As recently as last summer, plants that make ethanol from corn were sprouting across the Midwest. But now, with motorists driving less in the economic downturn, the industry is burdened with excess capacity, and plants are shutting down virtually every week.

In the meantime, plans are lagging for a new generation of factories that were supposed to produce ethanol from substances like wood chips and crop waste, overcoming the drawbacks of corn ethanol. That nascent branch of the industry concedes it has virtually no chance of meeting Congressional production mandates that kick in next year.

The decline in fortunes has been extreme for both kinds of ethanol since last summer, when $145-a-barrel oil appeared to shift fuel economics in their favor.

Only months ago, refiners in some regions were buying up as much corn ethanol as they could to blend with expensive gasoline, effectively keeping pump prices down slightly. Meanwhile, investors seemed willing to finance plants to produce next-generation biofuels.

But since the summer, oil and gasoline prices have plunged, while the price of corn, from which virtually all commercial ethanol in this country is made, has remained relatively high. Refiners are limiting their ethanol purchases to a level required to meet federal blending mandates – a level far below the industry’s capacity.

“The ethanol industry is on its back despite the billions of dollars they have gotten in taxpayer assistance, and a guaranteed market,” said Amy Myers Jaffe, an energy analyst at Rice University.

The government’s Energy Information Administration recently projected that the industry would fall short of the targets for expanded use of ethanol and other biofuels that Congress set in a 2007 energy law. “It’s possible we may have to look at the targets again,” said Senator Jeff Bingaman of New Mexico, the chairman of the Senate Energy and Natural Resources Committee.

VeraSun Energy, one of the nation’s largest ethanol producers, has suspended production at 12 of its 16 plants and is planning to sell production facilities. In recent days Renew Energy, Cascade Grain Products and Northeast Biofuels have filed for bankruptcy protection. Pacific Ethanol said it would suspend operations at its Madera, Calif. plant.

Bob Dinneen, president of the Renewable Fuels Association, a trade group, estimated that of the country’s 150 ethanol companies and 180 plants, 10 or more companies have shut down 24 plants over the last three months. That has idled about 2 billion gallons out of 12.5 billion gallons of annual production capacity. Mr. Dinneen estimated that a dozen more companies were in distress.

Ronald H. Miller, the president and chief executive of Aventine Renewable Energy, said, “The economics right now are very poor.” Aventine has suspended construction of one Nebraska plant and delayed completion of a second in Indiana.

This is not how it was supposed to be when Congress mandated in 2007 that refiners blend increasing amounts of ethanol into the country’s transportation fuel supply. The law came at a time when the country’s thirst for gasoline seemed unquenchable, and oil prices seemed only to go up.

In an effort to reduce the country’s dependence on foreign oil and to lower the greenhouse gas emissions that contribute to global warming, Congress mandated a doubling of corn ethanol use, to 15 billion gallons a year by 2015. Congress also mandated, by 2022, the use of an additional 21 billion gallons of ethanol and other biofuels produced from materials collectively known as biomass. The potential materials include corn stubble, wood chips and straw.

Congress hoped that advanced biofuels would overcome the longstanding controversies associated with corn ethanol, including the contention that its production raises food prices. Congress started small, decreeing that industry produce 100 million gallons of advanced biofuels next year and 250 million gallons in 2011. But it is becoming clear that even these modest targets will not be met.

Producing the advanced fuels entails breaking down a tough material, cellulose, that is abundant in corn cobs, wood chips and other biological waste, then converting it to liquid fuel. While scientists have proven it can be done, the cost is still high, and little if any cellulosic ethanol is being produced at commercial scale.

Carlos A. Riva, president and chief executive of Verenium, a company working to produce ethanol from sugar cane waste, said that solving the technological hurdles for this type of fuel was “not a slam dunk.” But he and other executives say they are optimistic the challenges can be overcome, and the 2011 and 2012 targets may be met a few years late.

