a look at ethanol plant profitability and farmers’ investment · pdf filea look at...

A Look at Ethanol Plant Profitability and Farmers’

Investment Portfolios

Bob Jolly

North Central Farm Management Extension CommitteeAmes, IA

May 9-11, 2006

Some Definitions and Rules of Thumb

• Nameplate capacity– Contractor’s certification

• Actual production level – 20% over nameplate capacity

• Capital Costs– $1.50/gallon rated capacity

• Ethanol yields– Anhydrous 2.75 gallons/bushel – Denatured 2.83 gallons/bushel

• DDGS yields– 18 pounds/bushel

• Natural gas consumption– 35,000 BTU’s/ denatured gallon– 1031 BTU’s/cubic foot

• Electricity– 1.1 kWh/denatured gallon

• Water– 5 gallons/denatured gallon??

Ethanol PlantRevenue Composition

EthanolDDGSCO2

Source: Tiffany and Eidman

Ethanol Cost Components(per denatured gallon)

CornNatural GasElectricityChemicalsOther

Source: Tiffany and Eidman

Some Stylized Facts

1. Capital Costs– Cube-Square Rule– Imagine an ethanol plant as a large cylinder– Capital costs are proportional to the area– Output is proportional to the volume– Decreasing returns to scale

Derived from Gallagher et al, 2005

Unit Capital Cost

$0.000

$0.050

$0.100

$0.150

$0.200

0 25 50 75 100 125 150

Ethanol Output (million gallons)

Dollars/gallon

Some More Stylized Facts

3. Corn Assembly Costs– Priced delivered to plant– Total assembly cost is linear function of distance– Unit assembly cost increases at a decreasing rate

Unit Corn Acquisition Cost

$0.720$0.730$0.740$0.750$0.760$0.770

0 25 50 75 100 125 150

Ethanol Output (million gallons)

Dollars/gallon

And a Few More Stylized Facts for Good Measure

2. Operations Costs– Fixed Proportions– Chemicals and Water – Energy

Operating and Other Processing Costs

$0.000

$0.100

$0.200

$0.300

$0.400

$0.500

$0.600

$0.700

10 20 30 40 50 60 70 80 90 100 110 120 130 140 150

Ethanol Output (million gallons)

$/ga

llon

Putting the Costs together

Full Production Costs

$1.460

$1.470$1.480

$1.490$1.500

$1.510

$1.520$1.530

$1.540

10 20 30 40 50 60 70 80 90 100 110 120 130 140 150

Ethanol Output (million gallons)

Mill

ions

d

Contested Market Areas

Discussion of Farm ResultsCorn Price Where 50:50 = 2/3:1/3 ($5.75 Beans)

35 40 45 50 55150 2.92 3.13 3.34 3.56 3.77160 2.78 2.98 3.18 3.39 3.59170 2.66 2.85 3.04 3.23 3.42180 2.56 2.74 2.92 3.10 3.28190 2.47 2.64 2.81 2.97 3.14200 2.38 2.54 2.70 2.87 3.03

Soybean Yield

Cor

n Yi

eld

Discussion of Farm ResultsCorn Price Where 50:50 = 2/3:1/3 ($5.75 Beans)

Soybean Yield Asian Rust35 40 45 50 55

150 2.51 2.70 2.89 3.09 3.28160 2.41 2.58 2.76 2.94 3.12170 2.31 2.48 2.65 2.81 2.98180 2.23 2.38 2.54 2.70 2.86190 2.15 2.30 2.45 2.60 2.75200 2.08 2.22 2.37 2.51 2.65C

orn

Yiel

d

Full Production Costs

$1.490$1.495$1.500$1.505$1.510$1.515$1.520$1.525$1.530$1.535$1.540

10 20 30 40 50 60 70 80 90 100 110 120 130 140 150

Ethanol Output (million gallons)

