Ethanol
. A type of alcohol, produced in the U.S. principally from corn. Ethanol is primarily used
as a blend component in the U.S. gasoline fuel market. Refiners and marketers, including
some of the major integrated oil companies and a number of independent refiners and
distributors, have historically blended ethanol with gasoline to increase octane and
reduce tailpipe emissions.
. The ethanol industry has grown significantly over the last few years, expanding
production capacity at a compounded annual growth rate of approximately 20% from
2000 to 2005. VSE believes the ethanol market will continue to grow as a result of its
favorable production economics relative to gasoline, ethanol’s clean burning
characteristics, a shortage of domestic petroleum refining capacity, geopolitical concerns,
and federally mandated renewable fuel usage.
Renewable Fuels Standard
In August 2005, President Bush signed the Energy Policy Act establishing the RFS,
which eliminated the mandated use of oxygenates and mandates minimum annual use of
7.5 BGY of renewable fuels in the U.S. fuel supply by 2012, up from a minimum of 4 BGY
in 2006.
Ethanol Industry
Ethanol is marketed across the U.S. as a gasoline blend component that serves as an
octane enhancer, a clean air additive and a renewable fuel resource. It is used by refiners
to meet clean air standards and to improve refinery production by increasing octane
levels and extending fuel supplies. As of January 1, 2006, ethanol accounted for
approximately 3% of the U.S. gasoline fuel supply. Use of ethanol is expected to continue
to grow as a result of the following factors:
• Source of octane to replace MTBE. In recent years, as a result of health and
environmental concerns, 25 states have banned or significantly limited the use of methyl
tertiary-butyl ether, or MTBE. The need for additional octane and clean blend
components has created additional demand for ethanol as refiners use ethanol in place
of MTBE.
• Improved refiner economics. As ethanol demand and capacity expands, refiners are
increasing production of suboctane blend stocks. Refiners are typically able to produce
suboctane fuel at a lower cost and in greater quantities than finished gasoline. Adding
ethanol increases octane and benefits the refiner by expanding the volume of the
gasoline it is able to sell.
• Favorable production economics relative to gasoline. VSE believes that its cost of
producing a gallon of ethanol currently is significantly lower than the cost incurred by
refiners to produce a gallon of gasoline. VSE also believes this will enable ethanol to grow not
only as a strategic blend component, but also as an alternative to gasoline in the form of
E85.
• Strong legislative and government policy support. The Energy Policy Act of 2005, or the
Energy Policy Act, mandates a baseline use of renewable fuels, such as ethanol, by
petroleum producers commencing at 4.0 billion gallons per year, or BGY, in 2006 and
increasing to 7.5 BGY by 2012. In addition, in January 2006, President Bush announced,
in his State of the Union address, support for the use of ethanol in motor vehicles as a
clean, renewable fuel to replace foreign crude oil and diversify the U.S. fuel supply.
• Shortage of domestic petroleum refining capacity.
. According to the EIA, the number of operable U.S. petroleum refineries has decreased
from 319 in 1980 to 148 in 2005. Also according to the EIA, while domestic refining
capacity has decreased approximately 5% from 1980 to 2005, domestic demand has
increased 21% over the same period.
. The EIA expects growth in refining capacity to average 1.3% per year until 2025, with
demand for refined petroleum products growing at 1.5% per year over the same period.
Because ethanol is blended with gasoline after the refining process, it directly increases
domestic fuel capacity.
. VSE believes that domestic fuel refining shortages will result in greater demand for
ethanol.
Supply of Ethanol – relatively easy to add supply capacity
. Production in the ethanol industry remains fragmented. According to the RFA, while
domestic ethanol production increased from 1.3 billion gallons in 1997 to 4.0 billion
gallons in 2005, the top five producers accounted for approximately 37% of the industry’s
total estimated production capacity as of April 2006.
. The remaining production generated by more than 50 smaller producers and farmer
owned cooperatives, most with production of 50 MMGY or less.
. Since a typical ethanol facility can be constructed in approximately 14-18 months from
groundbreaking to operation, the industry is able to forecast capacity additions for up to
18 months in the future.
. As of April 27, 2006, the RFA estimates ethanol facilities with capacity of an aggregate
of an additional 2.2 BGY were under construction.
. Most U.S. ethanol is produced from corn grown in Illinois, Iowa, Minnesota, Nebraska
and South Dakota, where corn is abundant. In addition to corn, the production process
employs natural gas or, in some cases, coal to power the facility and dry distillers grains.
Proximity to sufficient low-cost corn and natural gas supply, therefore, provides a key
competitive advantage for ethanol producers.
Production facilities
. Owns and operates two of the largest ethanol production facilities in the U.S., with a
combined ethanol production capacity of 230 MMGY.