Small, mostly private companies that go by names like Range Fuels, Poet and BlueFire Ethanol have built pilot plants and hope to move into commercial production. But private investment in advanced biofuels has plummeted since the economy went sour late last year, and it is unclear if the industry can scale up. “Cellulosic ethanol is something that is always five years away and five years later you get to the point where it’s still five years away,” said Aaron Brady, an energy expert at Cambridge Energy Research Associates, a consulting firm.

With gasoline consumption declining even as federal mandates for ethanol are increasing, demand for cellulosic ethanol may be insufficient anyway.

Energy experts project that national gasoline consumption in 2009 and 2010 will be 6 percent or more below the 2007 level, and future ethanol production targets could represent more than 10 percent of gasoline production. Since regulations set a 10 percent blend limit for ethanol in most gasoline, there would be no place for ethanol production to go.

“Without moving the blend wall, there is no future for cellulosic ethanol,” said Jeff Broin, president and chief executive of Poet, a company with interests in corn and cellulosic ethanol.

Automobile manufacturers say most of their cars are not designed to run on higher ethanol concentrations. But the Environmental Protection Agency and the Department of Energy are conducting studies to see if the 10 percent limit could be raised.

Senator Bingaman said he expected those tests to be completed over the next year or so, and he would like to see higher blend levels for ethanol.

“There’s no doubt when we wrote that bill, we did not anticipate the recession we are currently sinking into,” he said. “Exactly what that requires us to do as far as changing the law, I am not clear on yet.”  

At a meeting of petrochemical producers held recently in Dubai, Laique Rahman, Director of United States Petrochemical Industries, said he expected a turnaround in oil demand (and therefore petrochemical products) around Christmas.

On December 25, crude prices listed by Bloomberg suggested that Rahman and his colleagues did not celebrate as merry a Christmas in their Houston homes as they did last year.

Nymex crude meant for February delivery, Brent spot crude and West Texas Intermediate (WTI) spot crude dropped between 3.38 and 10.51 per cent.

Oil forecasts went awry for all quarters in 2008 and predictions continue to be confusing. This is how they stand for 2009. The World Bank in its latest report titled Global Economic Prospects – 2009 predicted that oil will stabilise at what the Opec giant Saudi Arabia recently termed a “fair price”. “Oil prices are likely to average about $75 a barrel next year,” the report said.

Rating and analysis company Moody’s in its new forecast predicted that oil will average at $50 a barrel – $25 below the World Bank’s prediction. Other institutions that analyse energy resources (including Merrill Lynch, PFC Energy and Standard Chartered) have predicted oil prices will fluctuate between $50 and $60 a barrel. Predictions have been revised, re-revised and, in some cases, re-re-revised.

Why is oil so unpredictable when producers can control every barrel that flows out? The ongoing economic crisis has played a large role in making prices so unpredictable.

“Oil prices are generally unpredictable because, in the short term, supply and demand respond little to price. Obviously prices have fallen substantially, but that’s a consequence of the economic crisis and sharp fall in demand, which likewise took people by surprise,” said Robin Mills, a Dubai-based petroleum economist.

The crash of financial markets the world over have had an impact on the oil markets as well, another analyst said. “Oil prices have been unpredictable recently because of uncertainties surrounding the fate of the world economy. We have seen turbulence in the financial system that has affected the oil prices severely,” said Dheeraj Shahdadpuri, an energy analyst with Dun & Bradstreet.

What has particularly been surprising in 2008 is that prices have dropped every time OPEC announced a production cut. The most surprising of it came just about a week ago. As OPEC announced a 2.2 million barrel cut at its meeting held in Oran in Algeria on December 17, oil prices fell to below $40 a barrel level. This price was last visible on the oil radar in 2004.

Mills said the fall would have been even steeper had there been no cut in production. OPEC cuts have failed to support prices, but prices would have fallen further without them. Partly worries about compliance levels have dampened the impact of the cuts. But partly prices were inevitably going to fall and continue falling as bad demand figures, firstly from the OECD and now China, keep coming in,” he said.

