Bush's Ethanol Bid Is Ignored by Exxon in Bear Market (Update1)

By Marianne Stigset and Bruce Blythe

Jan. 29 (Bloomberg) -- If President George Bush thought he had the remedy
for America's oil woes when he proposed an increase in ethanol production,
he's getting no support in the boardroom of the world's biggest energy
company and no respect in the stock market, where producers of the
corn-based fuel are among the biggest losers.

The State of the Union address Jan. 23 made ethanol the centerpiece of a
plan to reduce gasoline consumption 20 percent in 10 years by raising the
federal mandate for renewable-fuel use almost fivefold to 35 billion
gallons a year by 2017.

Shares of ethanol producers Archer Daniels Midland Co., Pacific Ethanol
Inc. and Xethanol Corp. have lost between 25 percent and 63 percent of
their value since July 14, when oil peaked at $78.40 a barrel. Pacific
Ethanol fell another 3 percent since Bush addressed the nation last week.

Exxon Mobil Corp., the world's largest publicly traded energy company,
considers ethanol irrelevant as a solution to an addiction that forces the
U.S. to import two-thirds of its oil. No ``viable, meaningful business
proposition'' exists for Exxon in ethanol, Senior Vice President Stuart
McGill told investors at a Jan. 17 conference arranged by Goldman Sachs
Group Inc.

``The nature of the science as it stands today and the technology involved
requires significant forms of subsidies and mandates to make a lot of
sense,'' McGill said in New York, dismissing an industry that counts
Microsoft founder Bill Gates and David Rubenstein, co-founder of the
Carlyle Group, the private equity firm, among its biggest enthusiasts.

Poor Substitute

Ethanol, after almost doubling in price in five years, is falling as prices
for corn, the main raw material for the fuel in the U.S., reach the highest
in a decade. Crude oil has tumbled 29 percent from its July record to
$55.83 a barrel, as of 10:19 a.m. Singapore time, cutting gasoline prices.
Oil must be above $70 for ethanol to be profitable, according to research
by Sanford C. Bernstein & Co.

``The gold rush is over,'' said Michael Liebreich, chief executive officer
of London-based New Energy Finance Ltd., which advises investors in clean
energy. ``Many of the new plants that have been announced will never see
the light of the day.''

Ethanol cost $2.04 a gallon in the U.S. on Jan. 17, based on data from
wholesale distributors in Des Moines, Iowa, and other Midwest locations, 41
percent more than unleaded gasoline, before taxes. What's more, ethanol
produces only 70 percent as much energy as petroleum.

`Not a Good Thing'

Ethanol is distilled from crops and used as a substitute or additive to
gasoline. In the U.S., ethanol comes from corn, while Brazil, the world's
biggest producer and consumer of the fuel, makes it from sugarcane. More
than half the cars in Brazil can burn ethanol.

Corn-based ethanol ``is not a good thing,'' Jose Sergio Gabrielli, chief
executive officer of Petroleo Brasileiro SA, Brazil's state-controlled oil
company, said in an interview last week at the annual World Economic Forum
in Davos, Switzerland. ``It's not as energy-efficient as sugar and there's
big protection for corn in the U.S.''

The U.S. government gives refiners and wholesalers a 51- cent tax break for
every gallon of ethanol that's blended with gasoline. To limit supplies and
bolster prices, a 54 cent-a- gallon U.S. tariff on imports blocks shipments
from countries outside the Caribbean and Central America.

Ethanol's backers, who include Gates, the world's richest man, and the
Carlyle Group, point to price gains and the more than doubling of U.S.
ethanol use between 2000 and 2005. Even after the seven-month plunge,
prices have jumped 93 percent in the past five years.

Rubenstein Undeterred

``Alternative energy is necessary,'' said Carlyle's Rubenstein in an
interview in Davos last week. ``It's a pretty good area to invest in.''

Carlyle and Riverstone Holdings LLC in September unveiled plans to produce
``hundreds of millions'' of gallons of ethanol in a venture with White
Plains, New York-based Bunge Ltd., the world's largest oilseed processor.

Reviving ethanol requires a breakthrough in technology that would make
current processes more efficient or cut the cost of so-called cellulosic
ethanol, made from corn stalks, wood chips and wild grasses. Switch grass,
for example, could yield 1,000 gallons an acre, more than double that of
corn, Bernstein said.

