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CORRESP
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    pacethanol_corresp-121311.htm

Larry A. Cerutti

Direct Dial: (714) 641-3450

E-mail: lcerutti@rutan.com

December 13, 2011

VIA FEDEX AND

EDGAR CORRESPONDENCE

Terence O’Brien

Accounting Branch Chief

Division of Corporation Finance

Securities and Exchange Commission

Mail Stop 3628

100 F Street, NE

Washington, D.C.  20549-3628

Re:

Pacific Ethanol, Inc.

Form 10-K for the Fiscal Year Ended December 31, 2010

Filed March 31, 2011

File No. 000-21467

Dear Mr. O’Brien:

This letter responds to the comments of your letter dated November 10, 2011 relating to Pacific Ethanol, Inc. (the “Company”), a copy of which letter is enclosed for your convenience.

We have reproduced below in bold font each of your comments set forth in your letter of November 10, 2011, together with the Company’s responses in regular font immediately following each reproduced comment.  The Company’s responses in this letter correspond to the numbers you placed adjacent to the comments in your letter of November 10, 2011.

Also enclosed with this letter is a letter from the Company containing its “Tandy” representations.

Form 10-K for the Fiscal Year Ended December 31, 2010

Kinergy Operating Line of Credit, page 45

       1.

You disclose on page 45 that Kinergy, your subsidiary, is required to meet specified EBITDA and fixed coverage ratio financial covenants. To the extent that future noncompliance of any debt covenant is reasonably likely, please revise future filings to disclose and discuss the specific terms of any such covenants, as well as the terms of your most significant and restrictive covenants in MD&A. Your disclosures should include actual ratios/amounts for each period and the most restrictive required ratios/amounts.  This will allow readers to understand how much cushion there is between the required ratios and the actual ratios. Please show the specific computations used to arrive at the actual ratios with corresponding reconciliations to US GAAP amounts, if necessary.  Your disclosure should also address the risks and potential consequences of not complying with your debt covenants. See Sections I.D and IV.C of the SEC Interpretive Release No. 33-8350 and Question 10 of our FAQ Regarding the Use of Non-GAAP Financial Measures dated June 13, 2003.

Terence O’Brien

December 13, 2011

Page 2

The Company will, to the extent that future noncompliance of any debt covenants is reasonably likely, include in future filings details concerning the specific terms of any such covenants, as well as the terms of the Company’s most significant and restrictive covenants in its Management’s Discussion and Analysis of Financial Condition and Results of Operations.  If applicable, the Company’s disclosure will also address the risks and potential consequences of not complying with its debt covenants.

       2.

Please revise future filings to disclose amounts borrowed and that are available to you to be drawn down under $20.0 million line of credit that Kinergy maintains.

The Company will include in future filings the amounts borrowed and that are available to the Company to be drawn down under the $20.0 million line of credit that Kinergy maintains.

Consolidation of Variable Interest Entities, page 46

       3.

Please explain specifically how New PE Holdco meets the definition of a variable interest entity under the criteria in paragraph 05-8 of ASC 810-10-05 and paragraph 15-14 of ASC 810-10-15. Provide supporting details as necessary to explain how the legal entity meets the relevant criteria.

Pursuant to the guidance in paragraph 05-08 of ASC 810-10-05 and Section b.1 of paragraph 15-14 of ASC 810-10-15, a legal entity meets the definition of a variable interest entity (“VIE”) if the holders of the equity investment at risk lack the power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entity’s economic performance.

Background

The Company constructed and operated four wholly-owned ethanol production facilities (the “Plants”) through a subsidiary holding company (“PE Holdco”) and four other indirect subsidiaries (together with PE Holdco, the “Plant Owners”). In late 2008 and early 2009, the Company idled production at three of the Plants due to adverse market conditions and lack of adequate working capital. These adverse market conditions and financial constraints continued, resulting in an inability to meet debt service requirements.  As a result, on May 17, 2009, each of the Plant Owners filed voluntary petitions for relief under chapter 11 of Title 11 of the United States Code in the United States Bankruptcy Court for the District of Delaware in an effort to restructure their indebtedness. The Plant Owners continued to operate their businesses and manage their properties as debtors and debtors-in-possession during the pendency of the bankruptcy proceedings.