Mill

ions

Monthly Ethanol Input and Output Prices

0.00

1.00

2.003.00

4.00

5.00

6.00

Jan-9

6Ja

n-97

Jan-9

8Ja

n-99

Jan-0

0Ja

n-01

Jan-0

2Ja

n-03

Jan-0

4Ja

n-05

Jan-0

6

Year

$/ga

llon

of e

than

ol

EthanolCornNatural GasDDGS

Estimated Ethanol Plant Monthly Profitability, 1996-2006

-$0.50$0.00$0.50$1.00$1.50$2.00$2.50

Jan-9

6Ja

n-97

Jan-9

8Ja

n-99

Jan-0

0Ja

n-01

Jan-0

2Ja

n-03

Jan-0

4Ja

n-05

Jan-0

6

Date

Dol

lars

Per

Gal

lon

Net Margins Gross MarginsTechnical and Cost AssumptionsBased on Tiffany and Eidman

Sensitivity TablePrice of Ethanol ($/Gal)Net Margin Breakeven

Price of Natural Gas ($/Dtherm)

Price of Corn($/bu.)

$5.00 $10.00

$2.00 1.02 1.19

$3.00 1.36 1.54

$4.00 1.71 1.88

DDGS at $80/tonDepreciation at $.08/gallon

Value Added What?...Horizontal Versus Vertical Investment in Iowa Production

Agriculture.

Josh RoeFormerly of

Department of Economics,Iowa State University

Now at Kansas State University

Or… Do ethanol investments make sense for farmers?

Sounds like a dumb question given current (rumored) rates of

return!

• Is Vertical or Horizontal Growth More Efficient for Iowa Agricultural Producers?

• What Attributes of a Farm Make it More Profitable for a Farm to Expand Vertically and/or Horizontally?

• Can a Farm’s Attributes Predict Their Optimal Investment Pattern?

Statement of The Problem

• Value Added Agricultural Investments-Investment in Ethanol Plant-Investment in Egg Production

• Stock Index-S&P 500

• Food and Agricultural Business Stocks-Fidelity Food Mutual Fund

Model Specification

Returns, Risk & CorrelationsValue-Added Investments

1993-2003

Correlation Matrix

Mean%

Std%

CV Ethanol Layers S&P 500

FidelityAgri-

business

Average Farm

Ethanol 10.13 16.51 1.62 1

Layers 7.23 6.28 0.86 -0.092 1

S&P 500 10.63 19.88 1.87 0.217 0.748 1

Fidelity Agribusiness 11.56 16.98 1.46 0.257 0.626 0.418 1

Average Farm 7.77 6.08 0.78 -0.249 0.663 -0.208 0.134 1

Source: Josh Roe, MS thesis

• Overall Implications-Farm Characteristics Not Accounted For-Each Producer Given a Unique Investment Alternative-Risk/Return Implications:

Model Specification

E-Va

σ

rf

µ

E-Vb

Results and Interpretations

Figure 4.5: Distribution of Average Portfolio Weight, by Cluster

0%20%40%60%80%

100%

1 2 3 4 5

Cluster Number

Perc

ent o

f Po

rtfo

lio

Farm Expansion Eggs Ethanol S&P Fidelity

Mean Values of Variables Used in Model, by Cluster

Cluster Number

Variable 1 2 3 4 5

Age of Operator*** 59 43 54 52 55

Grain Sales Ratio* 0.73 0.35 0.77 0.77 0.64

Net Farm Income Ratio*** 0.15 0.18 0.23 0.32 0.16

Return on Equity*** 0.12 0.18 0.09 0.12 0.09

Debt to Asset Ratio* 0.30 0.51 0.22 0.18 0.33

Interest Expense Ratio** 0.06 0.05 0.04 0.03 0.06

Government Payments Ratio 0.07 0.07 0.08 0.09 0.08

Non-farm Income 16,671 3,456 9,772 14,314 12,416

Conclusions

• Value Added Investments Fit Well into a Portfolio:-The Farm is Highly Dependant on Grain Sales-The Farm is Highly Leveraged and/or Relatively Inefficient-The Farm is Highly Dependent on Government Payments

• Stock Market Investments Don’t Appear to Be Profitable-Due to Greater Expected Risk-Would the Results Differ Across Another Time Period?-What About the Farms Who Heavily Invested in Them?