Exxon Mobil helps fund research into cellulosic ethanol at Stanford
University in California.

``We believe for ethanol to play a more significant role on a larger scale
that technological advances are needed on cellulosic,'' said Exxon Mobil
spokesman Mark Boudreaux.

Not Enough Corn

Vinod Khosla, the Menlo Park, California-based venture capitalist who 25
years ago helped start Sun Microsystems Inc., likens his ethanol
investments to the early days of the Internet.

``In the long haul, this is going to be a large market, and we should be
investing in it,'' he said in an interview last week. ``When the dot-com
bubble burst, I didn't feel like we needed to change our Internet plans,
and guess what, one didn't need to.''

Skeptics say ethanol will never become a significant part of energy use in
the U.S. because the country can't produce enough corn. Based on current
use, reaching Bush's 2017 goal would require more than 12.5 billion bushels
of the grain, more than the nation's entire harvest last year. No grain
would be left for hogs, cattle or chickens, or to make corn-based
sweeteners for Coca-Cola Co. and other consumers.

Prices Drop

As demand for the corn needed to make ethanol increased, grain prices
jumped. Corn is at the highest in a decade and may gain another 38 percent
to a record $5.50 a bushel as inventories shrink, according to Jim Gerlach,
president of AC Trading Inc. in Fowler, Indiana. By the end of August, U.S.
stockpiles may plunge to 725 million bushels, the lowest since 1996, the
U.S. Department of Agriculture forecasts.

``The economics of the sector are looking pretty ropey,'' said Richard
Lucas, an analyst with natural resources fund Ambrian Partners Ltd. in
London. ``Crude oil has gone back, feedstocks such as corn have gone up.''

The six-month decline in oil has slowed demand for ethanol, leaving
producers of the fuel struggling to make a profit.

The margins in the biofuels industry ``are really coming under pressure,''
said Matthias Fawer, an energy and food analyst at Zurich-based Bank
Sarasin & Cie AG. ``We might see some halt in the expansion of capacity.''

The price of corn at which some ethanol refiners stop making money is $4.50
a bushel and the price at which they stop producing is $5. Corn ended last
week at $4.055 a bushel in Chicago.

``The best investment of the time being is in farmland,'' Brodie said.
``This is very good news for farmers and it's bad news if you're an ethanol
refiner who hasn't hedged.''

Gates's Loss

Shares of Pacific Ethanol, in which Gates is the biggest holder, have
slumped 61 percent since their May 11 record. The stock of Aventine
Renewable Energy Holdings Inc. has dropped 59 percent since a June 28
initial public offering. Verasun Energy, which had the biggest IPO of any
U.S. ethanol company, has lost 42 percent since the offering June 13.

Among the losers in ethanol is Provident Investment Counsel, a Pasadena,
California-based mutual and institutional fund company that manages $3.09
billion. During the third quarter, Provident unloaded its 4,600 Aventine
shares, according to U.S. Securities and Exchange Commission filings.

``Capacity is coming on line a lot faster than demand is anticipated to
grow,'' said Ned Brines, a portfolio manager at Provident, in an interview
last week.

Thomas H. Lee Partners LP's Hawkeye Holdings, an ethanol producer in Iowa
Falls, Iowa, put off an initial stock offering last year, as did Global
Ethanol Holdings Ltd., a Brisbane, Australia-based producer of sugar-based
fuel, which scrapped a $350 million IPO on the eve of the deal.

`Like Tech Bubble'

``The new ethanol mandate raises insurmountable challenges spanning all
levels of the supply chain, from the corn field to the automobile,''
Antoine Halff, a former analyst at the Paris- based International Energy
Agency now with Fimat Inc. in New York, wrote to clients last week.

Corn comprised about 45 percent to 50 percent of the cost of production for
U.S. ethanol makers during the fourth quarter, according to Credit Suisse
Group. Corn has been the second-best performing commodity of the past 12
months, behind only nickel.

``Biofuels is rather like the tech bubble of the commodities,'' said
Christopher Wyke, who helps manage Schroders Plc's $100 million commodity
fund in London. ``The trick is to identify which one or two companies will
have a breakthrough in the biofuels refinery technology. If the technology
doesn't work, they could go bust.''

To contact the reporters on this story: Marianne Stigset in London at
mstigset@bloomberg.net ; Bruce Blythe in Chicago at bblythe@bloomberg.net .

Last Updated: January 28, 2007 21:44 EST