Terence O’Brien

December 13, 2011

Page 3

On June 29, 2010 (the “Effective Date”), the Plant Owners emerged from bankruptcy under the terms of a Plan of Reorganization (the “Plan”) structured by PE Holdco and the Company in cooperation with a number of the Plant Owners’ lenders. Pursuant to the Plan, all of the ownership interests in the Plant Owners were transferred to a newly-formed limited liability company, New PE Holdco, LLC (“New PE Holdco”), wholly-owned by the prepetition lenders of the Plant Owners. The Plan was intended to accomplish the following objectives: (i) restructure the Plant Owners’ debt, (ii) provide funds for ongoing operations of New PE Holdco, (iii) preserve assets of New PE Holdco, (iv) limit the loss of collateral of the prepetition lenders, and (v) provide the Company with the ability to reacquire an indirect ownership interest in the Plants through a direct ownership interest in New PE Holdco. On the Effective Date, New PE Holdco also entered into the following agreements with the Company and/or certain of the Company’s wholly-owned subsidiaries: (a) Asset Management Agreement (the “AMA”), (b) Ethanol Marketing Agreements, (c) Wet Distillers Grain Marketing Agreements and (d) Corn Procurement and Handling Agreements (collectively, the “AMA and Marketing Agreements”).  In addition, certain of the initial equity investors, with the authorization of New PE Holdco, granted the Company a call option (the “Call Option”) to purchase up to a 25% ownership interest in New PE Holdco for a purchase price equal to $120,000 per unit or up to $35,000,000 pursuant to the terms of a Call Option Agreement among New PE Holdco, the Company and the equity investors (the “Call Option Agreement”).

Under the terms of the Limited Liability Company Agreement of New PE Holdco (the “Operating Agreement”), the business, properties and affairs of New PE Holdco are managed by a committee of managers (the “Board”) consisting of up to five members.  Initially, the Board was comprised of four members consisting of representatives of a number of New PE Holdco’s equity investors.

Given that the initial equity investors and initial members of the Board of New PE Holdco do not have any experience in operating an ethanol manufacturing and marketing business, the Operating Agreement was designed to require the Board to appoint a management company to manage the day-to-day activities of New PE Holdco. In that regard, the Operating Agreement specifically provides that the Company shall be the initial management company.  In addition to appointing a management company, the Operating Agreement also provides that the Board must hire a Chief Operating Officer to administer New PE Holdco, including acting as the primary liaison between New PE Holdco and the Company.

Terence O’Brien

December 13, 2011

Page 4

Activities Performed by the Company

Under the terms of the AMA, the Company is in complete charge of, and has care and custody over, each Plant that is not operational (i.e., idled), including the recommendation as to when a Plant should become operational.  In that regard, the Company performs all activities necessary to support a cost effective return of each Plant to operational status once the equity investors approve the Company’s recommendation to re-start an idled Plant. In addition, the Company operates and maintains each Plant that is operational, including supplying all goods and materials necessary to operate and maintain each Plant.  In operating the Plants, the Company directs the production process to obtain optimal production yields, lowers costs by leveraging the Company’s infrastructure, enters into risk management agreements (e.g., insurance policies) and manages commodity risk practices. These activities, along with others as more fully described in the AMA, are performed by personnel provided and managed by the Company. The initial term of the AMA was six-months with certain renewal options. Either party may terminate the AMA upon failure to make payments, failure to perform material obligations under the AMA, or in the event of the insolvency of a party. The AMA has continuously been in effect since the Effective Date and has recently been extended through June 30, 2012.

The Company, through its wholly-owned subsidiaries also markets and sells ethanol and co-products manufactured by the Plants under the terms of separate marketing agreements with each Plant. The marketing agreements provide the Company with the absolute discretion to solicit, negotiate, administer (including payment collection), enforce and execute ethanol and co-product sales agreements with any third party. Although any sale of ethanol or its co-products by New PE Holdco directly to the Company (i.e., in situations where there are no third-party customer designated) requires the consent of the Board of New PE Holdco, these types of sales rarely occur. The marketing agreements are effective for a twelve-month period and may be renewed for an additional twelve-month period. Either party to an agreement may terminate the agreement upon failure to make payments, failure to perform material obligations under the agreement, or in the event of the insolvency of a party. To date, these marketing agreements have continuously been in effect since the Effective Date and have recently been extended through June 30, 2012.

