Aventine Renewable Energy Holdings (PINK:AVRW)

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Avinash Gandhi

Geoffrey Jordan

R.J. Gura

Aventine Renewable Energy Holdings, Inc. (PINK: AVRW) produces 10% of the ethanol made in the United States. Ethanol has received heavy support from the U.S. government as an alternative to gasoline, with subsidies making the production of corn-based ethanol profitable for domestic producers while import tariffs keep international ethanol producers (like those in Brazil) from competing. The Energy Independence and Security Act of 2007 targets, via subsidies, a five-fold increase in ethanol production by 2022, and Aventine, as one of the largest producers in the nation, is in a position to take advantage of rising demand for this fuel source.^[1]

Ethanol's momentum could slow or disappear, however, if a shift in public opinion fed by negative media coverage leads the government to back away from ethanol as a fuel source. Ethanol production has driven up corn prices, which in turn increases the price of food. Corn-based ethanol also ultimately uses more oil than an energy-equivalent amount of gasoline (because corn uses oil as a fertilizer), making it less carbon-efficient and even more petroleum-dependent than gasoline.^[2] Cellulosic ethanol is emerging as an alternative to corn-based ethanol, and Aventine has spend $600,000 in the past three years researching ways to produce it, but the company doesn't have any solid plans to enter the market yet.

Furthermore, running a car on ethanol requires a different type of engine not found in most cars on the roads, so making the switch from gas to ethanol would require replacing millions of vehicles. While gasoline today is 10% ethanol by volume, running a car on fuel that has a higher ethanol concentration would require a different type of engine. Though a few automakers are producing flex-fuel vehicles and ethanol companies are teaming up with refiners to bring the fuel to pumps around the country, there has not been any legislative support for these costly infrastructure changes. The 36 billion gallons of ethanol mandated by 2022 is less than 25% of the 160 billion gallons of gasoline used in the U.S. every year, making private industry unlikely to take the transition seriously.

On April 7, 2009, Aventine Renewable Energy Holdings filed for bankruptcy. On the same day, the company’s bondholders entered into a term sheet for a $30 million Debtor-in-Possession (DIP) Credit Facility with the company. The DIP Term Sheet provides for a first priority debtor-in-possession financing comprised of a term loan facility made available to certain of Aventine’s subsidiaries in a maximum aggregate principal amount of up to $30 million.^[3]

Company Overview

Aventine Renewable Energy Holdings primarily produces and markets ethanol in the U.S. Ethanol is a sugar-based biofuel that can come from a number of plant sources, and it is essentially a form of alcohol which produces energy when burned. In the current social and political climate, where people are worried about problems that stem from gasoline use (like climate change, terrorism, and oil prices), ethanol was once touted as the next major source of automotive fuel. Though it burns with only two-thirds of the energy of gasoline, it is relatively clean and is considered to be a renewable energy because it is most often made from corn (which can be regrown). Ethanol can also be produced from plant and animal wastes, known as cellulosic ethanol, which is generally considered to be more efficient and environmentally-friendly than corn-based ethanol.

As a secondary market function AVRW produces ethanol by-products such as corn gluten feed, brewers’ yeast, and distillers’ grain. In addition AVRW also markets bio diesel.

Aventine produced 197.5 million gallons and 188.8 million gallons of ethanol in 2009 and 2008, respectively.^[3] In 2009 and 2008, Aventine distributed 65.7 million gallons and 754.3 million gallons, respectively, of ethanol produced by others.^[3] The decrease in distributed gallons from 2008 to 2009 is attributable to the termination of the company's marketing alliance and substantial reduction in its purchase/resale supply operations in late 2008 and the first quarter of 2009.^[3]

Business and Financial Metrics

Second Quarter 2010 Results^[4]

During the second quarter of 2010, Aventine Renewable Energy reported total revenue of $96.9 million, down 18% from revenue of $118.1 million in the first quarter of 2009. The company reported a net loss of $9.3 million, down 81% from a net loss of $48.9 million in the year-ago quarter. Net loss per share was $1.06, compared to a net loss per share of $1.14 a year ago.

