Magnitude of the US ethanol problem (opportunity?) Go

Posted on 5/1/2009 with 0 comments

It has been well reported that the US ethanol industry is facing difficult times. At a high level, it is understood that there is significant overcapacity and that margins have been squeezed due to increasing feedstock (corn and natural gas) and declining ethanol prices. But how bad is the situation and where do the opportunities exist, if any?

US Ethanol Plants

The Ethanol Producer Magazine reports over 12 billion gpy of installed capacity (204 plants) with another 1.5 billion gpy in construction (15 plants). Of the existing capacity, 2 billion gpy (33 plants) are fully idled and those running are producing less than nameplate capacity. The locations and status are shown in the map below (interactive map). It should come as no surprise that most of the idled plants and ultimately those delaying construction are at a greater distance from the Midwest corn belt.

The extent of the ethanol expansion in recent years has been impressive. In 2007, ethanol production was approximately 6.5 billion gallons. In 2008, the Renewable Fuel Standard allowed for 9 billion gallons and will increase to 10.5 billion gallons in 2009. Ultimately for traditional biofuel, this reaches a plateau of 15 billion gallons in 2015.

USDA corn planting statistics and its use for ethanol underscore the magnitude of the expansion. In 2001, 75.7 million acres of corn were planted. By 2007, corn plantings had increased to 93.5 million acres. This increase is roughly equivalent to an area one half the size of Iowa. The percentage use of corn for ethanol increased from 9% in 2001 to over 30% in 2007/2008. By 2008, almost 100% of the increase in corn production from 2001 was due to the needs of the ethanol business. Interestingly, there was also a 10% decrease in the use of corn for feed and 20% decrease in its use for corn syrup over the same period. In effect, corn for syrup and feed was diverted to the production of ethanol.

Ethanol Returns

Don Hofstrand at Iowa State university has developed a model where he projects the profitability of ethanol plants. The graph below shows the changing profitability of ethanol production given his assumptions. For plants currently running, a small contribution margin is available for fixed costs. For newer, more expensive plants (2007 onwards) with high leverage, debt service is generally not possible. Consequently, ethanol plants are either being forced into bankruptcy by their lenders or at the very least going through some serious restructuring. To make matters worse, some of these later stage plants were not as well designed and therefore are “structurally” and “financially” challenged. Expect to see more distressed sales. As a additional point, the USDA graph below on current and historic ethanol prices underscores the effect of overcapacity and the resultant drop in spot ethanol prices.

Historic Ethanol Prices

As evidenced by Valero’s recent bid for Verasun’s ethanol assets (representing approximately 30% of initial capital costs), second owners stand to gain a competitive operational advantage with lower cost capital structures and in some cases, renegotiated corn contracts. Only last March, Valero was still dead set against ethanol. But with distressed assets available, a petroleum refiner is a prime candidate to purchase assets given their blending requirements and likely cash reserves. Ultimately, this further drives consolidation and better professional management of the plants. Expect to see more competition for assets geographically well situated and very low bids (scrap value?) for plants further afield.

Ethanol is here to stay, but just as in other markets (merchant generation ca. 2000), initially strong economics drove over expansion. Only time will allow for the installed base to be fully used. Cellulosic ethanol is still on the horizon and the industry is yet to see if full scale plants can be run profitably.