United States

Department of

Agriculture

RBS Research

Report 209

The Role of Information

Technology in the Fuel

Ethanol Industry
Abstract This USDA-sponsored study used panels of ethanol industry experts and follow-up

interviews with plant owners and managers to examine how information technology

has affected the structure, organization, and operations of the fuel ethanol industry.

The study examined the following questions regarding the future of the ethanol industry:

(1) Does the present ethanol industry represent a stable structure or a transitional step toward an inevitable concentration of ownership into the hands of a few large

processing firms?

(2) Have contemporary information technologies fundamentally changed the

information flows, scale of operations, access to markets, conditions of vertical and

horizontal coordination, sources of finance, and the competitive landscape for the

medium-sized, independent processing firm?

(3) To what degree have cost savings associated with better access to information and financing offset the cost savings traditionally associated with horizontal and

vertical integration in processing industries?

(4) What steps do medium-sized ethanol production entities need to take to continue to survive in this new information-based market environment.

The Role of Information Technology in the Fuel Ethanol Industry

Anthony Crooks and John Dunn

USDA, Rural Development

RBS Research Report 209

May 2006

The views and opinions expressed in this report are those of the presenters and do not necessarily reflect the policies and opinions of the U.S. Department of Agriculture.
Contents Abstract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .i

Executive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .iv

Study background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

The ethanol industry -- then and now . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

Information needs in the ethanol industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

Pricing and market information deficiencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

Futures market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6

Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Information technology and the rise of the ethanol plant “franchise” . . . . . . . . . . . . . . .8

Business processes and information technology . . . . . . . . . . . . . . . . . . . . . . . . . .9

Mobilizing business functions across many enterprises . . . . . . . . . . . . . . . . . . .10

Summary and conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12

Appendix 1— Emerging biotechnologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

Appendix 2— Relationship of the industry to the educational system . . . . . . . . . . . . .13

Appendix 3— Impediments to rapid industry growth . . . . . . . . . . . . . . . . . . . . . . . . . .15

Appendix 4— Discussion panel members and interviewees . . . . . . . . . . . . . . . . . . . .17

Appendix 5— Study team members . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

i
Executive

Summary USDA, Rural Development commissioned Informa Economics, Inc., of Memphis,

Tennessee, to conduct 2 panel discussions and 12 interviews with ethanol industry

participants and service providers to determine the impact of information technology

on the competitiveness of ethanol firms. Information from these panel discussions and

interviews was analyzed by a study team composed of experts from USDA's Rural

Development, Economic Research Service, the Office of the Chief Economist, the

University of Minnesota, and Informa Economics.

The principle discoveries from the panel discussions and interviews are:

1. Information technology (IT) has become a driving force in business operations,

strategies, structures, ownership, and performance.

a. IT innovations and applications have brought significant change to the nature

of business and its activities.

b. IT has altered industrial structure, conduct, and performance from vertical

“Command and Control” hierarchies to horizontal, multi-dimensional, multimodal, collaborations that are “real time” sharing and distribution of knowledge and work without regard for geography, distance, or language.

2. Structurally, the emerging fuel ethanol industry is uncharacteristic of typical agricultural processing.

a. There is a fragmented balance of the traditionally dominant multinational,

agribusiness processing firms and the medium-sized farmer-owned, -operated, and -controlled plants.

b. Ownership of those mid-sized plants is dispersed from production activities.

c. There have been very few efforts among the largest firms to integrate or

assimilate the assets of other firms either vertically or horizontally.

3. The fuel ethanol industry has expanded four-fold and altered its structure significantly since the mid-80s to early 90s:

a. Then the top 3 of a total 20 firms controlled 80 percent of production; annual

production capacity was about 1 billion gallons

b. Now the top 3 firms control 31 percent of production, and 44 of the remaining

71 plants are farmer-owned; annual production capacity is just over 4 billion

gallons.

4. Industry expansion and development was encouraged by a combination of factors including: Federal/State policies and incentives, a natural progression of an

emerging industry in a classic “production push” agricultural business model,

farmer-owned facilities and associated capital constraints, and oil prices $50+

per barrel.

5. The most prominent business development in the industry is the rise of the

ethanol “franchise.” These so-called “cookie-cutter” ethanol plants are offered

principally by two design/build firms, Broin, Fagen/ICM, who have adopted, . . . . .

ii
Executive

Summary developed, and now capitalize on two IT-enabled innovations - process design

technology and distributed control systems (DCS).

a. Process design technology standardizes the project design, construction,

and equipping of ethanol plants. Included in that design and equipment is the

DCS.

b. DCS is the central nervous system of an ethanol plant. DCS facilitates the

consolidation of the business process management functions across many

plants or firms. DCS enables precise factor/product coordination from established business/bio process metrics and benchmarking that is the result of a

massive data collection/analysis effort. DCS results/advantages include

sourcing/usage specifications, staff reduction, productivity gains, and cost

savings.

c. DCS enables the design/build firms to monitor/manage the operations of

many plants simultaneously.

