What does the entry of the largest U.S. oil refiner into the ethanol patch mean for corn growers? Not much, really. Discounted plants and a continued mandate for refiners to blend ethanol into their fuel have strengthened ties between oil and ethanol…and corn.

“To them, an ethanol molecule is a gas molecule,” says Ag Star Financial Services ethanol analyst Mark Schmidt, Mankato, MN, of oil companies.

Valero, San Antonio, TX, paid about 30% of what it would have cost to build its seven former VeraSun plants from scratch. Add to that Sunoco's purchase of the former Northeast Biofuels plant in Volney, NY, and Marathon Oil's purchase of plants in Illinois and Ohio to bring oil companies' ownership of U.S. ethanol plants to 7%, according to the Associated Press.

This trend “means oil companies believe that the ethanol business has matured and become low-margin,” Schmidt says. “When they're willing to invest in ethanol assets, it's because it's cheaper than refining gasoline.”

It's hard to assess this ownership change “without first weighing the health of the ethanol industry as a whole,” says Wally Tyner, Purdue agricultural economist who closely follows the ethanol industry. “The Valero purchase is just one part of the puzzle. Ethanol industry profits are so low that many plants aren't covering their cash costs, and covering their debt costs is a dream. About two-thirds of ethanol plants are profitable right now. About 2.2 billion gallons' capacity is shut down, with another 3.4 billion gallons in desperate straits, by one account. That's half of the U.S. ethanol capacity in trouble.”

Add to that a disappointing second quarter for the oil refining industry, due to low gasoline demand.

Looking beyond refiners to the major oil companies' involvement in ethanol, Tyner says, “The majors are less interested in corn-based ethanol than in second-generation biofuels. All of the majors except for ExxonMobil are researching cellulosic biofuels; both the thermochemical and biochemical pathways to make butanol, bio-gasoline or biodiesel from cellulose. Those products are compatible with existing petroleum pipelines.”

(ExxonMobil, the largest blender of ethanol in the world, has a $600 million partnership with biotech company Synthetic Genomics, Inc., to research and develop next-generation biofuels from photosynthetic algae.)

The Obama administration has signaled its intention to support advanced biofuels made from biomass. “Corn is not the right crop for biofuels,” says U.S. Energy Secretary Steven Chu. In July the Energy Department announced that $786.5 million in stimulus funds would be used to speed advanced biofuels research and demonstration projects.

“There is plenty of economic potential for corn growers on the cellulosic ethanol side,” Purdue's Tyner says. “I don't see a likely scenario with much additional investment in corn-based ethanol; it's a mature industry. There comes a point where corn prices choke off ethanol. The big growth potential for corn growers is corn stover-based ethanol. Our studies show that future biofuel plants will turn to stover long before other feedstocks. We project Indiana farmers earning $40/ton for stover compared to $60/ton for switchgrass.

“If we don't solve the blending wall barrier, it will be hard to top 12 billion gallons in annual ethanol production. Presently we're approaching 13.4 billion gallons of capacity, but only about 10.5 billion of actual production. The blend wall is already here in the Midwest and some other areas. Because of the blending constraint, the market cannot absorb all the ethanol that could be produced. That drives down ethanol prices to the breakeven equivalent of corn,” Tyner says.

WHAT MAKES THE difference in ethanol profitability, says Ag Star's Schmidt, is that the price of gas has increased in the past year, while ethanol has only gone up by 35-40¢/gal. “It's a great opportunity for blenders (refiners) to use more ethanol to increase their profitability. However, there is still an overhang of a very large ethanol surplus. Out of 190 ethanol plants, 20-24 are idle for various reasons,” he says.

Given the global recession, though, “Valero might be swamped by the economy and new energy policies,” says Michael Swanson, senior ag economist at Wells Fargo.

Returning the shuttered Valero plants to full production would provide a market for another 316 million bushels of corn. How likely is that?

“It would take a sharp increase in gas prices or a sharp drop in corn prices to improve the economics of the industry,” says Richard Brock, president of Brock Associates, Milwaukee. “Yet, the ethanol tax credit and tariff will stand, and that's what the industry needs. I'm not sure we'll have the ethanol capacity to meet the RFS mandates in the next two years, and the incentives aren't there to develop more domestically. I don't anticipate any plants starting construction in the next 18 months.

“There are a lot of interesting technologies for ethanol made from alternative sources, like switchgrass and algae, but we are five to 10 years away from that,” Brock says. “We're going to have ample supplies of corn, and as long as we do, the technology is not there to use anything else.”

THE TRANSITION TO biomass-derived ethanol will occur by 2019, according to an Iowa State University (ISU) report presented in Paris at the Organization for Economic Cooperation and Development (IECD). Entitled “Technology and Innovation in World Agriculture: Prospects for 2010-2019,” by Wally Huffman, ISU distinguished professor of agricultural economics, it can be accessed at http://ideas.repec.org/p/isu/genres/13060.html.

Valero “expects the plants to at least break even in 2009, and then be increasingly profitable in 2010,” says Bill Day, Valero spokesperson. “Valero is the largest refining and marketing company in North America, and we need a lot of ethanol to blend into the gasoline (to meet blending mandates of the RFS).

Valero plans to restart closed plants and run them at capacity,” he says. “We're also working with small biochemical companies on cellulosic technologies.”

THE BIGGER ISSUE

“If Obama shoots gas, he hits corn,” says Wells Fargo Senior Economist Michael Swanson. “Oil and corn are inextricably linked. The ethanol industry right now is running up a down escalator. U.S. demand for oil is down 5.2% from May 2007 projections, so the industry is missing 0.5 million barrels/day, he says. “If we add a carbon tax onto crude oil and subsidize hybrid vehicles, we could see demand shrink another 1 million barrels/day in the next three to five years. The ethanol industry has done a great job of expanding output, but we are in the face of a contracting market for fuels.”

VIEW FROM THE CAB

Floyd, IA, grower Pam Johnson reflects on the impact of Valero's purchase of her local VeraSun ethanol plant, where attractive corn contracts have been renegotiated. She is director of National Corn Growers Assn. Corn Board, chair of its Research and Business Development Action Team and director and former chairwoman of the Iowa Corn Promotion Board.

In the big picture, I'm so thankful every morning to see steam from the Charles City plant near us,” she says. “Corn growers and rural communities benefit from the economic stimulus when these ethanol plants are up and running. We would like to have them all resume robust full capacity. Increasing the demand for bushels of corn is critical to the profitability of the corn grower.

“Yet I cannot discount the pain of uncertainty and loss of value with the contract sales that were in limbo among farmers, elevators and VeraSun after its bankruptcy. There was a significant income loss when the plants changed and those contracts were renegotiated.

“Corn growers, ethanol plants and livestock producers are operating with razor-thin margins. Each sector needs to participate in the creation of value to be able to contribute and supply what the world needs for food and energy,” says the Iowa farmer.