Biofuels/Ethanol

In 2005, Congress changed the debate over biofuels that had been going on for decades and set the stage for a quick boom and bust cycle in the ethanol industry.

The 2005 Energy Act – among other things – required oil companies to blend a total of 7.5 billion gallons of renewable fuels into the nation’s gasoline by the year 2012. At the time, there was only 3.9 billion gallons being produced, and almost all of that was ethanol distilled from corn. In the same bill, Congress killed ethanol’s chief competitor as a clean-burning fuel additive, MTBE (methyl tertiary-butyl ether) because it produced groundwater pollution. Two years later, Congress required the production of 36 billion gallons of renewable fuels by the year 2022. Congress was demanding an eight-fold increase in the production of ethanol in 17 years. That law seemingly guaranteed the market for ethanol for the foreseeable future.

In addition, big states, like California, mandated that ethanol be blended into gasoline to reduce air pollution. Farm states, like Nebraska, set up incentive programs to push the construction of new ethanol plants.

These new laws and several other factors combined to make the construction of new ethanol plants seem like an economic gold mine. The industry responded, especially in Nebraska and the Midwest. Scores of new plants were planned; many were built. But then, factors changed and the boom turned into something approaching a bust.

Here are some of the factors that produced the ethanol boom and bust.

The Congressional and state mandates for ethanol use seemed to guarantee a market. In addition, the government has provided $20 billion in subsidies to the industry over the past decade. Those governmental actions seemed to settle the debate over support for ethanol that had been going on for decades. But then critics and the oil industry tried to chip away at the mandate. Corn farmers and ethanol producers became painfully aware that political mandates are potentially subject to the riptides of political opinion and pressure.

The price of gasoline at the pump affects the price of ethanol. In 2008, gasoline prices spiked to over $4 a gallon. Crude oil prices soared to over $100 a barrel. Most analysts blamed uncertainty about both the supply and demand for oil as well as profit-seeking speculators.

Ethanol prices went along for the ride. As oil prices rose in the middle of 2008, demand for ethanol rose as well. So ethanol prices spiked from less than $1.60 a gallon in the fall of 2007 to a high of around $2.80 per gallon in mid-2008. But even at its high, ethanol was still cheaper than gasoline at over $4.00 a gallon. The price of E-10 gasoline (with 10 percent ethanol) became cheaper than regular gas.

But, with historic high gas prices, consumers started driving less and buying more fuel-efficient cars. Gas prices plummeted to around $2.75 by fall 2009. Ethanol also declined to around $1.60 a gallon by fall 2009.

That put ethanol producers in a price squeeze.

The price of corn – the raw material for most ethanol plants in the U.S. – is also volatile. As the chart below shows, throughout most of the period from 1970 to 2009, the actual price of corn hovered between $2 and $3 a bushel. Then there was a spike to almost $5 in 1996 caused by drought conditions.

As more and more ethanol plants went online and started buying corn, the price naturally shot up. In 2005 – when a lot of new ethanol plants were planned – corn was under $2.00 a bushel. By mid-2008, corn peaked at over $5.50 a bushel. Many ethanol plants had locked in futures contracts for corn at high prices to make sure they had enough supply. Then the price for ethanol dropped, and the plants were in bad financial condition – paying more for their raw material and getting much less for their finished product.

As we’ve seen, when we adjust corn prices for inflation, the spike in 2008 was not as great a change as during the agricultural boom of the 1970s.

As the demand for ethanol shot up because of rising oil and ethanol prices plus governmental mandates and incentives, construction of new plants shot up as well.

• In 2000, there were 54 ethanol plants in production in the U.S. By 2005 there were 81. In 2007 at the height of the construction boom, there were 110 plants producing and another 71 under construction. By 2009, there were 170 plants in production and another 24 under construction or expanding.
• In addition to more plants, the new plants had more capacity. In 2000, there was 1.6 billion gallons of ethanol produced. By 2005, there were 3.9 billion gallons produced (as mentioned above). In 2009, production grew to over 9 billion gallons.
• Nebraska’s huge corn infrastructure, central location and incentives for new plants pushed new construction and the state’s ranking in ethanol production. Between 2007 and 2009, the number of plants in Nebraska rose from 18 to 23. Ethanol production rose from 1.1 billion gallons to over 1.6 billion. The number of bushels of corn converted into ethanol doubled from 300 million bushels to 600 million bushels. And Nebraska became the second largest ethanol producer in the country after Iowa.

Troy Otte (left) was one of those producers who invested in the ethanol boom. When he was interviewed in 2007, the Advanced BioEnergy plant at Fairmont was getting ready to start producing ethanol. “I was at the right spot at the right time, or the wrong spot at the wrong time, one of the two,” Troy said with a smile. He made a substantial investment in the plant and sits on its board of directors. It’s good for the local community,” he said. “If corn [price] is high, the farm wins. If corn is low, the ethanol plant wins. So, one way or the other, it kind of puts a synthetic floor under the corn price.”

Agronomy professor Don Lee (right) sees the advantages of ethanol for producers, but he also sees the dangers. “Political decisions have really driven the ethanol industry,” Don says. “If you’re a [agricultural] producer I have a tough time seeing where ethanol is a bad thing. The only way a producer or a farmer could be at risk is if they invest a lot of their own money in that ethanol plant and it really isn’t a well-thought-out longer-term economic decision. So, we’ll see how it goes. My own prediction is that it [ethanol] will find its place in our production systems.”

The boom in plant construction peaked in 2007, and then dropped as low ethanol prices and high corn prices put many of the new plants into financial difficulty. Also, the recession of 2008 and ’09 decreased demand for gasoline, ethanol and corn.

• In 2009, the agricultural news service DTN reported that there were 36 ethanol plants not producing and another 48 projects on hold.
• In 2008, the nation’s second largest ethanol producer, VeraSun, filed for bankruptcy protection. The company had 14 plants operating, but it had locked in corn contracts when prices were rising. When both corn and ethanol prices dropped, the company could no longer make it. In March 2009, the nation’s largest independent oil refiner, Valero, bought half of the VeraSun plants. It was the first time that a traditional oil refiner crossed over into ethanol production. An Omaha investment firm bought two more VeraSun plants in Nebraska, and at least one of those has started production again – this time with lower corn contracts.
• In October 2008, Troy Otte’s company Advanced BioEnergy defaulted on two loans the company had used to buy two plants in South Dakota. Those two plants were transferred to the creditors, but the Fairmont plant continued operations. According to the company’s SEC filings, 2009 profits were down from 2008. For the nine months ending in June, 2009 gross profits were $3.7 million compared to $19.1 million in 2008. But the company insisted the Fairmont plant can continue operating profitably.
• Across the Midwest, innovative plants that were experimenting with the next generation of ethanol technology were idled, as well.

The ethanol boom was in danger of becoming a bust.

Yet, ethanol advocates insist that, over the long term, renewable energy sources are good for the country and the rural economy. In 2009, new president Barack Obama reassured the ethanol industry about his administration’s support. Some of the huge economic stimulus money was set aside for biofuels, and the production mandates were still in place.

Written by Bill Ganzel, the Ganzel Group. First published in 2009. A partial bibliography of sources is here.