Trends and Forces

Aventine Greatly Benefits from U.S. Government Support for Ethanol

Aventine benefits directly from federal blenders subsidies of $0.51 per gallon.^[5]. In 2007, the average price at which Aventine sold its ethanol was $2.08 per gallon, while the company produced its ethanol at a cost of $2.22 per gallon.^[6] Without the subsidy, the company sees a loss of $0.14 per gallon and with it, the company turns a profit of $0.37 per gallon. The government subsidy is necessary for the company to make a profit with its current production methods.

In 2007, Congress passed the Energy Independence and Security Act of 2007, which mandates that renewable fuels production (ethanol) in the U.S. should increase from 2007 levels of around 4.7 billion gallons per year to 36 billion gallons per year by 2022. Though 21 billion gallons per year of this target are required come from cellulosic ethanol and other "advanced biofuels"^[7], that still leaves 15 billion gallons for the corn-based ethanol industry to produce every year - twice the estimated production for 2007.^[8] A federal tariff on imported ethanol of $0.54 per gallon should leave this demand to be met by U.S. companies. Mandated production increases and heavy corn-based ethanol subsidies make Aventine's industry very lucrative, though highly dependent on government support for continued success.

Corn-Based Ethanol Gets Bad Press for Raising Corn Prices and Requiring Oil to Produce

Since the Energy Policy Act of 2005, ethanol has been pushed as the next big biofuel. With oil prices shooting up in recent months, reaching $100/barrel at the New Year, consumer and government demand for alternative fuels has been increasing. As oil prices have risen, however, so too have corn prices; Aventine's average payment for a bushel of corn rose from around $2.41 in 2006 to $3.76 in 2007^[9], depressing its margins and making its fuels less price-competitive with gasoline.

Rising corn prices, aside from making ethanol much less cost-efficient, cause prices for many other foods to rise - corn is a major animal feedstock, forcing meat prices up, and high-fructose corn syrup is found in pretty much every mass-produced food product. Corn prices haven't just shot up on their own, however; petroleum is used as a corn fertilizer, making corn's price directly related to oil's price. Furthermore, demand for corn went through the roof because of the emerging ethanol market; it was the increased production of corn-based ethanol, demanded by the Energy Policy Act of 2005, that led 20% of all corn produced in the U.S. to go to ethanol production in 2006 - a rate that was surpassed in 2007^[10]. There is only enough corn in the U.S. to produce 15 billion gallons of ethanol per year^[11] - and some of that has to go to food production as well.

All these problems have lead to a wealth of bad press for corn-based ethanol; "The Clean Energy Myth", or some variation on it, has become a ubiquitous headline for newspapers and weeklies in recent months. As corn prices continue to rise, driven by oil prices and and capacity constraints, Aventine's margins will shrink; the backlash from the bad press related to ethanol's problems could ultimately harm the long-term prospects of the fuel source, as Congress may retract or amend its energy bills or U.S. consumers may simply not buy E85 cars when they are released.

Aventine May Enter the Cellulosic Ethanol Market

Aventine has spent $600,000 over the past three years on researching methods of producing cellulosic ethanol out of corn wastes, like husks. The company hasn't announced plans for a production facility, so it is well behind companies like Pacific Ethanol, who are moving into the cellulosic market to hedge against rising corn prices. If Aventine does eventually begin to produce cellulosic, it will benefit from a Cellulosic Ethanol Tax Credit, which became effective on January 1st, 2008, and gives a total government subsidy of $1.18 (for large producers) to $1.28 (for small producers) per gallon of cellulosic ethanol produced^[12] (this includes the $0.51 per gallon ethanol credit already in place). As public sentiment turns away from corn-based ethanol, Aventine will need to speed up its cellulosic program to effectively compete.

