Ethanol makers have had a tough year despite the soaring price of crude and products that have put ethanol's gasoline blending abilities in high demand.
The most recent sign of trouble came last week, when big producer VeraSun, considered a bellwether for the industry, effectively put itself up for sale after some hedges went south.
The company then announced an equity offering, but the market was skeptical VeraSun could generate enough cash as its share price sank to new lows.
Credit rating agency Moody's, which cut its VeraSun corporate family rating to B3 from B2 and left it under review for further downgrade, questioned the company's ability to tap equity markets. If VeraSun had difficulty selling its shares, Moody's warned it "would likely lower the company's ratings by multiple notches."
As the stock market tumbled, VeraSun suspended its planned offering and instead said it had hired Morgan Stanley to evaluate undisclosed "strategic alternatives."
VeraSun's hedge loss revelations highlight the tough spot many ethanol producers are in as they try to balance hedges for commodities straddling the agricultural and energy sectors--corn, natural gas and ethanol.
For VeraSun, corn was the biggest issue in the third quarter.
The company said in a securities filing September 16 it had exited short corn hedges in July after bad Midwest weather hurt crops and drove corn prices almost $2/bushel higher. They then bought their corn at market prices that were "significantly higher" than the current price of corn.
In addition, the company said higher corn price forecasts drove it to enter into "accumulator" contracts for the third and fourth quarters that allowed it to buy a specified volume of corn at prices below market rates, but also required VeraSun to buy the same volume of corn if market prices dropped to or below the price it paid for corn on those contracts.
"Shortly thereafter, corn prices commenced a sharp decline from almost $8.00 per bushel to a low of under $5.00 per bushel in mid-August 2008," said VeraSun. "As a result, we were required under the accumulator contracts to purchase additional amounts of corn at prices that proved to be higher than prevailing market prices."
Corn hedges also caused a "disastrous event" in August for Cargill-backed ethanol maker BioFuel Energy, according to BioFuel Chairman Thomas Edelman, who took the blame as " a major misjudgment on my part." The company was hit by $46 million in hedging losses for corn, ethanol and natural gas in July and August.
Also last month, Moody's spotlighted problems at Northeast Biofuels, owner of the first big ethanol plant in New York state. An EBITDA hedge based on ethanol, corn and natural gas was "terminated," according to Moody's. "Now that this protection has disappeared, credit risk has increased."
No further details were given on why the hedge was eliminated and the company did not respond to requests for comment.
VeraSun's strategic options include an outright sale or going private, according to Raymond James analyst Pavel Molchanov. He said in a report that VeraSun could be acquired by an ethanol industry or conventional energy company buyer, or "exit the public arena altogether via a private transaction, for instance a management buyout."
The only ethanol industry buyer big enough to afford VeraSun, despite the company's current discounted value, is Archer Daniels Midland, he said. But the giant agribusiness company would likely face anti-trust issues.
An ADM spokeswoman said the company does not comment on speculation.
Of the conventional energy companies, an independent refiner or integrated major could step forward to expand into ethanol, which is mixed with the gasoline it produces, said Molchanov, "but the counter-argument here is that they currently make better margins from ethanol blending than what ethanol producers are generating."
I cannot believe the federal government's mandate to supply a certain quantity of Ethnol in a certain period of time. John McCain said that he would stop the gov. particpation of Ethnol. VSE has broken all records to meet the needs of this country. Now Wall Street ran up the price of corn without knowing the potential of production and a company like Vse's ability.We are worring abould Wall Street? False rumors about Ethnol will jeapeordise our food supplies. They simply don't know anything about this country's ability to produce corn and the yield of per acre that is possiable. How about the 32 billion dollars paid growers not to produce to their capabilities? I have no sympathy for the lying bunch...in politics and the stock market. You'd better think twice about the action in process in Washington.