Ethanol Start-Ups and the Bankruptcy Bogeyman

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In mid-December 2007, Central Illinois Energy, a cooperative formed by 260 farmers and local investors who spent $130 million to build an ethanol plant near Canton, Ill., threw in the towel when they learned they'd lost their money—about one month shy of distilling their corn. Plant construction had mushroomed from its $40 million initial proposal in 2001, in part due to project additions, engineering delays and financing hurdles.

The unfinished plant faces $37 million in construction liens, a debt load of $87 million and a loss of all but two of its directors. It surrendered its grain license when the financial problems became insurmountable. The Central Illinois Agriculture Coalition, which spearheaded the fund drive, owns 71 percent of the defunct plant.

One week earlier, an innovative plant near Mead, Neb., filed Chapter 11 bankruptcy papers after mechanical failures undermined early output and profit projections and sent company finances spiraling downward. E3 BioFuels LLC, an $80 million plant called Genesis, had only been operational for five months. It employed a prototype technology. The plant was powered by biogas generated from cattle manure, compliments of a 28,000-head feedlot nearby. Distillers wet grains, a byproduct of the ethanol plant, fed the cattle in a "closed-loop" system.

E3 lists $10 million in assets and $73 million in liabilities in bankruptcy papers. Major bondholders CIT Group and Oppenheimer have an estimated $40 million outstanding; Wells Fargo Bank in Omaha is owed $57 million. More than $3.25 million has been filed in construction liens. In addition, E3 lost six directors in 2007.
Like the town of Canton, Mead felt the financial pain of the bankruptcy filing. Mead's 600 residents are among the creditors because their town board provided $5 million in tax increment financing for the project. Mead-area farmers who bypassed traditional grain markets to sell to the ethanol plant for a higher price are also listed as unpaid creditors.

Anatomy of a Meltdown: What Went Wrong in Illinois
Each plant failure features plenty of culprits and even more finger-pointing. CIE and E3 both cited an inability to pay their debts as they came due as a reason for filing for bankruptcy. Neither blamed volatile market conditions. Debt, and the near-death experience—came to both plants in the early stages of development and evolved over a period of several years before the filings.

In Canton, CIE's main contractor Lurgi PSI is the object of much of the blame for $50 million in cost overruns. Lurgi blames CIE management, plant size and engineering design changes during construction. The plant was designed to be powered by a waste coal generator.

Lurgi, a Memphis contractor, has designed, engineered and constructed more than $2 billion in projects in the corn wet milling, grain and starch industries. When asked about the cost overruns, project manager David Cooper said, "Ma'am this company is not going to comment on any of that."

CIE began with ICM-designed dry-mill technology in which the entire corn kernel is ground into flour. Bankruptcy attorney Barry Barash says at an early stage in the construction, the ICM technology morphed into Lurgi's own untested method of distilling, necessitating the escalating costs. "The contractor wasn't solely to blame," Barash says. "The amount of water that was available from the city of Canton is not sufficient to produce 37 million gallons of ethanol, which is the nameplate capacity of the plant."

Ironically CIE's small size may have been a factor in its demise. Its 37 MMgy is small by today's standards. Because of market factors most plants are currently going on line with three times that capacity.

To date, CIE investors have been unable to raise the estimated $25 million to $30 million remaining to complete construction. The plant will go on the auction block in March 2008. Barash says the pending sale has attracted a lot of attention—in part stimulated by the Energy Independence and Security Act of 2007, which mandated a six-fold increase in ethanol production.

The Meltdown in Mead: Clash of Two Energy Titans
In Nebraska, a boiler explosion in one of two boilers prevented plant personnel from attaining sustainable boiler operations to allow full capacity of the ethanol unit. Its anaerobic digester (the manure-to-methane conversion unit), was not the source of the problems even though early blame focused on the technology. The plant was never able to reach full capacity and losses mounted.

Plant officials estimated it was operating at 50 percent of its 25 MMgy capacity following the February 2007 explosion. E3 was intentionally designed small to capitalize on the feedlot's supply of manure. Again, the economy of scale may be to blame. Like CIE, the plant may be too small to compete with the mega-plants under construction or already in operation.

E3's start-up failures have been blamed on the pressure to bring the plant on line. Insiders who declined to be named say operators omitted some steps during the start-up that caused a "puff"—an explosion that blew a boiler door off. Former plant spokesman R.J. Wilson says contractors may be named as defendants in recovering the operating losses.

Bankruptcy filings indicate the wet cake conveyor at the feedlot wasn't operating properly and there was a freeze loss in November 2006 that contributed to its financial condition.
E3's difficulties began three years earlier and involved personalities, not mechanical failures. The closed-loop system was patented in 2002 by ethanol pioneer David Hallberg.

Founding president of the Renewable Fuels Association, he went on to form his own ethanol tech venture, PRIME BioSolutions LLC. In the interim, Hallberg was chief executive officer of E3.

In 1999, Kansas City businessman Dennis Langley, an oil and gas pioneer, sold Kansas Pipeline Co., to form Earth, Energy and Environment LLC, E3's parent company. In 2005, Langley invested in Hallberg's patent. Ground was broken on the E3 plant in late fall of that year. By June 2006, the partners' styles clashed. They severed their business relationship, agreeing in a bitter parting to share the patent through a holding company. Hallberg's PRIME BioSolutions became a minority owner in another holding company involving E3 while Langley retained 80 percent ownership. Hallberg resigned as CEO. He has observed the bankruptcy proceedings from the sidelines.

Hallberg characterizes the explosion as "an operational snafu. It was an unfortunate development but it's certainly very manageable. It had nothing to do with the method technology, the feedlot or the digesters." He's reluctant to elaborate further due to the litigation, but admitted he has spoken to financial backers about salvaging the plant because he has significant investments in the closed-loop technology. "Out of the ashes of disaster come opportunities and kernels of opportunity," he says. He declines to discuss his former partner but acknowledged he would only involve himself in E3's resurrection if Langley wasn't involved.