Cars Need Special Engines to Run on Purely Ethanol-Based Fuels

Most American cars can run on a mix of 90% gasoline and 10% ethanol, though there isn't nearly enough corn-based ethanol being produced to meet this capacity. Part of the goal of the government's support of ethanol is to increase ethanol production and use to a scope well beyond that of the standard 10% blend. E85, a blend of 85% ethanol and 15% gasoline, is the big hope for the biofuels industry because the widespread adoption of E85 would grow the level of ethanol demand almost as high as that of oil (for gasoline). There are, however, a number of blockades to the widespread adoption of E85 in the U.S.:

• E85 cars have been shown to run with an almost 50% reduction in miles per gallon - though this is measured in miles per gallon of E85, not of total gasoline^[13].

• There are over 247 million cars in the U.S.^[14], but very few of them are "flex-fuel" vehicles, which are compatible with E85. The prospect of replacing all of these with flex-fuel vehicles is staggering, and the automotive industry is dragging its feet at the idea of having to develop cost-efficient vehicles that are E85 compatible.

Without solutions to these obstacles, ethanol and cellulosic ethanol have no hope of being considered "replacements" for petroleum.

Competition

Aventine competes with other ethanol producers like Pacific Ethanol, VeraSun Energy, ConAgra, Nova Biosource Fuels, Verenium Corporation, and Bluefire Ethanol. Aventine is one the largest ethanol producers in the U.S., selling 10% of the country's total.

• VeraSun Energy's production capacity for corn-based ethanol, at 560 million gallons per year, represents 7% of the U.S. total^[15].
• Pacific Ethanol - Pacific Ethanol won $24.32 million from the Department of Energy to build the first cellulosic ethanol pilot plant in the Northwestern United States. The plant is expected to have a capacity of 2.4 million barrels per year^[16]. Currently, Pacific Ethanol is the largest manufacturer of corn-based ethanol on the west coast.
• Nova Biosource Fuels and ConAgra - ConAgra has agreed to have Nova use its animal wastes to produce biodiesel, and will purchase 130 million gallons of this biodiesel each year from the companies' joint venture to sell on international markets^[17]
• Verenium Corporation - Though Verenium started as an agricultural, industrial, and medical enzyme engineering company, it recently became heavily involved in researching enzymes to produce cellulosic ethanol, and will soon start construction of a 1.4 million gallon-per-year pilot plant in Louisiana and a 1.4 million liter-per-year pilot plant Osaka, Japan^[18].

References

1. ↑ Web page of Aventine Renewable Energy Holdings
2. ↑ http://www.coopamerica.org/takeaction/fordandgm/index.cfm
3. ↑ ^{3.0 3.1 3.2 3.3} Aventine Renewable Energy Holdings 10-K 2009
4. ↑ Aventine Investor Relations: AVENTINE RENEWABLE ENERGY HOLDINGS INC Form: 10-Q Filing Date: 8/5/2010
5. ↑ zFacts.com: "Subsidies for corn ethanol"
6. ↑ AVR 2007 10-K, Page 42, Calculated by dividing cost of goods by gallons produced
7. ↑ HR 6 Energy Bill Summary
8. ↑ Denver Post: "Not enough corn to fill Bush’s ethanol tank"
9. ↑ AVR 2007 10-K, Page 42
10. ↑ "Corn can't save us: Debunking the biofuel myth"
11. ↑ Denver Post: "Not enough corn to fill Bush’s ethanol tank"
12. ↑ "Salazar Lauds Passage of Finance Comm. Ag Tax Package/ Includes Ag Disaster Fund & Essential Ag & Energy Incentives", Point 3
13. ↑ Wikipedia: E85
14. ↑ http://en.wikipedia.org/wiki/Passenger_vehicles_in_the_United_States
15. ↑ VSE 2007 10-K, Page 3
16. ↑ Pacific Ethanol News Release: "Pacific Ethanol Wins DOE Cellulosic Energy Grant"
17. ↑ Seeking Alpha: "Look Out For Winners In the Transition from Petroleum"
18. ↑ Verenium News Release: "Verenium Corporation Announces Milestone Payment to the University of Florida for Cellulosic Ethanol Technology License"
19. ↑ VSE 2007 10-K, Calculated by dividing operating costs by gallons produced
20. ↑ PEIX 2007 10-K, Calculated by dividing cost of goods by gallons produced
21. ↑ AVR 2007 10-K, Page 42, Calculated by dividing cost of goods by gallons produced