ANALYSIS-Ethanol slump hurts producers, aids refiners

NEW YORK Oct 30 (Reuters) - Slumping ethanol prices have tarnished the stock prices of biofuel producers, but with oil prices hovering near record highs, the alternative fuel has turned attractive to gasoline suppliers.

Ethanol prices had tumbled by about $1 per gallon over the past seven months -- hitting a low of about $1.65 in mid-October and pushing margins for producers near break-even or worse, although prices have since rebounded to about $1.75.

Still, the weak prices have benefited the refiners and fuel blenders that mix the corn-based fuel with gasoline, and who also get the added incentive of the 51 cent per gallon federal tax break, putting the price of ethanol well below that of gasoline.

"The benefit these days is going to the refineries and the blenders," said Eitan Bernstein, analyst with Friedman, Billings, Ramsey & Co.

Under government mandates, gasoline blenders are required to mix at least 4.7 billion gallons of the alternative fuel in 2007. That level must rise to 7.5 billion gallons by 2012.

But with the current output capacity of 7 billion gallons expected to grow to nearly 13 million gallons next year, supplies remain ample, even though ethanol makes up less than 5 percent of the U.S. gasoline market.

That glut has meant that refiners who had bought ethanol strictly to meet regulatory requirements have found that high oil prices have made the fuel competitive.

"We were blending ethanol mainly from a mandated position, and we are now seeing with the falloff in the price of ethanol that discretionary blending makes sense for us," said Gary Simmons, vice president for planning at Valero Energy Corp (VLO.N), the largest U.S. refiner.

'KEEPS THEM IN THE GAME'

The rally in oil prices above $90 per barrel has helped make ethanol an attractive alternative to gasoline, but experts say the subsidy is still important for helping the biofuels industry grow, even if the producers do not reap the gains directly.

"I think it's important for the blenders because that keeps them in the game," said Tommy Mann, a consultant with Accenture. "(But) it certainly does hurt the producers."

Some biofuels producers have sought to market ethanol directly to retailers, such as VeraSun Energy Corp's VSE.N deal with supermarket chain Kroger Co (KR.N) to sell E85, which is 85 percent ethanol.

While such deals are likely to sop up only modest volumes, ethanol producers are sure to explore more partnerships -- either with corn producers or retailers -- to improve their economics.

"I don't think they have a sustainable model," Mann said. "In the end, (the sector winner) is going to be someone who has a more vertical business."

Shares in biofuels producers VeraSun, Pacific Ethanol Inc (PEIX.O) and Aventine Renewable Energy Inc AVR.N have tumbled between 58 percent and 65 percent from their 12-month highs in November last year, and U.S. BioEnergy Corp USBE.O, which launched its shares in December 2006, is down 62 percent since January.

That weakness has knocked the ethanol companies' stock ratios to between about 11 and 18 times 2008 earnings, although Aventine is far ahead of the pack at about 37 times earnings.

Aventine is scheduled to report quarterly earnings after the market close on Tuesday, while VeraSun, Pacific Ethanol and U.S. BioEnergy are all expected to report in November. (Reporting by Matt Daily)