Rough Times for Corn Ethanol
AgMRC Renewable Energy & Climate Change Newsletter
Iowa State University
The 2012 calendar year was an unprecidented rough financial time for corn ethanol production according to the Iowa State University Extension ethanol production model (insert link to model) that represents a typical 100 million gallon corn-ethanol facility in Iowa. A monthly average loss occurred in every month of 2012.
The major culprit was high corn prices. The widespread Midwest drought led to low corn yields and high prices. As shown in Figure 1, the cost of corn for ethanol production (and consequently total cost) was higher than any other year in recent history. Although 2011 corn prices rivaled those of 2012, the average 2012 price of nearly seven dollars per bushel was over 30 cents higher than the previous year. During the last six months of 2012, corn price averaged $7.60 cents, over one dollar higher than the same time period during the previous year. Another price impacting the cost of producing ethanol was natural gas which averaged slightly less in 2012 than 2011. However, natural gas was such a small cost component relative to corn that its offset against higher corn price was very modest.
On the revenue side of the equation, ethanol price was high during 2012 but not high enough to fully offset the higher corn prices. As shown in Figure 2, ethanol price averaged $2.24 per gallon in 2012, which is high by historic standards, but 30 cents lower than the previous year. By contrast, dry distillers grains price was a record high at $238 per ton, $40 higher than the previous year. However, the distillers grains revenue was not large enough to offset the lower ethanol revenue. So total revenue was 30 cents per gallon below the previous year.
According to the Iowa State University Extension ethanol model, monthly ethanol profits were negative throughout 2012, as shown in Figure 3. Although there were months of losses in previous years, 2012 was the first year the model showed an annual loss. The 2012 annual average loss was nine cents per gallon, well below the 2005-2012 average profit of 30 cents per gallon and far below the average profit of $1.09 per gallon in 2006. Similarly, the return on equity was a negative 8 percent in 2012, well below the 2005-2012 average return of 26 percent and far below the annual average return of 94 percent in 2006.
Although return over all costs was negative during 2012, return over variable costs was positive, as shown in Figure 5. Variable costs include corn, natural gas, chemicals and other direct costs. It does not include the fixed costs of depreciation, interest, labor and taxes which are incurred regardless of whether the facility is operating or not. Return over variable costs is often used as the marker to determine if production should be continued or suspended. As long as sufficient returns are generated to cover variable costs and at least a portion of the fixed costs, it is feasible to continue producing, because fixed costs are incurred even if production suspended as indicated above.
Another benchmark is the “grind margin”, Grind Margin is computed as revenue (ethanol and DDGS sales) less the cost of corn and the energy needed to operate the facility. As shown in Figure 4, the grind margin was positive for 2012 and averaged 30 cents per gallon.
Looking at ethanol production from the perspective of its supply chain (ethanol production plus corn production), the supply chain was profitable in 2012 and the profits went to the corn farmer, as shown in Figure xxx. The red line (white dots) at the top of the figure is ethanol revenue (similar to Figure 2). The remainder of the figure shows the various corn and ethanol costs associated with producing the ethanol revenue. The gray area below the revenue line represents the cost of producing ethanol, not including corn. The orange line at the bottom of the gray area is the ethanol production breakeven price for purchasing corn.
The green area at the bottom of the chart represents the cost of the production inputs of producing the corn (seed, fertilizer, machinery, labor, etc.). The blue area above the green area is the cropland cash rent associated with securing the cropland on which to produce the corn. The dark blue line is the breakeven corn selling price for the corn farmer. As expected, the per bushel cost of producing the 2012 corn crop is high due to the drought reduced yield of 2012. The white area between the blue and orange lines is the supply chain profits. It is the area above the breakeven corn selling price for the corn farmer and below the breakeven corn purchase price for the ethanol producer. Although the supply chain profit is not as great as for 2010 and 2011, it is well above the marginal supply chain profits for 2008 and 2009.
The red line (yellow dots) represents corn price which essentially allocates the profit (or loss) between the corn farmer and the ethanol producer. The corn price allocated virtually all of the profits from the 2010 and 2011 corn crops to the corn farmer. During 2012 the corn price has allocated more than the supply chain profits to the corn farmer. This has resulted in the ethanol producer losses.
So where do we go from here? On the corn side of the equation the next few months will focus on concerns about whether corn prices have risen enough to ration the limited 2012 corn supply. Also, there is potential for continued high corn prices due to a continuation of the Midwest drought. Conversely, a return to normal yields when the drought ends, whether it is 2013 or a subsequent year, when measured against the backdrop of drought reduced corn usage, could result in lower corn prices.
Although current gasoline prices are high, the long-term expectation of lower energy prices due to the emergence of shale oil and gas, in concert with the emerging trend towards lower U.S. gasoline consumption, may lead to lower ethanol prices and usage. The resistance against reduced usage is the increase in the annual U.S. government mandate for more corn-ethanol production. Without the mandate, the market would still utilize ethanol as an octane enhancer, which would require ethanol blending of three to five percent of the gasoline supply. However, the market would probably not accept ethanol above this level because ethanol would then become a direct substitute for gasoline. Due to ethanol’s low energy content compared to gasoline, ethanol would probably not flow into the gasoline market at current ethanol prices. So the wild ride will probably continue into 2013 and beyond.