Ethanol producers learn downside of hedging

With slim profit margins already weighing on the biofuels industry, VeraSun Energy Corp. this month found itself in a liquidity crisis after locking in at higher-than-market prices for the corn that it turns into fuel.

After a mid-September announcement of an expected third-quarter loss of $63 million to $103 million, the Sioux Falls-based company tried to raise $20 million in a public offering. VeraSun then said several companies had expressed a "strategic interest," a phrase typically associated with buyouts or a substantial sale of assets.

Spot corn prices by mid-August slumped below $5 per bushel but in the preceding months, as commodities prices spiked, VeraSun locked into an average per-bushel price of $6.75 to $7 for the quarter.

Denver-based Biofuel Energy Corp. found itself in a similar predicament in August.

"Hedging can be a useful tool for managing risk, but it can hurt as well as help, depending on whether or not the commodity moves in the direction that the company had expected," said Raymond James analyst Pavel Molchanov.

VeraSun's shares, which had traded as high as $17.75 in the past 52 weeks, slumped 92 percent to $1.33.

There are signals that Wall Street anticipates a takeover. On Monday--a day in which the Dow lost 778 points--VeraSun's stock jumped by more than 80 percent to $4.

Molchanov said a company would have to be of decent size to take on VeraSun's assets and debt. He said some possibilities include privately held ethanol producer Poet LLC or agribusiness giants Archer Daniels Midland Co. or Cargill Inc.

Although not every oil and gas company wants to run ethanol plants, some refiners may look at it as an opportunity as they're already using ethanol for blending. And such a deal would make sense from a purely financial standpoint, Molchanov said.