Iowa Corn Ethanol Supply Chain Profitability
AgMRC Renewable Energy Newsletter
Agricultural Marketing Resource Center
In this article we will examine the corn ethanol industry supply chain and the profitability of this supply chain over the last five years. The corn ethanol supply chain is composed of two major segments – ethanol production and corn production. We integrate these two segments into a supply chain because corn is by far the largest production input currently making up 65 percent of the total cost of producing ethanol. We will see that the profitability of the supply chain varies greatly. The allocation of these profits/losses between the corn producer and the ethanol producer also varies greatly.
The monthly revenue from ethanol production over the last five years is shown in Figure 1. In this analysis the spot ethanol and distillers dried grains and soluble (DDGS) prices are used. Revenue has been quite volatile and is currently substantially below the peaks that occurred in mid-2006 and mid-2008. The great majority of the revenue is composed of income from the sale of ethanol. Although the sale of the ethanol production co-product of DDGS is significant, it makes up a relatively small fraction of total revenue. The other co-product of ethanol product is carbon dioxide (CO2). Although some corn ethanol plants sell carbon dioxide to the soft drink industry, most facilities simply vent it into the atmosphere. The carbon dioxide emissions do not increase atmospheric levels because it is part of the natural carbon cycle. This carbon dioxide originates from the atmospheric carbon used for plant development from the process of photosynthesis by the corn plant.
The cost of producing ethanol, when corn is priced into the analysis at its cost of production, is shown in Figure 2. Based on the cost estimates used in the analysis, the cost per gallon of ethanol has risen from just under $1.50 per gallon to over $2.00 per gallon of ethanol. The blue and orange sections are the cost of producing corn. The dark blue represents cropland cost (cash rent) and the orange represents all other production inputs such as seed, chemicals, fertilizer, fuel, machinery, etc. (less any government payments). As can be seen, the cost of producing corn has increased significantly over the five year period and has been the driver of the ethanol supply chain cost increase.
The light blue section represents the cost of natural gas to operate the ethanol facility. This cost has generally declined over the period as natural gas prices have declined. The other ethanol production operating (variable) costs such as chemicals, electricity, water and other costs have been held constant in the analysis. Ethanol facility fixed costs such as depreciation, interest on debt and labor costs are represented by the green section.
When the total revenue and total cost figures are combined, a picture of periods of high supply chain profitability interspersed with periods of breakeven (or small losses) emerges as shown in Figure 3.
The mid-year revenue peaks of 2006 and 2008 were periods of high profitability for the corn ethanol supply chain. However, declining ethanol prices and increasing corn production costs have resulted in roughly a breakeven period throughout 2009 and into 2010.
The allocation of these profits between corn production and ethanol production is shown in Figure 4. The profit line from Figure 3 is replicated in Figure 4 (dark blue line) and shows the period of high profitability and breakeven. The light blue line shows the ethanol producer’s profits and the orange line the corn producer’s profits. During the 2006 peak, the corn ethanol industry was rather small and, although ethanol prices were very high, corn prices remained low. The profits accrued at the ethanol producer level. These large profit margins stimulated a rapid expansion of the corn ethanol industry. So, when the ethanol revenue peak of 2008 occurred, the profits were bid into higher corn prices due to the increased demand for corn from the expanded ethanol industry. The allocation of profits was opposite from that experienced in the mid-2006 revenue peak.
The large corn producer profits were quickly translated into higher cropland cash rental rates and higher production input costs (especially fertilizer). This resulted in the increase in supply chain costs shown in Figure 2.
During 2009 and into 2010, the corn ethanol supply chain has fluctuated between periods of profits and losses. During the first part of last year, corn price was high enough to allocate small profits to the corn producer and small losses to the ethanol producer. During the last half of last year and into 2010, it appears as though the situation has been reversed.
Future Supply Chain Profitability
During late 2010 and 2011 the corn ethanol supply chain cost of production is expected to drop as shown in Figure 5. Corn production input costs (especially fertilizer) have declined from their lofty levels of the 2009 corn crop. Also, natural gas prices are expected to stay moderate in the future.
However, much uncertainty exists as to whether this will translate into profitability for the corn ethanol supply chain. Although crude oil prices are relatively strong, concerns exist as to whether ethanol prices will continue to follow gasoline prices. Evidence is emerging that we may be rapidly approaching the ethanol “blending wall”. The blending wall is a limit on the amount of ethanol that can be blended with the nation’s gasoline. Current law dictates that gasoline sold in the U.S. cannot contain more than 10 percent ethanol, except for the very limited E-85 market.
The U.S. Environmental Protection Agency is currently assessing the safety of increasing the maximum blend amount. They recently announced that they are considering raising the maximum to 15 percent for newer motor vehicles. They originally stated that they would make a final decision by early summer. The decision was recently postponed to late summer.
Although flex-fuel vehicles can burn up to an 85 percent blend of ethanol to gasoline, the limited number of flex-fuel vehicles and the limited number of E85 fuel stations greatly limits the amount of ethanol that can be merchandized in this fashion. Moreover, ethanol price must be at a significant discount to gasoline to incentivize flex-fuel drivers to purchase E85 due to its lower Btu content.
So, the blend wall is a significant threat to the profitability of the corn ethanol supply chain. It is exacerbated by the limited ethanol storage capacity of most ethanol producers. Ethanol producers are required to move ethanol into the transportation fuels system rapidly because of this limited storage capacity. If the blending wall creates an ethanol glut in the marketplace, ethanol producers have limited ability to hold inventories off of the market to smooth-out the impact of the excess. This could cause a rapid drop in ethanol price, thereby pushing the corn ethanol supply chain into the red. Initially the losses would accrue to ethanol producers. However, as ethanol facilities close down and cause corn demand to decline, at least a portion of these losses will be passed on to corn producers in the form of lower corn prices.
Whether we are actually reaching the blend wall is still an uncertainty. However, even the threat of reaching the blending wall heightens the need to push the wall back by allowing higher blends of ethanol in gasoline.
If long-term corn yield trends continue to increase corn production as expected, excess supplies of corn may build up in future years if the corn ethanol industry is not allowed to expand through higher blending rates. These excess corn supplies would need to be absorbed by increased livestock feeding and/or increased corn exports. A significant corn price decline may be needed to achieve this.
However, if a significant expansion in the ethanol blending limit occurs, ethanol production capacity will continue to expand resulting in increased corn demand. This may result in a tightening of corn supplies with corn prices being bid up to breakeven levels for ethanol producers. Any profits will be passed on to corn producers. The corn producer profits generated from strong corn prices and increased corn yields will be bid into higher cash rental rates and land values.