Wall Street sours on ethanol producers as glut looms

By Haitham Haddadin - Analysis

NEW YORK (Reuters) - A potential supply surplus and eroding margins are tarnishing the outlook for ethanol producer stocks that soared last year as the United States began a push to increase biofuel use.

Ethanol companies rushed to build new production capacity for the corn-based gasoline additive over the past year as strong demand pushed the implied internal rate of returns (IRR) on projects to 60 percent.

But return estimates have now fallen to just 8 percent as corn prices have surged on rising demand, clouding the once-sunny outlook for ethanol producers.

"I think we had 'new era' thinking last year," said Mark Flannery, an energy analyst at Credit Suisse. "I don't see any investable future for the ethanol producers."

Shares of big producer VeraSun Energy Corp. (VSE.N: Quote, Profile, Research, Stock Buzz), which kicked off at over $30 in mid-June 2006, now trade at $19. MGP Ingredients Inc. (MGPI.O: Quote, Profile, Research, Stock Buzz) is trading at half of last May's peak of $36, and Xethanol Corp (XNL.A: Quote, Profile, Research, Stock Buzz) fetched $2.33 on Monday, down 80 percent from a high of $11.55.

The picture looks even worse for smaller producers. Shares of Earth Biofuels Inc. (EBOF.OB: Quote, Profile, Research, Stock Buzz), which trade on the Bulletin Board, fetched 38 cents Monday, down 95 percent from their peak price of $7.23 in May 2006.

PRODUCTION SURGE

Ethanol production capacity could surge from the current 5.6 billion gallons per year to 8 billion by the end of 2007, according to the Renewable Fuels Association, an industry group. Capacity could then tip 11 billion bpy by mid-2008 if all 78 ethanol plants now under construction come on stream.