Big Oil Makes Ethanol Splash

September 21, 2009 07:00 PM

Big oil has come to corn country, and it's not afraid to get its boots dirty. On a recent tour of their newly acquired ethanol plants, executives with Texas oil refiner Valero Energy Corporation donned aprons, grilled burgers and served them with a smile to local farmers in an effort to woo corn suppliers.

The nation's largest independent oil refiner plunged headfirst into the corn patch this year by gobbling up ethanol facilities for 30¢ on the dollar from bankrupt VeraSun Energy Corporation. It beat out ethanol giant Archer Daniels Midland with a $477 million bid to purchase seven ethanol plants in the Corn Belt.

 Until now, Valero had only procured ethanol, not produced it. The refiner bought state-of-the art plants in South Dakota, Iowa, Minnesota, Nebraska and Indiana for a fraction of what it would cost to build today.

The timing could not have been better for the ethanol industry, which faced a weak fuel market and tighter credit and desperately needed a cash infusion. The ethanol industry expects to idle about 12 billion gallons this year, according to the Renewable Fuels Association.

Mandate Key.
With the Obama administration mandate that refiners blend 36 billion gallons of renewable fuels into gasoline by 2022, the move makes business sense.

"I suspect if there wasn't a mandate, they wouldn't touch ethanol,” says Roger McEowen, director of the Center for Agricultural Law and Taxation at Iowa State University, who helped farmers during the VeraSun bankruptcy. "It's just not a profitable industry now.

"This is vertical integration, pure and simple,” he adds. "If they are going to be forced to blend ethanol as an oil refiner, they might as well own the source.”

 Valero had been looking at the move for some time. "We were already in the business as a purchaser, so it made sense to get in as a producer, especially at these prices,” says Bill Day, a spokesman for the company. "It has worked out better than we expected, since the ethanol plants have provided us cash flow when the recession has affected other business lines.”

Wooing Farmers. This year is all about building farmer relationships. Farmers who contracted with the former VeraSun facilities to sell corn were burned last year when the company declared bankruptcy, which voided all contracts.

Valero had no obligation to honor contracts signed when corn prices were much higher. But as a gesture of goodwill, Valero offered to pay farmers the spot price for corn, plus 40% of the difference between the spot price and contracted price with VeraSun.
"The majority of farmers we offered that deal to accepted it,” Day says. It provided farmers an above-market price for their corn.

Humboldt, Iowa, farmer Jay Lynch supplied corn to the former VeraSun Fort Dodge ethanol facility when it went bankrupt, and he was offered a deal by Valero to keep his contract. He appreciated the goodwill gesture and says it helped local farmers gain faith in the new owners. Lynch, however, was able to recoup his losses by working with the local co-op, which priced corn through Valero.

"I don't have any problems supplying the ethanol plant in the future, but since the bankruptcy with VeraSun, I guess I'm still a little gun-shy,” he notes.

Not Like the Others. Lynch also wonders what will prevent Valero from suffering the same fate as VeraSun. Day maintains that Valero is a much larger and more financially secure company. With annual revenue of more than $100 billion and 16 refineries scattered along the coasts (see map), the company has economies of scale to buffer the ups and downs of the ethanol and grain markets. It is No. 10 on the 2009 Fortune 500 list of America's largest corporations.

"This was a big deal in terms of entering the ethanol business, but ethanol represents a small portion of our business,” Day says.

Craig Schnupp, Valero's vice president for commercial operations, says the company will be much more of a cash grain buyer than VeraSun. Valero executives know something about buying and selling commodities; unlike integrated oil companies like Exxon Mobil, Valero doesn't produce oil and must buy 3 million barrels of crude oil each day to supply its refineries.

"We have been buying and selling commodities for many years, so we are just extending that experience to corn and ethanol,” Day adds.
Future Plans. Although Valero has staked a claim in corn ethanol, the refiner is also eyeing next-generation biofuels opportunities. Valero has invested in several companies that are developing biotech and cellu-losic technologies: One makes gasoline from landfill waste, another is developing biofuel from algae.

"All of the ethanol plants we purchased have the ability to add on new technologies as they become available in the future,” Day says.

Valero has made inroads in the wind industry too, installing 33 windmills to help power one of its refineries in Texas. The wind farm is expected to pay for itself in 10 years and cover the refinery's electric needs 40% to 45% of the time.

Valero is seeking community relationships. It has already made the commitment to run the former VeraSun plants at full capacity, and is preparing to roll out philanthropic activities in the rural communities surrounding its ethanol facilities. 

"We are not as well-known in the Midwest [as on the coasts], but we hope people are going to get to know Valero as more than someone who buys corn,” Day says.

Ethanol on the Rebound?

The U.S. ethanol industry shows signs of a rebound. "More sanity in energy and commodity markets, an improving economic situation and continued growing demand for ethanol have all helped contribute to a rebound in ethanol production,” says Renewable Fuels Association President Bob Dinneen.

Top Producer, September 2009

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