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Tickers in this Article: MGPI, PEIX, AVRNQ.PK, VSUQE, TSO, MRO, VLO, MMP
Last year was not kind to corn-based ethanol refiners or their investors. Unfortunately, it doesn't look like 2009 is shaping up to be any better. Last Wednesday, following on the heels of their rival Verasun (OTC:VSUQE), Aventine Renewable Energy (OTC:AVRNQ.PK) filed for Chapter 11 bankruptcy protection. With over $490.7 million in debt, Aventine has been struggling due to poor commodity hedging and a nearly frozen investment in auction rate securities. Last March, during Avertine's quarterly earnings release, the company reported that it would not have enough liquidity to pay a key $15 million interest payment or a $24 million payment to a major contractor. The company had less than a million in cash as of March 12. The news doesn't look any better elsewhere in the sector. West Coast's Pacific Ethanol (NASDAQ: PEIX) also announced that it is in default of a $250 million loan covenant and has until April 30 to renegotiate the terms. Smaller player, MGP Ingredients (NASDAQ: MGPI) has exited the fuel alcohol market completely.

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Future Outlook
The nation's renewable energy standard, as set forth by the Energy Policy Act of 2005, calls for at least 11 billion gallons of ethanol to be blended with conventional gasoline this year. That number steadily rises to 36 billion gallons by 2022. Cellulosic ethanol, or ethanol made from other biomass, is still in its infancy, contributing less than 300,000 gallons to the overall fuel market. The other option is importing ethanol made from Brazilian sugar cane, but this defeats the point as we're trying to stretch our own oil reserves with less reliance on foreign deposits. So corn-based fuel is here to stay, until the science behind cellulosic technologies becomes more mainstream and mass production becomes capable. (For more on biofuels, take a look at The Biofuels Debate Heats Up.)

The Way to Play
As with many sectors in the natural resource world, consolidation seems to be the name of the game and with biofuels and ethanol it is no different. With the recent bankruptcies and turmoil caused by the credit crisis, larger and better capitalized firms should do well in picking through the remains of the former pure players. The best bet for the investors wanting to buy into the space is to skip the few remaining straight biofuel businesses and buy into the large companies that have other operations besides the ethanol market. Interestingly enough, some of the better picks can be found in the oil and gas space.


Finding Some Petroleum Picks
Petroleum refiner, Valero Energy's (NYSE: VLO) recent purchase of seven ethanol plants from defunct Verasun for $477 million could be a sign of things to come. More and more diversified petroleum companies flush with cash could jump into the biofuels market at these fire sale prices. Valero paid just under 30 cents on the dollar for Verasun's assets. As one of the lowest cash cost producers of petroleum products, Valero should be able to apply the same economies of scale to its biofuel operations as its oil based ones. In addition, the company gains vertical integration benefits. Valero will be able to blend its own ethanol into its own refined gasoline and then sell it at its own gas service stations. It'll be interesting to see what other pure refiners such as Tesoro (NYSE: TSO) or Marathon (NYSE:MRO) do in the space.

Another interesting biofuel development is a proposed $3.5 billion ethanol dedicated pipeline. In conjunction with private ethanol company Poet LLC., crude pipeline operator Magellan Midstream Partners (NYSE: MMP) is undertaking the 1,700 mile project. By connecting the corn belt with the population dense markets in the northeast, Poet can overcome major inefficiencies in transportation and help drive down the pump cost for fuel type E85. If the pipeline is a success, as ethanol has some technical challenges due to its corrosive nature, look for other pipeline operators with midwest assets to follow suit. In the meantime, shares of Magellan offer about a 9% dividend yield while you wait.

Bottom Line
As long as the Energy Policy Act remains in play, and given the current administration's bullishness for alternative/renewable energy, ethanol will remain a part of United States' fuel consumption. However, given the recent market turmoil and lack of credit, some of the pure ethanol companies will find it increasingly hard to thrive. Investors wishing to participate in the space may find it better to invest in much larger and diverse energy concerns that have recently taken to biofuel refining. (If you're interested in more alternative energy companies, check out Five Companies Leading The Green Charge.)



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