By Chris O'Malley, The IBJ
During one day this month, Randolph County farmer Troy Prescott drove hundreds of miles to visit three western Ohio towns-gladhanding potential backers gathered at a VFW hall, an armory and a restaurant. And just a few days ago, in Fishers, he spelled out his vision to more than 50 people, some wearing suspenders and down-on-the-farm twangs. Prescott isn't running for Congress, but his 25-city road show to win investors in Cardinal Ethanol has all the fervor of a political campaign. The gist of his message: Invest at least $20,000 in his upstart Winchester refinery and you're investing in the future of the Midwest Motherland. The $151 million ethanol refinery it plans for Randolph County plans to buy up to 38 million bushels from Indiana and Ohio corn farmers each year to make 100 million gallons of alcohol as a gasoline substitute. "The profits stay in these local communities," said Prescott, Cardinal's chairman and president, who is trying to drum up at least $45 million from investors. Whether investors will see a prosperous return from the red-hot ethanol industry is another question, however. Observers say the industry remains highly speculative despite a frenzy of hype reminiscent of technology stocks during the late 1990s. A return on one's investment depends largely on gas prices remaining high and corn prices low, and state and federal tax breaks remaining in place. Record-high oil prices have helped make the gasoline substitute liquid gold as the primary ingredient in E85, a mostly ethyl alcohol concoction with a 15-percent dash of gasoline. About 6 million vehicles in the United States can burn E85, with automakers heavily promoting ever-more models capable of using it. Because E85 provides slightly lower fuel economy, the price of the fuel generally must sell at a 30-cent discount to gasoline to make it cost-effective for motorists. Also driving demand is the adoption of ethanol as a substitute for a gasoline fuel additive MTBE. It and ethanol both make gas burn cleaner. But many states have banned MTBE because it has been found to contaminate drinking water. Amid this seemingly insatiable demand for ethanol, a number of so-called biorefineries are springing up on the prairie. At least a dozen such facilities are planned for Indiana alone. Most are being built by national firms, such as Dallas-based ASAliances Holdings LP, whose plants will include one in Mount Vernon, in southwestern Indiana. But Cardinal is one of a handful of startups seeking local investors to secure and supplement bank financing to build the capital-intensive operations. Cardinal is among 34 new plants and seven expansions planned nationwide that will add 2.2 billion more gallons to the nation's 4.8-billion-gallon annual ethanol production industry, according to the Renewable Fuels Association. Investors put more than $14 billion in U.S. ethanol stocks in the last 12 months, according to data compiled by Bloomberg. Among them is Thomas Chronister, who poured $40,000 of his own money into Cardinal and joined the company's board. The Fort Wayne pharmacist and manager of Chronister Kendallville Drug said the prospect of energy independence from foreign countries and the economic development potential for his home state helped fuel his interest. "This is an industry that a state like Indiana can excel at," said Chronister, noting the state ranks fifth in corn production. "We're all very, very optimistic … . It's an industry that can't be exported to China." With demand for ethanol high, and with new technology to bring efficiencies to production, "it could be a great new potential industry in the state of Indiana," said L.H. Bayley, chairman of Indianapolis investment house David A. Noyes & Co. "Now the margins are here to perhaps justify these capital expenditures." But long-term success-the Cardinal plant won't be operating until 2008-hinges largely on whether oil prices remain high, Bayley added. One issue facing ethanol producers is that gasoline is still subject to price swings based on supply, said George Farra, a principal of Indianapolis investment firm Woodley Farra Manion Portfolio Management. He pointed to a drop in gasoline prices after Hurricane Katrina, as refineries came back on line. Farra said high gas prices of late are due partly to strong seasonal demand and because refineries couldn't convert from the phased-out MTBE quickly enough-both situations that won't last. "If the price of gas falls, it will become difficult to compete with that," Farra said. "It's going to be very difficult for those guys to have what I call a sustainable business without significant subsidies or a sudden decline in the availability of oil." Cardinal's Prescott is the first to admit the price of oil "is a risk." Still, he sees a "big window" of production and has in mind a number of ways to become more competitive. One is to use waste material from production, such as biomass from the corn crop, as a fuel to fire the plant-reducing the need for pricey natural gas. Another revenue source is the byproduct of ethanol production, distiller's grain, which is leftover corn kernel that can be sold for such uses as animal feed. Ethanol industry supporters point to another incentive: the 2005 energy bill that requires at least 4 billion gallons of renewable fuels be used in 2006-nearly doubling to 7.5 billion gallons in 2012. A number in the ethanol industry have made good money of late, with the average U.S. ethanol price up about 95 percent this year, when it hit a record $3.61 a gallon on June 13, according to Bloomberg data. "Right now, it's extremely profitable," said Jeremey Herlyn, a Cardinal director and investor. "We hope that continues. We anticipate it will." Herlyn said ethanol amounts to only about 3 percent of the nation's annual 143-billion-gallon gasoline consumption, giving it plenty of room to expand to at least 10 percent-a percentage cited by some of the most pessimistic analysts. He said public acceptance of E85 "flex fuel" vehicles and uses of ethanol as a gasoline octane enhancer portend more growth. But some on Wall Street see a cloud on the horizon. By the time many plants, like Cardinal's, come on line in 2008, supply might exceed demand by 1.3 billion gallons, according to a Standard & Poor's report issued last month. Of course, continued high oil prices could lessen the impact of an ethanol glut. "Right now, there is a real ethanol boom because the price is sky high. Probably by the time many of the plants being considered today get into operation, the ethanol price will have fallen considerably," said Wallace Tyner, a professor of agricultural economics at Purdue University. But, "If oil remains around $70 and corn does not go up too much, ethanol will still be profitable even after the current price bubble bursts." The volatile energy markets haven't scared away investors from other ethanol producers. The nation's second-largest distiller, South Dakota-based VeraSun Energy Corp., last month raised $420 million-more than double what it had expected. But while the shares rocketed as high as $30, they now trade around $24, just above their $23 offering price. Weeks later, shares of an initial public offering by Illinois-based Aventine Renewable Energy Inc. stumbled out of the gate, partly because the company boosted the sale price and put more shares on the market. That ruined the appetite for ethanol stocks among some investors, said David Menlow, president of New Jersey-based IPOFinancial.com. "Maybe the octane is coming off the ethanol bloom," he said. "The fact is that the investing public has not bought into the concept this is the new gasoline." Menlow said investors will be looking for strong financials from ethanol companies and likely will pick stocks of those that do more than just produce the fuel. More attractive will be those with vertically integrated divisions, such as ethanol distribution and service stations, for example. "It's really an industry that's just emerging" for investors, he said. One challenge facing Cardinal in raising money is that, unlike the companies that recently went public, it's a startup. Also unlike the other firms, its shares won't trade on a public stock exchange, making it hard to cash out, said Chris Baker, a principal of Oaktree Financial Advisors in Carmel. "I would probably tell a client, 'Don't invest more than you can stand to lose.'"
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