I don’t actually enjoy posting “I told you so” stories, especially when the news is negative. This means someone has failed, and I don’t enjoy seeing people fail. But when I put a spotlight on a company, naturally I am going to follow that company. If it does fail, then that will be reported upon, as has been the case previously with Xethanol and later on with algal biofuel producer GreenFuel. If a company that I have cast doubts on goes on to success, I will highlight that as well, but I don’t believe that has happened yet. If Coskata proves me wrong, or Vinod Khosla goes on to great success as a biofuel magnate, I will write about it.
Today Pacific Ethanol (PEIX), one of the companies that I have tracked the longest, declared bankruptcy for Pacific Ethanol, Inc. This is not bankruptcy for the entire company, but it is bankruptcy for the ethanol plants themselves, which apparently leaves the marketing branches (Kinergy Marketing LLC and Pacific Ag. Products LLC) intact. I state that as a matter of fact, not with any smug satisfaction.* I recognize the people who work at these plants are hard-working people with families to support, and I don’t delight at seeing anyone out of work. As I told someone recently (in fact, we were talking about Pacific Ethanol and Coskata) “This is never personal. I am just stating my opinions.” With that preface, I offer my sincere condolences to all the people impacted by this development.
It was in July 2006, in the wake of a very positive article on investing in ethanol that I wrote an article for Financial Sense that suggested that ethanol stocks were overvalued. I focused on Pacific Ethanol, stating that I would “take a look at Pacific Ethanol to show why I think the underlying fundamentals make it a very risky investment.” Here was the problem as I saw it in a nutshell:
Another factor working against Pacific Ethanol’s success is the ability to secure cheap corn supplies for their plant. According to http://www.ethanol.org/FAQs.htm [RR: This link and the next one are both now dead], an important factor to consider when building an ethanol plant is proximity to corn. Local grain supplies, preferably within 50 miles of the plant, are important for keeping costs down. Yet California produces little corn. In recent years, California’s corn crop amounted to barely over 1% of the corn crop in Iowa (http://www.corn.org/web/uscprod.htm). This makes it likely that PEIX will have to import corn from out of state, driving up production costs. It will probably be cheaper for a producer to produce ethanol in the Corn Belt, and then ship the ethanol to California than it would be to ship the corn there and produce it locally. There is a reason that California is not a hotbed of ethanol activity, despite the fact that Californians consume ethanol. It’s too far from the corn, so it is more cost effective to ship in finished ethanol.
I just never thought they were going to be able to compete with the guys in the Midwest. When you ship all that corn from Iowa, you are shipping all of the waste products and all of the water as well. You end up with byproducts in greater quantities than the local markets can absorb. It always made more sense to me to produce ethanol in Iowa, feed the byproducts to cattle in the area, and ship the finished ethanol to California. To me, that was going to be the low cost producer for ethanol in California (with the possible exception of ethanol from Brazil).
On top of the geographical problem, the sector as a whole has been in big trouble as too many producers joined the party. While PEIX was at one time fairly well-capitalized, they were ultimately unable to withstand the problems plaguing the sector in general. My prediction is that the plants will end up being auctioned off as the Verasun assets were.
* OK, maybe a tiny bit of satisfaction toward people who suggested that since Bill Gates had invested in PEIX, I must be an idiot for criticizing it.