November 9, 2006
Nine Clouds on the Ethanol Horizon
A frenzy to build ethanol plants is spreading across rural America, due in large part to the passage of the Renewable Fuel Standard (RFS) in 2005. Interest and investment in the ethanol industry has been steadily rising during the past decade, but reached fever pitch when RFS bill mandated the use of 7.5 billion gallons of renewable energy by 2012. Prior to passage, ethanol plant investments were highly profitable, with some paying off original investors in five years or less.
RFS insures that demand for ethanol probably will remain strong for at least the near term. Consequently, North Dakota agriculture likely will be affected by ramifications of this frenzy. In addition, several emerging changes in technology may temper robust growth of the industry.
There are nine factors that will influence the industry.
1) A very noticeable impact will be the increased demand for corn by these plants. It is estimated that Iowa will be a net importer of corn by 2008. Corn acreage likely will expand significantly across North Dakota as well. Even so, rotational limits and other agronomic considerations will limit the expansion of corn in many regions. Thus, corn prices probably will rise in response. While this is good news for corn producers, other corn users, such as livestock feeders and processors, should factor in a new “corn price plateau” when formulating future budgets. Rising corn prices also could jeopardize many small ethanol plants that were marginally profitable before passage of the RFS.
2) The volatility of energy markets will be transmitted directly to agriculture. Since so much of agriculture is tied to corn, such as livestock, feed barley and soybean prices, those commodities will experience increased volatility as well. This past summer, fuel ethanol terminal market prices reached $4 a gallon in June and fell to less than half that by September. The ethanol industry’s derived demand for corn suddenly shifted and impacted the price it could pay for corn as a feedstock.
3) The RFS contains tax credits that underpin ethanol industry profitability at the moment. The current tax credit is 51 cents a gallon to blenders, which effectively lowers the cost of producing ethanol. However, these credits are due to expire in 2010. Last year, when retail ethanol prices spiked, several congressional members suggested terminating the credits even earlier. While renewal of the tax credits is likely in 2010 because of the strong political support for the industry, it is not assured. Thus, investors need to carefully assess future investment risks.
4) With less corn available, North Dakota livestock producers must plan on using more dried distillers grains (DDG) in their rations. For every bushel of corn entering an ethanol plant, one-third bushel of DDG is produced. Although DDG is not a perfect feed and difficult to handle in cold climates because of its high moisture content, the price likely will be quite competitive. DDG partially replace corn and soybean oil meal because they are lower in energy and higher in protein than corn grain. Given the saturation of ethanol plants in many areas, feasibility studies for new ethanol plants are placing minimal value on this byproduct because of the difficulty in finding willing buyers. For the long term, DDG prices probably will rise and protein prices could fall if soybean meal becomes more plentiful from biodiesel processors.
5) The impact of a new ethanol plant on local corn prices is modest. Any effects evaporate more than 60 miles from the site because the corn market is very large and fluid. While corn producers always hope for higher local prices and livestock feeders dread the new competition, research shows that the total effects are quite modest, often increasing corn prices less than 10 cents a bushel. New plants do end up being a convenient delivery point for many growers, which reduces local transportation costs.
6) The growth of ethanol plants nationwide could indirectly dampen relative prices for crops that are shipped by railroad out of North Dakota. Ethanol plants are high-volume businesses and prefer to have corn railed in and DDG railed out. To meet the emerging need for existing and planned ethanol plants, the railroad industry says it will need 30,000 new rail cars. Historically, North Dakota has had difficulty obtaining adequate numbers of rail cars to ship grain to buyers. Given strong profits in the ethanol industry, grain elevator managers will have greater difficulty competing and obtaining cars to ship other commodities, leading to a wider basis for those crops. Although demand for all crops likely will increase, those dependent on rail transportation may increase less rapidly.
7) Although DDG are readily available and a surplus byproduct at the moment, livestock producers should not count on their future availability. Since ethanol producers place minimal value on DDG at the moment, they are diligently working to find other outlets for disposal. Some alternatives under consideration include DDG gasification to extract even more ethanol from residue starch (not all starch is removed from DDG) or even direct burning of DDG to reduce plant energy needs. It is quite foreseeable that future ethanol plants could fully utilize all DDG, further reducing livestock feeders’ access to corn and its byproducts.
8) Other new technologies, such as fractionation, will yield different byproducts including higher fiber feedstuffs, a smaller amount of high-protein feed, and corn oil. Feed manufacturers may be better able to adapt these byproducts to specific livestock species.
9) While corn ethanol plants are highly profitable at the moment, this could rapidly change as new technologies emerge. The federal government is exploring and heavily investing in many new alternative renewable energy feedstocks, including cellulostic materials, such as grasses and tree pulp. Several of these technologies are being commercialized in Canada, Denmark and Spain. It is expected that they will be competitive within five to 10 years in the U.S. This would make existing corn ethanol plants less competitive. North Dakota is highly competitive with respect to cellulostic grasses, but this would be additional competition for crop acres. Range and native hayland will not be the source of cellulostic feedstock. Instead, cellulose probably will come from cropland as crop aftermath or plantings of high-fiber crops, such as switchgrass or trees.
In many respects, the future of the ethanol industry remains bright. It certainly has been a new engine of economic growth for rural communities. However, technology is rapidly changing and corn ethanol investors, producers and feeders will have to adapt to rapidly changing industry conditions.