Ethanol: Not dead yet

Special Reportfull coverage

Oil climbs above $77 on inventory decline Oil rises on surprise inventory drop Exxon's drilling juggernaut Oil climbs above $74 Oil pares gains, settles lower Oil rises on weaker dollar

Quick Vote

What would happen if the government let some big banks fail?

• It would devastate the global economy
• It would send a strong message to the banking industry
• It wouldn't make a difference

or View results

NEW YORK (CNNMoney.com) -- The old kings of ethanol are struggling for survival but a new crop of companies are poised to ascend to the throne and hope to offer a superior product.

Tight credit and slim profit margins in the traditional corn ethanol business are felling the sector's once-mighty big boys. Pacific Ethanol (PEIX), where Bill Gates had a big stake, has seen its shares fall to a paltry 25 cents from over $40 in 2006. Verasun, formerly the second biggest ethanol producer in the country, is currently in bankruptcy.

It was thought these companies would transition from corn-based ethanol - which drew fire for being inefficient and driving up food prices - to "second-generation" ethanol made from cheaper non-food crops and trash.

Now that seems dead in the water.

"I think they might not be around to see the second generation," said Cristoph Berg, an ethanol analyst with commodity research firm F.O. Licht in Germany.

Even the country's biggest ethanol producer, the agricultural giant Archer Daniels Midland (ADM, Fortune 500), isn't thought to be doing much research in second-generation technology.

That leaves plenty of room for less known players to fill in the gap.

There are a few large firms in the corn ethanol business that are now working on second-generation ethanol.

South Dakota-based Poet is a big player, said Berg, as is Missouri-based Abengoa. While not as well known, both Poet and Abengoa have second-generation pilot plants up and running. Poet's produces about 20,000 gallons a year.

Plus, there are hundreds of small and privately held companies currently playing in this space.

"For the time being, those sending out the press releases will be mostly new names," said Berg.

Melissa Stark, global head of biofuels at Accenture, said second-generation ethanol prices should be between $3 and $4 a gallon when commercial plants get up in running, expected sometime around 2012.

That could make it competitive with gasoline if the economy recovers and oil prices move higher, as is widely expected. A law restricting greenhouse gasses, driving up the cost of fossil fuels, would only tip the balance that much more in ethanol's favor.

"We weren't really excited about this space until this year," said Stark. "But we've never been as hopeful about second generation as we are now."

But for years the commercialization of these biofuels has been "just around the corner."

It appears it still is. While it is certainly possible to make second-generation ethanol today, it remains too costly to make it commercially viable.

"All the risk capital has disappeared," said Nick Gogerty, a portfolio manager at the hedge fund Fertilemind Capital. According to Gogerty, people are no longer chasing risky projects hoping to make a lot of money, they're looking to invest in projects where they hope their money will be safe.

Gogerty said it may take even longer for cellulosic ethanol to hit the market, as many of the firms building the infrastructure to transport the biofuel - from pipelines to train cars - have left the market with the drop in gas prices and freezing of credit.

"If anything, we're further away," he said.

But further away does not mean never.

A few high profile projects were recently announced but many have been put on hold amid the credit crunch.

"I'm concerned for the industry as a whole," said Jef Sharp, an executive at Qteros, a Massachusetts-based company looking to commercialize cellulosic ethanol made by feeding plant matter to microbes.

Sharp said his company isn't at the point of actually "putting steel in the ground" and building a big plant.

But even though he hasn't had a hard time finding money so far, Sharp said, "if it [the economy] continues like this for years to come, it will definitely impact us as well."

Last month Verenium, a Massachusetts-based ethanol company, and British oil giant BP announced plans to build a commercial-scale cellulosic refinery in Florida.

At 30 million gallons a year, it will be the world's largest such refinery, although its still smaller than a traditional corn refinery, which can process over 100 million gallons a year. It also pales in comparison to an average petroleum refinery, which can churn out several billion gallons a year.

The Verenium-BP plant is set to come online in 2012.