Last week the Des Moines Register was only one of a score of corn-belt newspapers reporting in depth on the precarious financial situation of the nation’s ethanol industry. The Register’s lead with, “Experience is said to be a hard teacher, and the ethanol industry has learned some painful new lessons in the last half-year.”
The Register analysts go on to note that “…ethanol producers now know that when corn prices fall, the prices of crude oil and ethanol decline as well.”
Their observation is more or less correct, but their assignment of corn prices as the precipitating factor in oil and ethanol market adjustments is likely at least in part backward. This cart-before-the-horse outlook is probably illustrative of one of the major pitfalls the ethanol industry faces – faulty assessment of the driving factors in corn and ethanol markets.
Most ag economists agree that in the present market, corn and ethanol prices are dictated by oil prices, rather than the reverse. “Corn prices are now tied directly to oil prices,” said Paul Burgener at the Dec. 9 Colorado-Nebraska Crop Clinic in Sidney, Neb. An Ag Economics Research Analyst for the University of Nebraska, Burgener works out of the Panhandle Research and Extension Center in Scottsbluff. “Corn is no longer a food and feed commodity,” he said.In the last six months, three of Iowa's 32 ethanol plants have closed and declared bankruptcy. Across the nation, more than a dozen plants have closed and even more newly built plants have delayed opening. At the beginning of the year the industry worried about winning political debates over environmental and food-cost concerns; now as 2008 draws to a close a major issue for many ethanol companies is surviving financially.
The outlook for the industry is far less rosy than it was in January.
Monte Shaw, Director of the Iowa Renewable Fuels Association, sees the climate as “frustrating” for the industry, and admits that more plants may be closing in the near term as the market stabilizes. “The industry probably overbuilt itself,” he said.VeraSun, on Oct. 31 the first major ethanol producer to file for chapter 11 restructuring, recently closed facilities in Albert City and Dyersville, Iowa, and has closed or delayed opening of several other plants across the corn belt.
Shaw is optimistic, however, and cites the federally mandated one-and-a-half billion gallon increase for ethanol production in 2009.
Only time will tell whether that mandate is realistic or even achievable.
Perhaps the largest challenge facing the industry is that, at least in some sense, the numbers don’t add up.At first glance, falling corn prices should mean increased profits for ethanol producers. With oil prices driving the first iteration of a so-called “new energy economy,” however, ethanol prices have plunged along with oil and corn, stripping hoped-for profits from ethanol. As oil plunged from near $150 per barrel in July to less than $40 in December, corn fell from more than $8 per bushel to near $3 while ethanol plunged to $1.50 per gallon from a summer peak of $2.90.
The crude oil price dive reflects a demand falloff coincident with the worldwide economic downturn which followed the sharp downward adjustment of speculative hedge funds which had become such a major market player in recent years. Unfortunately for the ethanol – and nearly all aspects of the ag sector – speculation and hedging were rife in ag and energy markets as well.
Ethanol companies bought corn feedstock at high futures prices last summer, when it seemed high ethanol prices and a federal production mandate would make their business models cash flow. Now they find themselves in the unenviable position of trying to produce a less valuable product with comparatively hyper-costly corn, or as Shaw puts it, “…the (ethanol) plants are having to sell lower-priced ethanol while using more expensive corn.”
Ethanol profit margins plunged from 31 cents to 3 cents per gallon in only about 120 days, according to Iowa State University Extension research.
As some ethanol plants close their doors and others turn away previously contracted corn shipments, Chapter 11 safeguards are beginning to look less than safe. A Wichita facility which recently filed bankruptcy found only one auction bidder last month, and that bidder was the bank holding the plant’s note. On the block in Ohio, a multi-million gallon capacity plant didn’t draw a single bid. The ethanol industry has joined the long line of troubled enterprises seeking government bailout. The Renewable Fuels Association (RFA) has been floating bailout proposals to lawmakers and President-elect Barack Obama's transition in recent weeks, asking $1 billion in short-term credit and $50 billion in loan guarantees to pay for industry expansion.
RFA and other industry groups are also asking the federal government to up the allowable percentage of ethanol in gasoline formulations. The current limit is pegged at 10 percent by the Environmental Protection Agency. The industry as asking for an increase to 15 percent initially, and to perhaps as high as 30 percent.
EPA and other regulatory agencies seem to be wary of increasing ethanol percentage in gasoline blend formulations. More study is needed, they say, not the least of which is an assessment of potential damages to current automobile engines at higher ethanol concentrations in pump fuel.
In addition, the ethanol industry, already receiving the benefit of a growing federal usage mandate, a significant tax subsidy and tariffs on imported ethanol, will likely face a serious fight from livestock interests and environmental groups before it receives any additional federal aid. Iowa’s Senator Charles Grassley recently opined that the industry must concentrate on preserving the incentives it presently enjoys.
Even though the new Obama administration, as well as a new congress heavily in favor of alternative energy, will soon be in place, executive and congressional support for the ethanol industry is unlikely to overcome all the problems facing ethanol plants.
With VeraSun recently allowed by a Delaware court to unilaterally void previously agreed to corn contracts, ethanol plants may now find it hard to purchase corn from skeptical farmers concerned that their delivery contracts might be voided as well.
Leaving aside the industries new credibility gap with farmers, low corn prices will make it difficult for many farmers to justify planting corn at last year’s record levels. The projected breakeven corn price for farmers is about $4 per bushel. Facing projected $3.50/ bu. prices, many farmers are already looking to alternatives.Nor can ethanol plants look to distiller’s grains to prop up their operations. Once a tidy chunk of industry profit, prices for the livestock feed – a by- or co-product of ethanol production, have plunged in recent months also. Summer prices neared $190 per ton for distiller’s grains, but have fallen off to about $100 per ton this month.
What does the future hold for the ethanol industry? Only time will tell, but in December, 2008 the ethanol boom seems to have gone at least slightly bust.