"Emerging as the major new customer for the American row-crop farmer, ethanol, more than any other single factor, explains the extraordinary boom in U.S. and worldwide agriculture in the past 5-10 years, as far as we're concerned," says Charlie Rentschler, machinery analyst for Wall Street Access.

Ethanol also fueled the record sales of farm machinery in 2007 and 2008.

But with three publicly traded companies in bankruptcy and few, if any ethanol producers, making any money, the industry is finding itself in a state of flux that, in all likelihood, will result in a smaller, but more viable producer base.

"It's like so many other things in that it unfortunately got overdone. Now we're feeling the consequences," Rentschler told Ag Equipment Intelligence.

"The industry isn't going to go away. It'll probably shrink somewhat with those left standing remaining marginally profitable. I suspect companies like Valero, the Andersons and ADM will be the kind of firms that will buy up a lot of these assets."

The 'Ethanol Paradox'

The USDA projects that 3.7 billion bushels of 12.1 billion bushels of corn produced in the fiscal-year ending this summer, or 31%, will go into producing ethanol. "Putting it another way," says Rentschler, "corn-for-ethanol is taking up about 10% of our entire crop ground.

Ethanol's rise has been "disastrous for livestock producers but great for row-crop farmers," he says. "Ethanol per se has, to our thinking, caused over the past few years the price of corn and soybeans to more-or-less double because they compete directly for acreage. And, because of the significance of American agriculture in terms of global production, the prices for grain and oilseed commodities have been driven up worldwide by the ethanol phenomenon."

'Entrepreneurial Spirit'

Rentschler points to the stand-alone, co-op owned Cardinal Ethanol refinery in Union City, Ind., which just came on-line last November. He sees this as a symbol of the entrepreneurial spirit that has been driving ethanol production, while at the same time demonstrating the limiting factors of relying on corn for ethanol.

One of nearly 200 ethanol plants constructed in the U.S. in the past decade, Cardinal raised the equity to construct its facility as local farmers bought shares at town hall-type meetings across eastern Indiana and western Ohio.

But in the past few months, all three of America's pure-play publicly owned refiners have filed for Chapter XI protection, including Aventine Renewable Energy, VeraSun Energy and Pacific Ethanol.

According to Rentschler, the Andersons, which has joint interests in 3 facilities, reported their ethanol business lost $3 million on just over $100 million of revenues in the first quarter, vs. a profit of $3.3 million in the year-earlier period. And Cardinal — though private and has about 1,200 shareholders and files quarterly reports with the SEC — recorded a loss of $500,000 on sales of $51 million in its very-first reporting period.

Price of Corn

The general manager of Cardinal told Rentschler in late May, that the price of corn is the industry's main problem. July futures on the Chicago Board of Trade was $1.77 per gallon of ethanol during the first week of June, vs. $4.42 per bushel of corn, or $1.62 per gallon of ethanol. Assuming a bushel makes 2.7 gallons of ethanol, this leaves a refinery with just $.15 per gallon margin after corn cost.

"While sales of the dry distillers' grain helps (it's tied pretty directly to corn), corn prices over the past 2-3 years have moved in very close correlation to oil prices, so this is a tough situation for the ethanol producers. Meanwhile, natural gas, a refiner's second biggest cost, has been behaving very benignly. Overall, this isn't a pretty prospect," the analyst says.

He notes that matters become worse for producers that have lots of debt, small plants and high transportation costs if they're located on a short-line railroad.

Where's It Heading?

In the near-term, Rentschler sees no real solution to the price/cost squeeze aff licting ethanol producers. "Our view is that the industry will survive via a massive shakeout. It's already started to happen."

The Renewable Fuels Assn. reports that the ethanol business is currently operating only 10.9 billion gallons of its 12.6 billion capacity. At the same time, Archer Daniels Midland

soon plans to bring on line two behemoth facilities — one in Nebraska with 500 million gallons of capacity.

"These plants likely will be the last corn-ethanol facilities built in this country. We believe the pace of plant shutdown will accelerate from here," Rentschler says.

"We expect that, just as Valero picked up 7 of VeraSun's facilities on the cheap, substantial firms, maybe other oil companies, will help consolidate this industry."

Hands Off

At the same time, Rentschler says that the government needs to take a hands-off approach and allow the industry settle out. "We disagree with those that think the answer is for Washington to raise the mandated blend-rate to 12-15% from the current 10% level.

"This country has no more capacity to grow more corn. Truth is, there isn't enough corn to go around right now. As a case in point, Cardinal, we learned recently, has to out-bid nearby ethanol facilities to get ample raw material they need.

"What Washington does need to do, in our opinion, is not mess with either the blend rate or the import tariff on Brazilian sugar-cane ethanol. Either one could really put the corn processors on the ropes," he says.

"While the problems in the ethanol industry will likely persist for some time, our confidence in U.S. agriculture remains high over the near and long term."