By Connie Hardy, content specialist, AgMRC, Iowa State University, chardy@iastate.edu.
Profile revised April 2008.
Production and Demand
Consumer demand and the 2007 Renewable Fuels Standard continue to help the ethanol industry set production records. In 2007, ethanol production capacity stood at 8 billion gallons with an additional 6.6 billion gallons of production capacity under construction. Projected ethanol production for 2008 is 7.7 billion gallons with a total operating capacity of 8.5 billion gallons per year (bgy). Worldwide production capacity stands at 43 bgy from 565 plants located in 56 countries.
Ethanol plants are located in 26 states, but most production is concentrated in the high corn production arreas of the Midwest. According to statistics gathered by the Renewable Fuels Association, 147 plants are operating, 6 are expanding and 55 new plants are in various phases of construction. New construction and expansions will add over 5 billion gallons of production capacity, bringing total U.S. ethanol production capacity to 13.5 billion gallons by 2009 and requiring 4.7 billion bushels of corn. The USDA Economic Research Service report, Agricultural Projections to 2017, estimates a reduction in planted U.S. corn acreage from 93.6 million acres in 2007 to 88.0 million acres in 2008.
Although ethanol has been around for hundreds of years and used in automobiles dating back to Henry Ford’s Model A, it has never generated as much attention as it has during the past decade. Historically low corn prices coupled with relatively high gasoline prices provided an environment that was favorable for rapid growth of the ethanol industry. These pricing dynamics, along with favorable margins in the industry, attracted considerable investor interest, resulting in a surge of plant development based on favorable indicators for the industry.
Triggered by low grain prices and high fuel prices, rapid growth and expansion of ethanol plants occurred quickly, despite the fact that a considerably different economic situation existed as recently as the mid 1990s. During the mid 1990s, corn shortages and lower gasoline prices placed substantial pressure on the growing ethanol industry. Perhaps the most critical variable for the industry was a pending Renewable Fuels Standards (RFS), which was passed in 2005. The RFS mandated a minimum of 7.5 billion gallons of renewable fuels to be used in the United States by 2012. The new RFS passed in the 2007 Energy Bill requires 36 billion gallons per year of fuel to be produced from renewable resources by the year 2022.
The majority of the growth in the domestic ethanol industry has been a result of farmer ownership and investment in dry-mill ethanol facilities. These highly efficient dry-mill plants typically go from the drawing board to production in less than two years. Farmer-owned facilities represent 34 percent of the total production capacity currently operating, but only 12 percent of the capacity that is currently under construction. Although ethanol can be produced from a variety of feedstocks, the majority is made from corn in dry mill plants.
Increasing demand can also be attributed to MTBE bans in states such as California, New York and Connecticut and has often resulted in a complete transition from MTBE to ethanol. Currently 20 states have some form of legislation limiting or banning MTBE. As a result of a MTBE ban in California, the state quickly became the largest consumer of ethanol in the country. Nationally, ethanol can be readily purchased in 37 states. Following California, the next largest consumers of ethanol are Illinois, Iowa, Minnesota, Ohio, Indiana, Michigan, Missouri, Wisconsin and North Dakota.
Another factor that supported the industry growth was a federal tax exemption program of 5.3 cents per blended gallon of gasoline. This federal tax declined gradually to 5.1 cents per gallon by 2007. In addition to the tax incentive programs, the federal government created the Bioenergy Program to encourage expansion in the production of bioenergy, including biodiesel and ethanol. This program makes payments to production facilities that increase production from year-to-year. Numerous states also have created incentive programs to encourage or assist in the development of plants.
Ethanol is becoming a fuel of choice for many consumers for one or more of the following reasons: either as an oxygenate, an octane booster, an extender or as an alternative fuel supporting energy independence. Ethanol is predominately used as an oxygenate to help gasoline burn cleaner. Typically sold as a 10 percent blend of ethanol with regular petroleum grade fuel, it is commonly referred to as E10. At this 10 percent blend, ethanol also improves the octane rating of the fuel, improving its performance by resisting early ignition. Ethanol can also be used as a gasoline volume extender to compensate for petroleum supply shortages or reducing the U.S. dependence on foreign oil. Recent studies show that ethanol can be used successfully in blends up to 30 percent. Ethanol is also gaining favor as an alternative fuel in specially designed flexible fuel vehicles (FFVs) that will burn E85, an 85 percent blend of ethanol with petroleum gasoline.
