering the atmosphere. And further, the corn-based fuel will supplant some oil imports, perhaps as much as 250,000 barrels a day by 2012, say supporters.
Meantime, ethanol got a lift when California banned the use of MTBE in 2003. More recently, New York and Connecticut have done the same. The overall result, according to S&P is that ethanol production grew to 2.8 billion gallons per year as of the end of 2003. That's up from 1.4 billions gallons per year in 1999. As of September 2004, production capacity soared to 3.4 billion gallons per year. About 80 plants are in existence and another eight are under construction.
The growth signs may be positive but they are dependent on a few external realities, some of which may be out of the control of ethanol producers. All in all, credit ratings focus on stability and predictability of cash flow to service the debt. That means that there must be a guaranteed margin for the life of the debt, or as much as 20 years. Without that guarantee, S&P says the rating will be "highly speculative."
Government Subsidies
Ethanol is now the recipient of a federal tax subsidy of about 52 cents per gallon, and will continue to get that benefit until 2010 unless it is extended. S&P maintains that the "industry cannot survive without this subsidy." Ethanol has also been the fuel of choice to replace MTBE, which some states are phasing out as a fuel additive. If that trend continues, S&P says production of ethanol could increase by 1.5 billion gallons per year.
Others question the value of ethanol. For starters, they point out that added farming contributes to top soil loss and more pollution associated with fertilizers. Considerable energy is used in the production of ethanol, causing critics to question its merit. Most of all, ethanol enjoys the support of powerful Washington lobbies that include the agricultural industry. "Ethanol gets a lot of government subsidy money in the form of a tax credit and less aggressive enforcement of pollution standards at production facilities," says Anne Keller, with the Jacobs Consultancy in Houston. "It's because of politics and not because the science shows it's by far the better solution."
Ethanol has been in use since the late 1970s but as the nation turns its attention to expanding the use of renewable fuel sources, its prominence has increased. With the petroleum industry's clout in Washington and its vertically-integrated corporate structure that has controlled most aspects of gasoline production, fuel additives have traditionally gotten short shrift.
Fuel additives and renewable fuel sources began gathering steam since it was discovered that MTBE, a gasoline additive made from methanol, contaminates ground water supplies. The oil refiners subsequently bargained to have mandated oxygen standards removed, arguing it would allow them to more effectively blend fuels and create a cleaner burning product. Now, the use of ethanol has moved to center stage.
"During the next 15 years, replacement fuels offer the greatest promise for reducing transportation sector greenhouse gas emissions," says a study released recently by the Pew Center, an independent opinion research group based in Washington, D.C. "Because replacement fuel blends are compatible with the ubiquitous existing fuel distribution and retailing systems, they could quickly displace some petroleum in transportation without having to overcome the transitional barriers faced by alternative fuels."
According to the report's authors, David Greene of the Oak Ridge National Laboratory and Andreas Schafer of the Massachusetts Institute of Technology, the key variable is that the ethanol must yield more energy than the fossil energy used to produce it, which it does, they say. Further, ethanol produced from corn in the United States reduces full fuel cycle?"cradle to grave"?greenhouse gas emissions by 30 percent compared to gasoline. That corresponds with similar findings from the National Center for Vehicle Emissions Control and Safety at Colorado State University.
Speculative Investments
Ethanol is a liquid alcohol fuel produced from biomass, which consists of trees, grasses and wastes. It also comes from grain or agricultural waste as well as natural gas. While ethanol creates fewer ozone-forming compounds and toxic air pollutants, it reduces mileage per gallon because its energy content is lower than pure gasoline.
It's an unknown as to whether ethanol can reach its potential. Not only is the industry at the behest of market whims and public policy, but producers' margins are notoriously thin while the underlying feedstock of corn and natural gas are subject to wide price swings. There is little that ethanol producers can do to mitigate such risks because no long-term fixed price contracts are available, says S&P.
End users of ethanol are typically large gasoline blenders, such as Shell Oil Co., ExxonMobil Corp. and BP. They usually use a 10 percent ratio for ethanol in gasoline to comply with government regulations. But, such conglomerates do not enter into long-term price contracts with regards to ethanol. So, S&P says the best alternative is to hedge against such exposure using futures contracts for unleaded gasoline because the two tend to track each other closely.
For those reasons, ethanol projects will remain speculative. But, producers will continue to lobby Congress and argue for favorable tax policies saying that ethanol production for transportation is good for the environment and energy independence.
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