. As of April 27, 2006, VSE’s ethanol production capacity represented approximately 5%
of the total ethanol production capacity in the U.S., according to the RFA. In addition to
producing ethanol, we produce and sell wet distillers grains, or WDGS, and dry distillers
grains, or DDGS, as ethanol co-products, which serve to partially offset VSE’s corn costs.
Expansion
. VSE expects to operate three facilities with an aggregate production capacity of 340
MMGY by the end of August 2007 and five facilities with an aggregate production
capacity of 560 MMGY by the end of the first quarter of 2008.
Aventine (also in the IPO pipeline) Marketing Arrangements
As a member of the Aventine marketing alliance, substantially all of VSE’s ethanol is sold
and priced through a pooling of VSE’s and other producers’ ethanol.
. VSE believes its ethanol constitutes over 35% of the ethanol pool that Aventine
manages, which makes VSE the largest contributor to the pool.
. On February 15, 2006, VSE notified Aventine that it will terminate agreements with
Aventine on March 31, 2007.
. At the expiration of agreements with Aventine, VSE intends to market and sell ethanol
directly to blenders, refiners and other end users.
. Up to this point in the development and expansion of our business, VSE has used its
marketing arrangement with Aventine to pool ethanol with other producers, allowing VSE
to establish relationships with ethanol buyers seeking large suppliers.
. VSE believes its business has become large enough to market ethanol directly to
customers, giving VSE the benefits of direct customer contact and control of contract
negotiations.
Recent developments
• In February 2006, VeraSun and General Motors Corporation, or General Motors,
announced a collaborative partnership to promote the awareness and use of E85, a fuel
blend composed of up to 85% ethanol, in flexible fuel vehicles, or FFVs, and the
installation of fuel pumps for VE85tm, VeraSun’s branded E85, at 20 service stations in
the Chicago area. In March 2006, VSE announced that it is adding VE85tm fuel pumps at
14 service stations in the Minneapolis area.
• In February 2006, Ford Motor Company, or Ford, announced the creation of a Midwest
ethanol corridor through the planned conversion of fuel pumps to VE85tm in Illinois and
Missouri. This plan is part of the initiative announced in November 2005 by Ford and
VeraSun to raise awareness of the benefits of VE85tm and to expand the VE85tm
distribution infrastructure.
• In February and April 2006, acquired options to purchase three separate sites, each
consisting of over 300 acres, near Hartley and Everly, Iowa as potential sites for the
construction of the Northwestern Iowa Facility.
• In April 2006, we purchased approximately 300 acres of land near Welcome, Minnesota
for construction of our Welcome Facility.
• Has an agreement with American Milling, LP, or American Milling, a grain processing
and transportation company, for the acquisition from time to time of rights to purchase or
lease real property sites suitable for future construction and operation of 110 MMGY
nameplate ethanol
Competition
According to the RFA, world ethanol production rose to 12 billion gallons in 2005. Non
U.S. ethanol accounted for 65% of world production. The U.S. and Brazil are the world’s
largest producers of ethanol. As of April 27, 2006, industry capacity in the U.S.
approximated 4.5 BGY, with an additional 2.2 BGY of capacity under construction.
. The ethanol industry in the U.S. consists of more than 90 production facilities and is
primarily corn based, while the Brazilian ethanol production is primarily sugar cane
based. As of April 27, 2006, the top ten producers accounted for 46.5% of the ethanol
production capacity in the U.S. according to the RFA.
. With approximately 5% of the production capacity in the U.S., VSE is the second largest
ethanol producer in the U.S., according to the RFA, and competes with ADM, which has
approximately 24% of the production capacity in the U.S., as well as other large
producers such as Aventine, which has 3% of the U.S. production capacity, Cargill, which
has 3% of the U.S. production capacity, and Abengoa, which has 2% of the U.S.
production capacity.
Archer-Daniels-Midland Co. (ADM) – ADM stock has doubled in the past year
(the following from the ADM website)
"As an industry leader with decades of experience, ADM can deliver consistently high-
quality ethanol. As the largest producer of fuel ethanol in the United States, we are also
committed to maintaining supplies and providing ethanol when you need it. ADM’s
nationwide network of railcars, trucks, barges, and storage facilities assures you of
convenient, cost-effective options for receiving ethanol on an as-needed or just-in-time
basis. As the phase-out of MTBE in gasoline continues, we can help you meet your
needs for oxygen in reformulated gasoline by offering high-quality, environmentally
friendly fuel grade ethanol."
Use of $191mm in IPO proceeds from sale of 11mm shares
(shareholders intend to offer 6.25mm shares)
Finance a portion of the construction costs of the Northwestern Iowa Facility and the
Welcome Facility at an estimated aggregate cost of $280.0 million, with the balance of
$88.6 million expected to come from cash-on-hand and cash generated from operations
during the construction period.