July 9 (Bloomberg) -- The steepest decline in ethanol since 2001 may be ending, buoying profits at Archer Daniels Midland Co., VeraSun Energy Corp. and Aventine Renewable Energy Inc.

Ethanol tumbled 43 percent in the past 12 months, making the corn-based fuel additive cheaper than gasoline for the first time in two years. The difference in price will persist through 2007, spurring ethanol sales as oil refiners use it to stretch fuel supplies, said Ian Horowitz, an analyst at Soleil Securities Corp. in New York.

``We're getting close to the bottom and optimism is building with new markets opening up,'' said Randy Stratton, chief executive officer of Stratton Group, a Sioux Falls, South Dakota, adviser to distillers. ``That means a lot of cash will be made.''

Profits for ADM, the largest U.S. ethanol maker, VeraSun and Aventine probably will rise 46 percent next year, while earnings drop at Exxon Mobil Corp. and Chevron Corp., according to analyst forecasts compiled by Bloomberg. Bumper corn crops in the U.S. and China, the two biggest growers, will reduce costs for ethanol distillers and President George W. Bush's support for the fuel may increase demand.

Ethanol was the pick of energy investors in 2005 and 2006 as record oil prices lured Microsoft Corp. Chairman Bill Gates and venture capitalist Vinod Khosla to alternative fuels. Publicly traded ethanol makers lost a combined $2 billion in market value this year.

Corn Prices Ease

A rebound in ethanol became more likely after corn prices dropped 27 percent from a 10-year high in February. U.S. farmers planted more corn than in any year since World War II. Every $1- a-bushel decline in corn lowers the cost to make a gallon of ethanol by 25 cents, said Eitan Bernstein, an analyst at Friedman Billings Ramsey & Co. in Arlington, Virginia.

Ethanol touched its all-time high of $3.98 a gallon on July 3, 2006, according to data compiled by Bloomberg. Distillers built new mills, boosting annual capacity to 4.9 billion gallons by the end of 2006, more than double what it was four years earlier. Ethanol makers plan to add another 6 billion gallons of capacity by the end of next year.

A glut from those new mills caused ethanol to fall to $2.20 a gallon at the end of last week. The worst annual performance for ethanol in the nine years it has been tracked by Bloomberg was in 2001, when it fell 43 percent. Ethanol makes up about 4 percent of the U.S. gasoline supply.

IPO Price

The slump forced BioFuel Energy Corp., an ethanol producer controlled by David Einhorn's Greenlight Capital Inc. hedge fund and Daniel Loeb's Third Point LLC, to slash the price of an initial public offering last month by 71 percent to $10.50 a share. Stock in the Denver-based company has risen 6.4 percent since the June 12 sale.

Oil companies may be eager to use lower-priced ethanol to add to gasoline inventories, said Patricia Riet, a trader at Integra U.S. Marketing LLC in Houston.

A gallon of ethanol, a form of alcohol derived primarily from corn in the U.S. and sugar in the rest of the world, was 14.9 cents cheaper than wholesale gasoline on July 5, the biggest discount since June 2005. The difference will expand to about 30 cents in the July-September period before contracting to 11 cents in the fourth quarter, Soleil's Horowitz predicted.

Ethanol and Gasoline

Ethanol usually traded at a 40-cent premium to gasoline in the U.S., said Neil Koehler, chief executive officer at Pacific Ethanol Inc., a Sacramento-based distiller whose biggest holder is Gates. Pacific is having no trouble making a profit now that ethanol has fallen to about $2, he said.

``There's a compelling price advantage to using ethanol and we're currently in a mode where we're opening up new incremental demand,'' said Koehler, whose company distills corn near Fresno and is building four more plants in California, Idaho and Oregon. Pacific also owns 42 percent of a Windsor, Colorado, distillery.

The margin on distilling corn into ethanol in the U.S. more than doubled in the week ended July 5 to 35 cents a gallon, according to data compiled by Bloomberg. As recently as June 15, distillers were losing more than 9 cents on every gallon. Last year, the margin averaged $1.07 a gallon.

Pacific Ethanol shares rose 9.3 percent last week to $14.43. They are down 68 percent from their all-time high in May of 2006. Archer Daniels Midland shares rose 6.2 percent last week to $62.14. Aventine shares are up 27 percent in the past two weeks to $17.79.

Government Backing

The U.S. ethanol industry, propped up by 25 years of federal subsidies, still needs government support to ensure its future, Ron Miller, chief executive officer at Aventine, said in a June 13 interview in Chicago.

``We are very much a public policy-driven industry,'' Miller said.

Distillers applauded a June 14 vote by the California Air Resources Board to force fuel makers to almost double the amount of ethanol in the state's gasoline by the end of 2009. The mandate will boost demand by 700 million gallons a year, or 11 percent of current nationwide output, Miller said.

The U.S. Senate approved an even more ambitious plan that would demand a sixfold increase in U.S. sales. Energy legislation passed by the Senate on June 22 included a mandate that refiners use 36 billion gallons annually of ethanol and other crop-based fuels by 2022. That's more than twice the amount currently produced worldwide. Similar legislation is pending in the House of Representatives.

`Public Policy Driven'

Excluding the proposals before Congress, the federal government has 20 separate laws and incentives to boost ethanol use, and 49 states offer additional subsidies and supports, according to the Energy Department in Washington.

The subsidies, and the increasing ethanol supply from new distilleries that are being built to take advantage of the government support, may create the biggest risks to investors. Ethanol profits and share prices probably will remain in the doldrums for another 18 months, said Christoph Berg, managing director at Hamburg-based F.O. Licht, a commodities researcher.

Market Share Fight

Distillers will have to cut prices ``to fight each other for market share,'' Berg said in a July 3 telephone interview. Corn still is 35 percent more expensive than a year ago, even with the increase in plantings by U.S. farmers, and that will drag down ethanol profits, he said.

``I don't expect any strong rebound this year or next, frankly,'' Berg said. ``The industry is currently in a downswing cycle that maybe won't end until the end of 2008 or the first part of 2009.''

For now, the drop in prices is the best thing that could have happened, said Anthony Flagg, a former wheat trader and flour-mill manager who's building an ethanol distillery in Pelham, Georgia. As long as ethanol doesn't fall below $1.80 a gallon, his mill will attract more than enough demand from refiners to make money.

``Lower ethanol prices are good for us,'' said Flagg, chief executive officer of First United Ethanol LLC, which is owned by 800 farmers and local investors. ``We need a market price that enables our customers to make money.''

To contact the reporter on this story: Joe Carroll in Chicago at jcarroll8@bloomberg.net; Mario Parker in Chicago at mparker22@bloomberg.net.

Last Updated: July 9, 2007 00:13 EDT