Ethanol use has seen continued growth since the late 1970s when it was first introduced as a product extender during OPEC oil embargos and gasoline shortages. In the mid-1980s, ethanol began to see widespread use as an octane enhancer and grew even more rapidly as an oxygenate with the passage of the 1990 Clean Air Act Amendment, which required the addition of oxygenates, such as ethanol, to gasoline in heavily polluted regions of the country.
Internationally, ethanol has seen similar but not as rapid growth in countries such as Brazil, Argentina, United Kingdom, Canada, China and Thailand, which have all implemented some form of ethanol requirements to address either environmental or fuel dependency concerns.
Competitive Products
In major metropolitan areas that require a reduction in automobile pollution, ethanol is currently the only oxygenate that can reduce emissions sufficiently to meet EPA clean air standards. MTBE was its primary competition but is being eliminated from the market due to health risks. The California, New York and Connecticut MTBE bans have resulted in unprecedented growth trends for ethanol usage in those states.
Since ethanol helps in meeting EPA regulations and is the only environmentally friendly and readily available renewable fuel, the outlook for continued growth in demand is likely. A comprehensive national energy bill promoting renewable fuels will ensure that growth trends experienced in this industry over the past decade will continue. Ethanol blended for marine and aviation applications is also showing potential for new market opportunities.
Nearly all of the ethanol produced in the United States uses corn as its primary feedstock. This is based solely on the availability of corn and its efficiency of conversion, which results in 2.8 gallons of ethanol per bushel. With such a dependence on corn as a feedstock, the market's greatest vulnerability is in large fluctuations in corn prices. However, research is being done on alternative bio-based feedstocks, as well as capturing existing waste streams from other milling and manufacturing plants that might provide cost-effective substitutes for corn.
Although competitive ethanol production is dependent on an ample and affordable supply of grain, it is important to note that ethanol prices historically follow gasoline prices rather than corn prices. Because there is less correlation between corn and ethanol price, it is important for investors to remember that they are dealing with two related but independent commodities.
Competitive Intensity
Increasing ethanol production capacity has been a popular investment opportunity given recent strength in energy demand and consistently high fuel costs. Continually increasing domestic demand, coupled with a desire to reduce dependency on foreign oil, clearly signals continued capacity building will likely continue into the near future.
About 28 perecent of the currently operating ethanol plants are farmer owned or have significant famer investment. The majority of these plants produce between 30 and 110 million gallons per year or larger. The typical design of these plants will allow most of them to add capacity as the market demand grows. Farmer ownership of ethanol production facilities was responsible for most of the industry expansion through 2006; however, significant investments are now coming from non-farmer investors. Farmers own approximately 12 percent of the production capacity under construction now. The majority of the new plants have been built in the upper Midwestern Corn Belt; the leading states in order are Iowa, Nebraska, Illinois, South Dakota and Minnesota.
Favorable outlooks for the industry have kept entry into the market both easy and brisk. Because ethanol production technology is a relatively mature science, it is not likely to see significant reductions in production costs. Therefore, new facilities will find it increasingly important to locate in areas that maximize access to both expanding fuel markets and cheap feedstock material. Competition from import markets has increased from 135 million gallons in 2005 to 653 millions gallons in 2006. Brazil is the major exporter of ethanol to the United States, sending over 433 million gallons in 2007, followed by Costa Rica and El Salvador with 36 and 38 million gallons respectively.
Industry or Product and Life Cycle
Often perceived as a new industry, ethanol has actually been around for centuries. In more recent history, even the rejuvenation of the industry as a competitor with petroleum has taken over 30 years. Current national interests and the rapid growth of production facilities have cemented this industry into our national economy as a significant economic development opportunity. Stabilizing factors in the industry are multiple ownership scenarios, investments from outside the industry, existence of proven science with low-technology and low construction risks, expansions of established plants and ability to capture value in the byproducts and waste streams.
Supply Chain Elements
Interest in the rapid growth of farmer-owned facilities has raised many questions as to the proper location and placement of new facilities in order to be competitive in the marketplace. Major areas of consideration for inputs are consistently the cost of feedstock, access to natural gas lines and electricity. On the output side, consideration must be given to the proximity of a plant to expanding ethanol markets and outlets for byproducts such as carbon dioxide and distillers grains. From an infrastructure side, access to quality roads, rail and utilities are critical to a plant's success. Approximately 75 percent of ethanol is moved by rail and 25 percent by truck. Creation of a new ethanol pipeline is under consideration. Continued profitability and growth in the industry will be highly dependent on efficiencies of production and favorable economic scenarios that keep the country focused on energy independence and a cleaner environment.
Sources
Governor's Ethanol Coalition
National Corn Growers Association
Renewable Fuels Association
USDA Economic Research Service
U.S. Department of Energy