Before OPEC began its 151st meeting in Oran, analysts had been of the opinion that any decision to reduce production would be aimed at reducing the building up contango (future prices above spot). But the desired impact has not emerged and oil futures continue to be traded handsomely above the spot prices at all the commodity exchanges that trade oil.

“The current spot price being below the future prices indicates that the market expects the future supply/demand balance to be tighter than it is today. This should happen as the impact of the OPEC cuts feeds through to the market, non-OPEC output is hit by lower prices, and demand stabilises and begins to recover. The current contango is exceptionally steep,” said Mills.

It has largely been unnoticed that oil, which once threatened to touch $200 a barrel, began sliding down the price charts with the collapse of leading financial institutions such as Lehman Brothers. “With the collapse of Lehman Brothers the liquidity in the system also is no more easily available, which has affected all classes of assets,” said Shahdadpuri.

Since it is the US where the collapse began and as it is the US benchmarks that reflect on prices the world over, oil faced a cascading impact.

“With the deepening of financial crisis, the stock levels of oil in US, which is the world’s largest consumer, have increased over the last couple of months, giving clear indications of slowing demand for energy in industries and by the general public,” said Shahdadpuri.

The Gulf currencies are pegged to the US dollar and collect their sale proceeds in dollars. This makes oil highly susceptible to the greenback’s performance. The US dollar has gyrated in 2008 and likewise oil has danced to a similar tune.

OPEC countries repeatedly blamed speculators as they received requests from oil consumers to hike production in July. Their allegations apparently were not far from true and money from pension funds in the US is said to have been thrust into oil markets in June and July. Analysts said there was a sharp decline in prices the moment this money was taken away.

“Oil being a dollar denominated commodity attracts a lot of hedge funds, especially in cases where equities have been battered, which we have seen over the past one year. In my view, during the first three quarters of the year, oil has risen because of falling stock markets (as oil and gold act as perfect hedge for equities) and weakening US dollar. But as we have seen the financial crisis has affected many other nations as well, the dollar has regained its shine due to which we have seen declining interest from the hedge funds,” said Shahdadpuri.

Anything from a storm to bad weather can impact spot and oil prices for an immediate future. Even an oil spill or a major announcement of a hike or shaving off of production by major refineries can impact oil prices. News agency reporters have cited incidents wherein they have seen an immediate impact of reporting a major oil industry related announcement on price charts.

However, in 2008 even though such developments kept taking place at regular intervals, the effects where stymied in from of the global economic slowdown.

Things have been particularly frustrating for OPEC whose efforts to check crude prices have repeatedly gone in vain. OPEC, which accounts for 70 per cent of the world’s oil reserves and 40 per cent of its production, has found it increasingly difficult to control prices. Adding all the reductions that have been made since September, a total of 4.2 million barrels of oil will stand slashed from the markets this month. However, that has neither helped in its prime objective of raising the spot prices nor has it impacted the demand.

OPEC cuts will become more difficult and compliance will become increasingly difficult. In the longer term, OPEC has to be patient and wait for the cuts to take effect and the world economy to recover,” said Mills.

Besides, OPEC needs to pull its socks up as far as ensuring compliance to cuts is concerned. What has deeply offset OPEC cuts recently was a tremendous decline in demand in the US and Western Europe. The organisation understands this well and is said to have closely analysed winter demand of oil and gas in the US and Europe before announcing its recent cuts.

Russia, which can single handedly determine the effectiveness of the impact of the OPEC reduction, has of late been reluctant in standing on its promises.

Gas to average $5.50 this year

Using Henry Hub as the benchmark, Moody’s forecast that for 2009 North American natural gas will average $5.50 per million British Thermal Units (BTUs).

“For 2010, this rises to $6.00 and over the near to medium term we assume gas will average $6.50,” Moody’s said in its latest oil and gas industry report.

The recent Gas Exporting Countries Forum (GECF) saw the Russian Prime Minister Vladimir Putin reiterating the warning that gas will not remain a cheap commodity any more. The warnings have come time and again with the last one having been made in Doha in 2007.