The partners were viewed as the "Odd Couple" of ethanol. Where Hallberg was precise and methodical, Langley was flamboyant, launching an international press campaign and a "YouTube" video on the self-sustaining technology when E3 began operations. The opening day fanfare included an appearance by Nebraska Gov. Dave Heineman. Langley's expansion plans announced at that time included building 15 similar plants around the globe in a five-year span.

Some area residents, who did not want to be named, suggested a preoccupation with politics, instead of plant production, as the source of E3's demise. Langley, a political activist, was hosting fundraisers while E3 was starting to struggle. In the fall of 2007, he hosted a soiree for the Association of State Democratic Chairs at his home in Shawnee, Kan. ASDC publicized the event with an Internet slide show of the mansion, its waterfalls and rock grotto. Kansas Gov. Kathleen Sebelius attended, along with other dignitaries. Some offered testimonials as to the lucrative aspect of Langley's support.

Campaign financing records indicate Langley has contributed more than $350,000 to various state and federal Democratic Party candidates since 2000. His wife, Lynette Shaw, has contributed more than $90,000 in that time. E3 hired the Gephardt Group, a lobbying firm run by former House Minority Leader Richard Gephardt, D-Mo., to ensure political clout.
Gordon Ganz, owner of Alvo Grain in Ashland Neb., has never met Langley, but E3 owes the company nearly $100,000 for grain sold in good faith. "My official comment should be ‘no comment,'" he says, noting that plant officials asked the farmer creditors not to discuss the bankruptcy. "But I think ethanol plants should be bonded."

"It is common for creditors in bankruptcy cases to express discontent," says Jeffrey Deines, Langley's attorney. Langley declined to comment for this story. "Creditors are certainly entitled to full and prompt payment of their debts and various aspects of the bankruptcy process sometimes are not consistent with this desire. The company is working hard to make this bankruptcy a success and the views of discontented creditors should be weighed accordingly."

Langley's holding company and E3's parent company are listed as creditors for $6.5 million. At a court hearing on Jan. 7, Hallberg says there were "a lot of angry creditors." One creditors committee is questioning numerous expenditures. Langley is scheduled to be deposed some time this spring.

The Way Back
Representatives of both plants feel they've been thrown a life preserver in the form of the Energy Bill. The Illinois Department of Agriculture seized CIE's $6 million worth of grain in late December. That asset, sold to high bidder Cargill, was liquidated to pay off creditors. Depending on the grain's quality, the sale may make many farmer-suppliers whole. Central Illinois Grain Co. is a member of the Illinois Grain Insurance Fund, which will help cover any insufficiencies that the sale doesn't.

Chicago financial advisor Alex Moglia was brought in to restructure the company's operations. He abruptly departed after three weeks, citing a conflict of interest within his firm, Moglia Advisors. He says he stabilized the plant and positioned it "for new investors to step in."

Farmer investors, several of whom declined to comment, will not recover their investments, however. Although there were attempts to set aside money for the unsecured creditors, "the equity has been wiped out," Moglia says.

Canton, too, had angry creditors at its January meeting. But Elaine Stone, president of the Fulton County Farm Bureau, said the sentiments were mostly based on heartsickness.
Barash sympathizes with the farm co-op that spearheaded the plant fund drive. He stops short of calling the farmers naïve, but says, "I don't think farmers should sign any of these contracts that require subordinated loans and long-term deliveries over a period of years, of corn at a discount, at a deferred payment." Barash suggests—too late—that a fixed-cost contract might have protected the investors by containing exorbitant costs and protecting them against renegotiations with the contractors during construction that weren't in their best interests. All the contractors, including Lurgi, will be paid because they filed mechanics' liens, which have priority in bankruptcy shake-outs.

CIE's senior secured creditors, or a consortium of them, likely will be the successful bidders in March, Barash predicts. International financier Credit Swisse has extended nearly $6 million in operating costs to keep the plant afloat until its sale. Whitebox Advisors LLC, a Minneapolis arbitrage and hedge fund firm, has purchased 70 percent of CIE's debt, Barash says. Neither entity returned calls seeking comment. Barash estimated CIE's value at $25 million because most ethanol developers are looking to cellulosic feedstocks rather than corn.

Wisconsin ethanol developer Rich Ryan expressed interest in CIE, but may not be in a position to negotiate the senior debt. Ryan was initially involved in building a plant near Sparta, Wis., but sold his interest. That plant has been mired in litigation over site selection.

Meanwhile in Nebraska, there is a grassroots groundswell to license and bond ethanol plants, much like grain elevators as Ganz suggests. That way, sellers such as Alvo would be covered in the event of insolvency instead of waiting for a bankruptcy referee to sort out the mess. Twice since 2002 the Nebraska Legislature has toyed with the notion of licensing ethanol plants but both bills died in committee.

Deines says Langley is "fully cooperating with the bondholders to resolve certain mechanical and construction issues and allow for a successful restart of the plant." Hallberg, although troubled by the events that caused E3's ill health, still champions the technology that gave it life. "This was a very regrettable development," he says. "For the industry in general and the community, we all want to get it rectified for the employees. The future of this industry is very exciting and one of the new dimensions is an emphasis on producing biofuels with no fossil fuels, with as small a carbon footprint as possible, sustainably, and with as little water as possible. That is exactly what this technology was designed to do."
And in the wake of the Energy Bill, there are more ethanol plants on the horizon.

Sarah Smith is an Ethanol Producer Magazine staff writer. Reach her at [email protected] or (701) 663-5002.