Ethanol Production in the Upper Great Plains
AgMRC Renewable Energy Newsletter
March 2010
Dr. Gregory McKee,
Department of Agribusiness and Applied Economics, North Dakota State University
Dr. Gary W. Brester and Joel Schumacher, MS
Department of Agricultural Economics and Economics, Montana State University
The U.S. ethanol industry has expanded rapidly during the past decade aided, in part, by both State and Federal production subsidies. Much of this expansion has occurred in Minnesota, South Dakota, and North Dakota. Along with Montana, we define this four-state region as the Upper Great Plains (UGP). In this report, we discuss ethanol production activity in the UGP. We provide an overview of ethanol and corn production in each State and associated subsidy programs.
Ethanol, corn, and by-product production in the upper great plains
Ethanol production in the upper great plains
The four-state region is a significant producer of ethanol. Although Montana lacks ethanol production facilities, the other three states produced over 2.2 billion gallons in 2008. This represented approximately 24% of total U.S. ethanol production. In 2008, South Dakota was the fourth largest producer of ethanol and Minnesota was fifth, with each producing approximately 1 billion gallons or 11% of U.S. production. North Dakota produced 233 million gallons of ethanol in 2008, and was the 11th largest producing State.
Corn production in the upper great plains
Minnesota is the largest corn producer of the four States with approximately 1.1 billion bushels in 2008 (figure 1). South Dakota produces approximately one-half as much corn as Minnesota (550 million bushels in 2008). North Dakota produces approximately 285 million bushels of corn per year, while Montana is a minor producer with an average of about 5 million bushels in each of the past two years. The four-state region produced approximately 17% of the U.S. corn crop in 2008.
Ethanol by-product production in the upper great plains
UGP ethanol facilities produce a significant amount of dried distillers grains and solubles (DDGS) as a by-product of dry corn milling. DDGS are primarily used as livestock feed in either a wet or dry form. Although some variability exists among facilities, modern facilities produce 2.8 gallons of ethanol from a bushel of corn. The four-state region used approximately 1.1 billion bushels of corn in 2008 to produce ethanol. Assuming that 18 pounds of DDGS are produced from each bushel of corn, the region also produced approximately 11 million tons of livestock feed.
State ethanol subsidy programs in the upper great plains
Federal ethanol tax credits were first established by the Energy Tax Act of 1978 and remain the most significant subsidy for the ethanol industry. In recent years, the value of this subsidy has ranged between 1/3 and 1/6 of per gallon ethanol prices. State subsidies are generally smaller than Federal subsidies.
Minnesota
Minnesota has 21 ethanol production facilities with a combined annual production capacity of over 1 billion gallons. Minnesota provides ethanol producers a $0.20/gallon subsidy for ethanol produced by facilities that were operational as of June 30, 2000. Such facilities are eligible to receive subsidy payments for 10 years. Payments are limited to $3 million per facility annually. About one-half of Minnesota’s facilities qualify for the subsidy. The program is scheduled to end on June 30, 2010.
South Dakota
South Dakota has 15 ethanol production facilities with total annual production capacity of over 900 million gallons. The State offers a production incentive of $0.20/gallon to ethanol producers. However, the program includes several constraints that limit subsidy expenditures. For example, the subsidy payment can only be applied to 416,000 gallons/month (5 million gallons/year) per facility. In addition, total State expenditures on this program cannot exceed $7 million/year. Commercial facilities eligible for this subsidy in 2008 received between $0.005/gallon to $0.03/gallon depending on facility size. Only facilities that were operational prior to 2006 are eligible for this program.
North Dakota
North Dakota has six ethanol facilities with total annual production capacity of over 300 million gallons. Two of these are older and somewhat smaller facilities, and both have been shutdown periodically in recent years. North Dakota offers an ethanol production incentive based on ethanol and corn prices. The program began in 2003, but ethanol and corn prices did not trigger payments until 2007. The program consists of two parts. The first part reduces the price of corn used by an ethanol facility by providing a $0.001/gallon subsidy for every one cent that corn prices exceed a pre-established threshold price (currently $1.80/bushel). The second part of the program reduces this subsidy by $0.002/gallon if ethanol prices exceed a pre-established threshold (currently $1.30/gallon). Only facilities built after July 1, 1995 are eligible, and total statewide program expenditures cannot exceed $1.6 million annually.
Montana
Montana does not have any commercial ethanol production facilities at this time. However, several incentive programs exist for potential ethanol producers. The key incentive is a $0.20/gallon production subsidy. This subsidy is only available to facilities that use a certain percentage of Montana-produced agricultural commodities as feedstock. The program limits individual facility payments to $2 million annually, and $6 million over the life of a facility.