Though gas prices are increasingly being linked to oil, gas has not taken a beating similar to oil during the ongoing crisis. Gas contracts apparently are long term, lasting for as long as 25 years. This keeps the gas exporters immune (to some extent) from short-term market fluctuations.

The current gas scene looks brighter as compared to oil. On December 25, natural gas futures in New York rose for a second day after a government report showed that the US (gas) stockpiles dropped more than expected last week as a cold snap in much of the US lifted demand. Natural gas for January delivery gained 17.3 cents, or three cents, to settle at $5.91 per million BTUs. UK natural gas and electricity for delivery next month rose on forecasts of cooler weather that may boost heating demand. It rose 1.7 per cent and was selling at $8.86 per million BTUs.

Who better to know the real story of the future sustainability and cost of oil than the leaders of oil companies? In a recent study sponsored by the consulting firm Deloitte only 17% of 50 senior oil and gas company executives believe that fossil fuels will be the most sustainable fuel source in 25 years’ time; 23% think it will be the cheapest. In 25 years most oilmen place their bets on renewable energy as the cheapest and most sustainable fuel.

About face for oil

The sentiments expressed in the study come from the same industry leaders that have in the past sought to downplay either the viability of renewable energy sources or the need to transition to a new energy economy, while dismissing outright the reality of climate change. The future was oil, baby, oil.

The number of oil executives that still think oil will be the cheapest energy source in 25 years has dropped a full 48 percentage points to the current 23%, according to the Deloitte study – that’s worse than president Bush’s approval rating.

The times they are a’changin’.

Reality bites

Oil company execs can see the writing on the wall. Not only in terms of a new administration ready to spend billions in renewable energy projects, but also in the reality of a dwindling supply of “cheap and easy” oil. There may be lots of oil to be had in tar sands and oil shale, but those projects are economically tricky with oil trading at $140 a barrel, let alone $45 – with the added bonus that those methods of extraction bring with them environmental catastrophe.

You can stand in the way of progress only so long. Then reality takes over.

Concern about foreign oil

Gary Adams, vice president for Deloitte’s oil and gas division, says that most oil company executives think their industry should play a significant role in helping America transition to a new energy economy: “…more than half of the executives in our study felt that petroleum companies should work toward helping America transition to the use of more renewables and other alternative fuels,” Adams said in a press release.

Three in four industry leaders expressed “strong concern” about America’s dependence on foreign oil, a concern shared by just about everyone else in the country (with legendary oilman T. Boone Pickens leading the charge).

Nothing you and I didn’t already know

In a separate study of registered voters across the country, Deloitte found almost everybody agrees with the newly converted oil company executives. An overwhelming percentage of voting citizens believe that renewable energy is the way of the future, and that oil will ultimately be unsustainable and more costly than alternative sources within 25 years. Virtually no one likes importing 70% of our oil from foreign sources.

The concern from the oil industry, according to the report, is realistic expectations for that change:

“It’s clear from our survey that most voters believe renewable energy is the way of the future,” said Adams. “While this is very important, many voters may not understand the current costs and complexities of developing renewable energy.”

Renewable energy – are you feeling confused?

Adams further states that there is confusion among voters about the real costs of renewable energy: “Right now, renewables simply are not as cheap as fossil fuels, which adds to the challenge of satisfying the public’s desire to move away from conventional oil and gas in a short time period.”

Adams stresses the need on the one hand for a comprehensive energy strategy promoting investment and development of renewable energy, while on the other pushing for domestic exploration and development of oil and gas as a sort of “bridge loan” to fill the gap. Says Adams:

“The world will be primarily reliant on fossil fuels for at least two generations – the bridge to tomorrow’s new energy future depends on this. The key is to have a sensible plan to transition to a new, cleaner energy era. It is also clear that the oil and gas industry needs to do more to educate the public on the challenges ahead.”