The Company, through its wholly-owned subsidiary, acts as agent for the Plants with the authority to take actions and execute documents in the name of the Plants under the terms of the Corn Procurement and Handling Agreements. Under these agreements, the Company, solicits, negotiates and administers the purchase of corn. Each of these agreements is effective for a twelve-month period and may be renewed for an additional twelve-month period. Either party to an agreement may terminate the agreement upon failure to make payments, failure to perform material obligations under the agreement, or in the event of the insolvency of a party. To date, these agreements have continuously been in place since the Effective Date and have recently been extended through June 30, 2012.

Terence O’Brien

December 13, 2011

Page 5

Capital and annual operating budgets are prepared by the Company in its capacity as the management company and are approved by the Board as more fully discussed below.

Activities Performed by the Board and Equity Investors

Pursuant to the terms of the Operating Agreement, the majority of the actions requiring approval of the Board and/or the equity investors, are primarily strategic and ministerial in nature, including approving loans, making changes to the form of management, issuance, purchase or redemption of membership units, request for additional capital contributions, approving the sale of assets of the Company, acting in connection with legal matters, approval of capital and operating budgets and expenditures, commencement of operations of any Plant that is idled, and substantially ceasing operations of any Plant for any reason.

Discussion and Analysis

The Company believes the activities of New PE Holdco that most significantly impact New PE Holdco’s economic performance are as follows:

·

operations and maintenance – performed by the Company;

·

production process – performed by the Company;

·

administering risk management strategies– performed by the Company;

·

sale of ethanol and its co-products – performed by the Company;

·

purchase of raw materials – performed by the Company;

·

asset preservation – performed by the Company;

·

creation of capital and operating budgets – performed by the Company;

·

approval of capital and operating budgets – performed by the Board;

·

recommendation of a change in a Plant’s operational status – performed by the Company; and

·

approval of a change in a Plant’s operational status – performed by the Board.

The Operating Agreement provides that the equity investors share in the income and losses based on their percentage ownership interests in New PE Holdco. In addition, the equity investors are responsible for the approval of a number of activities that are primarily strategic and ministerial in nature. The Operating Agreement provides that these activities must be approved by a majority of the Board and/or equity investors and, as a result, there is not one entity that has unilateral decision making rights over these items. Additionally, although these activities are important, the Company believes that the majority of these activities do not impact the economic performance of New PE Holdco in any significant manner. As described above, the equity investors are responsible for the approval of capital and operating budgets and a change in a Plant’s operational status. However, these approval rights are not considered substantive as the Board does not initiate these activities.

Terence O’Brien

December 13, 2011

Page 6

The initial equity investors are comprised of financial institutions and hedge funds with no experience in operating an ethanol manufacturing and marketing business.  It is for this reason that the Operating Agreement mandates that a management company be appointed to manage the business of New PE Holdco.  In that regard, New PE Holdco and the Company entered into the AMA and Marketing Agreements which, on a collective basis, vests with the Company the power to direct substantially all of the activities of New PE Holdco that most significantly impact New PE Holdco’s economic performance. However, the AMA and Marketing Agreements also provide New PE Holdco certain kick-out and participating rights.  Pursuant to Section b.1 of paragraph 15-14 of ASC 810-10-15, kick-out rights or participating rights held by the holders of an equity investment at risk shall not prevent interests other than the equity investment from having the power to direct activities significant to the entity unless a single equity holder (including its related parties and de facto agents) has the unilateral ability to exercise such rights.  The Operating Agreement provides that a change in the form of management of the Plant Owners requires the approval of a majority of the Board and all of the equity investors. Given that (i) the Operating Agreement designates the Company as the management company for New PE Holdco and (ii) the equity investors and members of the Board do not have experience in operating an ethanol manufacturing and marketing business, any restriction or revocation of the authority granted to the Company would be tantamount to a change in the form of management thereby necessitating the approval of a majority of the Board and all equity investors (i.e., a single equity investor does not have the unilateral ability to exercise the kick-out or participating rights contained in the AMA and Marketing Agreements).

Pursuant to the guidance in paragraphs 55-5 to 55-7 of ASC 810-10-55, in situations where both the equity group and the parties outside the equity group  hold voting rights or s