Simulated financial performance of UGP ethanol plants
A simulation model was used to determine ethanol facility-level returns-over-variable costs and profitability in the presence of State and Federal ethanol production subsidies. An economic model developed by Hofstrand (2008) was adapted to production conditions in the UGP. The model accounts for state-specific variability in ethanol, corn, natural gas, and by-product prices. A model is created for a typical, large 100 million gallon per year (MGY) facility, and another for a typical, small 30 MGY facility.
We first consider whether ethanol facilities in the UGP are able to generate returns-over-variable costs. Firms that are unable to generate positive returns-over-variable costs will cease to operate. For the 100 MGY and 30 MGY facility models, returns were positive between January 2005 and December 2006, but were negative for the smaller facility models, on average, between January 2007 and July 2009 (figure 2).
The profitability of ethanol production depends on facility size. Profits for ethanol producers were greatest in this simulation during 2005 at $0.55/gallon for the 100 MGY facility, and $0.34/gallon for the 30 MGY facility. Between 2006 and 2008, average simulated profits declined to $0.09/gallon for the 100 MGY facility and -$0.17/gallon for the 30 MGY facility. Simulated profits were negative in 2009 regardless of facility size. Figure 3 illustrates simulated profits for these two facility sizes over the most recent five years. These results indicate ethanol production at the 100 MGY facility was profitable in most years, but was often unprofitable for the 30 MGY facility.
Simulated financial performance of UGP ethanol plants by ownership structure
Agricultural producers and non-producers have made substantial investments in ethanol production facilities (The Economist, 2007). The effects of reducing State ethanol production subsidies may differ depending upon the ownership structure of ethanol facilities.
Therefore, we calculate the total profits of vertically integrated ethanol facilities (i.e., those owned by corn producers). Figure 4a shows the total profits to corn and ethanol producers for all five years. Corn production profitability is calculated as the difference between per bushel corn prices and corn production costs including inputs and cash rents (Duffy and Smith, 2008). These differences are converted to profits (or losses) with respect to per gallon ethanol production, and then summed with the profitability presented in figure 3 (which shows simulated ethanol production profits for investor-owned facilities). Except for July 2009, figure 4a shows that total profits for the vertically integrated 100MGY facility were positive throughout the period. Figure 4b indicates that total profits for farmer-owners of the smaller 30 MGY facility were positive between 2005 and 2008, but negative in 2009. With the exception of 2005 for which corn production profits were negative, simulated total profits from vertically integrated corn and ethanol production are greater than those for investor-owned facilities obtained from ethanol production alone.
Summary
The UGP region is a significant producer of ethanol. Although Montana lacks ethanol production facilities, the other three States produced over 2.2 billion gallons in 2008. This represents approximately 24% of total U.S. ethanol production. During the past year, South Dakota was the fourth largest producer of ethanol and Minnesota was fifth, with each producing approximately 1 billion gallons. North Dakota produced 233 million gallons of ethanol in 2008, and was the 11th largest producing state.
Most UGP ethanol production facilities use corn as a feedstock. Minnesota is the largest corn producer of the four states with approximately 1.1 billion bushels. South Dakota produces approximately one-half as much corn as Minnesota (about 550 million bushels). North Dakota produces approximately 285 million bushels of corn per year, while Montana is a minor producer with an average of about 5 million bushels in each of the past two years. The four-state region produced approximately 17% of the U.S. corn crop in 2008.
Each State in the UGP offers a variety of ethanol production subsidies. State subsidies range from less than $0.01/gallon to $0.20/gallon. However, per gallon subsidies are often lower in practice than as stated in legislation because of restrictions on annual total State expenditures for specific programs. Although difficult to quantify, it appears that the effective State ethanol subsidies in the UGP are approximately $0.05/gallon.
We use a simulation model to calculate returns-over-variable costs and profitability for ethanol production for two facility sizes -- 100 million gallons per year and 30 million gallons per year. Smaller plants generally have older technology and have been unable to maintain returns-over-variable costs over the past two years. Firms that cannot generate enough returns to offset variable costs will cease operations. Although State subsidies are generally small, reductions or elimination of such support could cause smaller, older ethanol plants to cease operations. These plants also have negative profits and profitability, making them unattractive investments for corn producers or other investors. However, simulated total profits from vertically integrated corn and ethanol production are greater than those for investor-owned facilities obtained from ethanol production alone.
References
- Anon. “The Craze for Maize; Iowa’s Ethanol Economy.” The Economist, May 2007. Downloaded September 2009.
- Duffy, M. and D. Smith. “Estimated Costs of Crop Production in Iowa-2009.” December 2008. Iowa State University Extension Publication FM-1712.
- Hofstrand, D. “Tracking Ethanol Profitability.” Agricultural Marketing and Resource Center, January. Ames, IA, 2008.