There is no doubt, as Adams says, that there are costs and complexities involved with transitioning an entire economy from oil to renewable energy. Its an enormous task, and one made all the more urgent by the appalling lack of leadership in energy policy of the past eight years. Need we be reminded that it wasn’t all that long ago that president Dick, er, vice president Dick Cheney said “Conservation may be a sign of personal virtue, but it is not a sufficient basis for a sound, comprehensive energy policy”.

It was never really clear to me what did, in Bush and Cheney’s mind, constitute a sound, comprehensive energy policy. Obviously nothing to do with personal virtue.

But all that is nearly behind us now. From the average voting citizen to oil company executives (if driven by different motives than you or I) are chomping at the bit for change.

Despite the “confusion” and complexities Adams speaks of, I think the American public is ready to step up to the challenging road ahead. I see enormous momentum for change and a great upwelling of talent and innovation coming to bear that may bring along the transformation to a new energy economy quicker than Adams suggests, despite the ongoing recession (perhaps to some degree spurred on by it). In some cases, wind and solar are already at or within a few years of grid parity.

There is certainly a long way to go before we are free of the “addiction”, but let now be our “bottom”. Whatever the time frame or cost, there is no turning back. Everyone knows that; from the oil company CEO’s to Joe Q. Public.

We live in revolutionary times.

Anadarko Petroleum Corp. and Dana Petroleum Plc, oil drillers that lost more than 25 percent in market value this year, may become acquisition targets as they show it’s cheaper to buy oil and gas reserves than to go and find them.

Anadarko’s proven deposits had a stock market value of $6.99 a barrel Nov. 7 after its shares tumbled 45 percent this year in New York trading, while Dana’s were at $7.80 a barrel. That’s more than 39 percent below the $12.87 a barrel Royal Dutch Shell Plc spent last year to find and develop its own fields, data compiled by Bloomberg show, and may attract offers.

Exxon Mobil Corp., Shell, BP Plc, Chevron Corp. and Total SA, the five largest non-state oil companies, held $82 billion of cash at the end of September, enough between them to acquire seven of the 11 members of the Standard & Poor’s 500 Oil & Gas Exploration & Production Index. Smaller companies such as Talisman Energy Inc. may also have funds for acquisitions.

“It’s cheaper to buy a barrel on Wall Street instead of a barrel that companies need to find and develop,” said Andrew Bartlett, global head of oil and gas corporate advisory at Standard Chartered Plc in London. “Companies with cash are looking for infill-opportunities with a large resource base.”

The last time oil plunged, when crude fell to $10 a barrel in 1998, led to a transformation of the industry as BP bought Amoco Corp., Exxon acquired Mobil Corp. and Total Fina SA took over Elf Aquitaine SA. Deals now are for niche targets.

Acquisition Trail

“It may prove better value to buy than to build over the course of the next 12 to 24 months,” Talisman Chief Executive Officer John Manzoni said Nov. 4. BP CEO Tony Hayward said Oct. 28 the credit crisis may create opportunities which BP would look at “very closely.”

As oil stocks trade close to their lowest in four years, smaller producers are more vulnerable to takeovers. The 224- member Bloomberg World Oil and Gas index tumbled more than 40 percent this year as crude declined 59 percent from its July record of $147.27 a barrel on forecasts a global recession will cause oil demand to slump to its slowest growth rate since 1993.

International oil companies are seeking reserves as decades- old fields from the North Sea to Alaska dry up and as producing nations keep their best resources and more profits for themselves.

Analysts say targets include The Woodlands, Texas-based Anadarko, the second-largest independent U.S. oil and natural-gas producer. It has been among 25 companies with the lowest ratio of reserves to market value on the World Oil & Gas index.

Stock Decline

Anadarko had 81 percent of revenue last year in the U.S. and in September announced a deep-sea discovery off Brazil. The stock market valuation of its deposits compares with $7.68 a barrel for ConocoPhillips, $14.25 for Chevron and $18.29 for Exxon, according to data as of Nov. 7 compiled by Bloomberg.

“Anadarko has gotten killed,” Gene Pisasale, who helps oversee about $13 billion at PNC Capital Advisors in Baltimore, said of the company’s stock price, which this year has fallen more than Apache Corp., Devon Energy Corp. and EOG Resources Inc. “All four of those are large enough companies that they’d be attractive,” Pisasale said.

