High corn prices mean hard times for ethanol producers

Iowa State U., Ames, IA, Feb 09, 2009 (Iowa State Daily/UWire via COMTEX) -- VSUNQ | Quote | Chart | News | PowerRating -- With rising corn and energy prices remaining low from the slumping economy, ethanol production in Iowa faces a rocky future.

VeraSun Energy Corp., an ethanol producer with several plants in Iowa, announced last month it will auction off seven biorefineries, including plants in Albert City and Dyersville, after filing for Chapter 11 bankruptcy in October.

"The collapse in energy prices has been so strong that the current price of corn hasn't gone down enough for them to continue to make a profit," said Dave Swenson, associate scientist of economics - agriculture and life sciences. "Energy prices are where they were before the ethanol boom took off, yet corn prices are still a buck fifty or maybe as much as two dollars higher than before the boom took off. So they're very much squeezed right now."

Don Hofstrand, field specialist with Iowa State University cooperative extension, said the economic crisis has also hurt ethanol production because there has been a decrease in consumption of fuel.

The crisis A-- In the spring of last year, there was a rapid rise in commodity prices, including corn. This rise drove up ethanol plants' production costs, Swenson said. Energy prices rose as well, so ethanol producers weren't initially hit as hard when production costs grew.

"They were buffered a little bit because energy prices rose at the same time and because ethanol is a substitute for gasoline, its price got bid up pretty nicely," Swenson said.

In July of last year, Swenson said corn prices began to fall again, which should have been good news for ethanol producers, but because of contracts they were still paying farmers high prices for corn.

"Many of them locked into longer-term contracts when prices were running on the way up, and so they found themselves in a period of constrained profitability because they had promised to buy grain at higher prices than the markets were at the time the prices went down," Swenson said.

He said this is exactly what happened to VeraSun -- they committed to buying corn at high prices and when energy prices fell, they went into debt and had to file for bankruptcy.

The credit crunch has also hit ethanol producers, Swenson said. When ethanol started to increase in popularity in 2005, investors rushed to get a piece of the profit and as a consequence, the industry overbuilt. Many producers borrowed money and went into debt to build plants and are now unable to find "bridge financing to get them through this rough spot."

The future AA-- Hofstrand said he couldn't say if there will be more ethanol plants shut down in Iowa, but said if companies like VeraSun file for bankruptcy, it doesn't necessarily mean the plant is closing.

"Ethanol plants are built for one thing and that's to produce ethanol. If one business can't make it work, somebody's going to come along and buy those plants and get them back into production," Hofstrand said. "So just because some ethanol businesses don't make it, it doesn't mean the production capacity is going away."

Ethanol producers have had significant help from the federal government through mandates and tariffs, which create demand and shield the industry from foreign producers of ethanol.

Swenson said a mandate from the federal government requires oil producers to use a certain amount of ethanol in their fuel and later rewarded ethanol companies by doubling the original mandate.

Sugar-based ethanol from Brazil has also been on the rise, but Swenson and Hofstrand said it doesn't pose too much of a threat to corn-based ethanol because of tariffs placed on it by the federal government.

"We're supporting ethanol to the tune of 51 cents a gallon here in the United States, we penalize Brazilian ethanol, I think it's 54 cents a gallon," he said. "The gap then per gallon, is over a dollar, so we're doing everything we can to keep Brazilian ethanol out."

He said larger producers will be able to fare the economy better because "they take advantage of economies of scale" so they can produce more ethanol at a cheaper cost.

"The long run expectation for this industry is very slim profits, large scale production very slim profits and only the most efficient firms will be in business," Swenson said.

He said he expects there to be a "healthy demand" for corn-based ethanol, but even if the demand goes away, it wouldn't hurt the Iowa corn producers because the export market for corn is still healthy and many foreign countries are looking to Iowa corn for livestock feed.

"If corn ethanol disappeared it would be devastating in the short run for corn farmers because they've basically geared up to produce an extra several billion bushels of corn," Swenson said. "But no one's talking about ethanol going away."

Hofstrand said he doesn't see corn-based ethanol disappearing in the near future.

"You have to keep in mind that the corn ethanol industry is very young, and it's evolving fast," Hofstrand said. "There's a lot of technologies out there that can greatly improve the efficiency of converting corn into ethanol. So I think in the foreseeable future it'll be a player and it'll become more efficient to produce and it'll be produced with less fossil fuels and with a smaller carbon footprint."

Major events in the history of corn-based ethanol

2005 - Heightened awareness and rhetoric about the environment, as well as government support, sparks increase in ethanol production.

2005 - Energy prices spike after some sectors of domestic oil production are shut down by Hurricanes Katrina and Rita.

Summer 2006 - The federal government refuses to provide liability protections to petrochemical plants for use of the additive Methyl Tertiary Butyl Ether, or MTBE. The additive, originally used for clean-air requirements, is found to be a carcinogen. Ethanol replaces MTBE as the additive, causing ethanol prices to spike and a rapid expansion of the ethanol industry.

2006 - Congress mandates companies use a certain amount of ethanol as an additive, creating an assured demand for ethanol industry.

2006 and 2007 - Demand for ethanol creates a "gold rush" demand for more ethanol plants in corn-producing states.

2008 - With rapid expansion of ethanol plants, corn prices rising and energy prices falling, the industry finds it hard to make a profit.

-- Information from Dave Swenson, associate scientist of economics - agriculture and life sciences

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