Ethanol dream evaporates: Minneapolis hedge-fund manager Redleaf wants out

CANTON, I LL . -- A mile down an unpaved road on the outskirts of Canton, Ill., population 14,500, stands a shuttered ethanol plant.

Corn farmers in the area chipped in $5,000 to $300,000 each -- some even mortgaged their farms -- to form the Central Illinois Energy Cooperative. They broke ground on the refinery in 2006, hoping that ethanol would bring higher prices for their corn and more jobs for Canton, which has been hurting since International Harvester closed its plow factory in 1983.

But the ethanol plant was a poor replacement. Central Illinois Energy, the corporation that built the plant, went bankrupt in December 2007 without producing a drop of fuel, hurt by construction delays and $40 million in cost overruns. The 260 farmers in the co-op lost every dime.

Some of them blame the flameout on a poker-loving, libertarian math savant named Andy Redleaf, whose hedge-fund firm, Whitebox Advisors, now controls the plant.

With $2.7 billion in assets, Minneapolis-based Whitebox is one of a small group of bottom-fishing hedge funds looking to profit from the ethanol collapse. They're sifting through the wreckage of a highflying industry that started falling to earth on June 20, 2006.

That day, the price of ethanol, the main ingredient in moonshine whiskey, peaked at $4.23 a gallon on the Chicago Board of Trade, buoyed by a strong economy and President George W. Bush's pledge to replace 75 percent of the oil the United States imports from the Middle East with ethanol by 2025.

Distillers erected dozens of ethanol plants across the Great Plains, backed by some very smart money. Microsoft co-founder Bill Gates invested $84 million in Pacific Ethanol, based in Sacramento. Hedge fund managers David Einhorn and Daniel Loeb backed Denver-based BioFuel Energy Corp.

"There was too much built too quickly, with too much leverage," says Neil Koehler, the company's chief executive officer.

Redleaf, 52, is an unlikely ethanol speculator. He rails against government bailouts on his blog and in his frequent letters to investors.

Ethanol is an easy target for conservatives like Redleaf. The government gives refiners a 45-cent tax credit on every gallon they blend with gasoline and levies a 54-cent-a-gallon protective tariff on competing fuel made from Brazilian sugar cane. In return, it requires oil refiners to mix more ethanol into their gasoline each year. This year, the quota is 12 billion gallons.

Whitebox's involvement in the Canton ethanol plant started when it bought a fraction of an $87.5 million syndicated loan for the farmers' cooperative in April 2006. It was part of a bigger ethanol play. Redleaf also bought $28.4 million of bonds issued by Pekin, Ill.-based Aventine Renewable Energy Holdings when it emerged from bankruptcy in March, a right he had as a holder of Aventine's original debt. And he owned bonds issued by bankrupt Sioux Falls, S.D.-based VeraSun Energy, which raised $420 million in a 2006 public offering and operated 16 ethanol plants before it went under.

Another hedge-fund firm, New York-based Brigade Capital Management, also bought debt of Aventine and VeraSun. Unlike those companies, Central Illinois Energy, or CIE, didn't have any shares to short. When the bonds crashed, Redleaf could have taken the loss and moved on. Instead, he took control of the plant in bankruptcy.

Whitebox also used its equity ownership to block the sale of the plant to other buyers, which could have salvaged some of the farmers' investment, says Dennis Streitmatter, an investor and CIE board member.

"It took a 100 percent vote to do anything," Streitmatter says. "And they always voted against it."

Whitebox's chief operating officer, Jonathan Wood, says he knows of no offers to buy CIE before it went bankrupt.

Redleaf says Whitebox spent $30 million to finish the plant -- much more than the farmers invested -- and made a sincere effort to save it.

"You can look at what was spent," he says in an interview. "Most of the money wasn't spent by the community."

Even so, Redleaf says he's done with running private companies.

"We prefer shuffling paper to making widgets," he says in an interview in his office overlooking Lake Calhoun.

Redleaf says he has put the Canton plant up for sale and will avoid private-equity deals in the future.

But Redleaf hasn't escaped Canton yet. The Illinois Environmental Protection Agency in March asked the state attorney general to force CIE and a nearby grain handling facility to clean up a discharge of black sludge that killed turtles in a nearby pond.

The closed plant contains 2.3 million gallons of toxic soup from the ethanol-making process, says Canton City Attorney Chrissie Peterson. The city has plugged a pipe leading from the plant to make sure none of the material makes its way into the town's water-treatment facility.

"There were high hopes for the ethanol plant," Peterson says. "It has left a bitter taste."