Anadarko rose $1.82, or 5 percent, to $38.15 in New York Stock Exchange composite trading. The company’s “capital structure and liquidity position remain very strong,” said John Christiansen, an Anadarko spokesman. Its market value is $17.5 billion, compared with between $20 billion and $34 billion for Apache, Devon and EOG. “We don’t comment on rumors or speculation,” said Chip Minty, a Devon Energy spokesman.

Credit Markets

Other U.S. explorers whose asset valuations have plunged include Exco Resources Inc., valued at $2.68 a barrel, and Pioneer Natural Resources Co., at $2.99 a barrel, both as of Nov. 7. Neither could be reached for comment.

“The liquidity crisis is hurting small to midsized companies with difficulty funding growth and operations,” said Alessandra Pasini, a Milan-based banker at Citigroup Inc.

In Europe companies priced below $9 per barrel of oil equivalent reserves include Aberdeen, Scotland-based Dana Petroleum, DNO International ASA of Oslo and JKX Oil & Gas Plc.

“That’s below the finding and producing cost for the majors,” said Jason Kenney, an analyst at ING Wholesale Banking in Edinburgh who recommends buying Shell, Total and Eni SpA shares. “Market conditions are creating unique opportunities to make targeted acquisitions.”  

Until about a week ago, the conventional wisdom was that high – and growing – crude-oil prices were here to stay, and that Americans had to change their wasteful driving habits. A tank of gas blew the family budget, taking the bus became fashionable and you couldn’t unload a used Hummer unless you threw a new house into the deal.

Then, just like that, it’s over.

Just a few weeks ago, experts were predicting crude-oil prices would hit $200 a barrel next year, but last week the price dropped below $70 for the first time in more than a year, thanks to an unexpected drop in U.S. gas consumption with the economic slowdown. Pump prices in the Des Moines area have dropped from above $4 a gallon just weeks ago to less than $2.50 in places.This is certainly good news for Americans struggling in a time of financial stress. One economist pointed out that if oil stabilizes at $80 a barrel next year, it would translate into a $275 billion economic stimulus that won’t cost the U.S. Treasury a dime.

This is bad news, however, for the goal of weaning the nation from burning oil for transportation, a leading source of greenhouse gas. Rising fuel prices provided long-overdue incentives for improved vehicle efficiency, research into alternative fuels and more healthful alternatives to driving.

High gas prices prompted a serious conversation about a more rational approach to transportation, not just increased efficiency and alternative fuels but creative thinking about how we design our cities and transportation systems to rely less on single-occupant automobiles and more on walking, bicycling, mass transit and sharing rides. The net effect would be cities that are more vibrant and livable, cleaner air, healthier lifestyles and less reliance on energy that comes from unstable parts of the world.

While the rocketing price of crude oil globally forced this conversation, market forces are an unreliable substitute for leadership on energy policy. The market price of oil over the past year bears less relationship to the realities of oil reserves and refinery capacity than to external market forces, including wild economic gyrations. As witnessed in recent days, changes in those external market forces can cause the price to drop, and the incentive for a sensible transportation policy evaporates.

Along with it goes the incentive for investment in new technologies and retooling to build more efficient vehicles. Public-transportation planners would have less reason to invest in expanding mass-transit routes and service at the risk of running empty buses and trains. And, if consumer demand sours for more walkable communities, developers and city planners won’t be as interested in changing the way they do business.

In other words, it’s back to driving the old gas hog to the corner store and shipping more U.S. wealth to the Middle East. That is not the way it should be. Instead, there must be more courageous leadership at every level of government and long-range thinking by private industry to change the way this nation views transportation.

That may require a hike in gas taxes – which Iowa needs to do in any case to pay for neglected roads and bridges – but it will require a commitment to change that does not rise and fall with gas prices.

And, if we get it right, we won’t be whipsawed at the gas pump any more.