6. Design/build firms offer a “one-stop ethanol shop” of ethanol business services

from feasibility to turn-key and beyond -- Hand-holding producer-investors

through the entire project process and providing operational contracts into 5th

marketing year with:

i. Marketing “partnerships” for ethanol and distiller grains.

ii. Procurement “contracts” for feedstock, energy, and inputs.

iii. Management “agreements” for operations/process benchmarking,

trading/risk mitigation, and market analysis/consulting.

7. IT enables design/build firms to practice dynamic specialization -- the digitalization, decomposition, of activities for outsourcing

a. Supply chain management -- marketing and procurement

b. Product innovation/commercialization

c. Customer relationship management

8. IT enables design/build firms to weave together processing networks that

encourage coordination across enterprises, companies, and specialties that are

dispersed geographically, institutionally, and dimensionally, and are the basis for

using “productive friction” to build and accelerate capabilities.

9. By fostering standardization IT -- Strips costs out of system, squeezes time loss

out of system by speeding up construction time - groundbreaking to turn-key, and

reduces downtime - 320 to 360 days of operation per year. All of these things

reduced perceived risk of investment in ethanol plants and facilitates the flow of

capital into the industry.

iii
Executive

Summary 10. By digitizing and decomposing activities for outsourcing IT -- alters asset location

requirements, encourages labor mobility, further separates ownership from management, and alters the skill sets needed for management and labor.

11. IT encourages firm transformation by - giving rise to the ethanol “franchise,” supporting a contracts-based industry structure, and creating a “Web” of collaboration across enterprises, companies, and specialties.

12. IT reduces bounds of uncertainty by providing a better understanding of risks that

in turn helps to reduce lenders' equity participation requirements, reduce interest

rates and the overall costs of capital, and invite participation from outside

investors.

13. IT has altered the ethanol industry/market structure by changing the emphasis

from gaining market power through accumulation of production capacity to that of

the aggregation of information. Market power no longer resides with the ownership of physical capital, but in the control intellectual capital.

iv
The Role of Information Technology 

in the Fuel Ethanol Industry

Anthony Crooks and John Dunn

USDA Rural Development

Study background

In recent years, information technology and an

increasingly transparent financial sector have become

key driving forces in business -- operations, strategies,

structures, ownership, and performance. These forces

cut across many industries to force changes that, in

turn, have had significant economic and social impacts

in rural communities.

Structurally, the emerging fuel-ethanol industry

is uncharacteristic of typical agricultural processing.

As the fuel ethanol industry grows out of its developmental stage into a more embedded role within the

U.S. fuels system, a substantial portion of production

capacity is characterized by investments of individual

enterprises in single plants with annual capacities that

range from 50 to 100 million gallons. Not all ventures

have succeeded. However, a substantial flow of capital

investment continues unabated into and across the

industry.

This emerging structure lies in sharp contrast to

what is generally observed in sectors that process bulk

agricultural commodities. Typically, a commodity sector is composed of a few, large, multi-plant firms that

achieve relative prominence after attaining significant

economies of scale, size, and scope, and then work to

capture additional value through their trading and

financial operations. These traditional industries are

also characterized by a high degree of vertical integration and/or coordination.

The ability of traditional firms to achieve competitive advantage is predicated, in part, on their capacity

to develop efficient, internalized information systems

to provide market coordination and linkages between

their operations and global commodity and financial

markets. However, the rapid and widespread change

in information technologies has arguably eroded the

power provided to these global processing concerns.

When viewing the emerging ethanol industry

from the context of the impact information technology

has had upon the development of the industry, the following four questions emerged as central issues for

this study:

(1) Does the present ethanol industry represent a

stable structure or a transitional step toward an

inevitable concentration of ownership into the hands

of a few large processing firms?

(2) Have contemporary information technologies

fundamentally changed information flows, scale of

operations, access to markets, conditions of vertical

and horizontal coordination, sources of finance, and

the competitive landscape for the medium-sized, independent processing firm?

(3) To what degree have cost savings associated

with better access to information and financing offset

the cost savings traditionally associated with horizontal and vertical integration in processing industries?

(4) What steps do medium-sized ethanol production entities need to take to continue to survive in this

new information-based market environment?

The primary methodology of the study was to

gather and synthesize opinions of a number of ethanol

industry leaders and experts under a framework built

upon contemporary thinking on the nature of the modern firm, business practice, and application of information technologies in a global competitive environment.

The study was conducted in two phases. In the first

phase, two discussion panels composed of 10 to 12

industry experts were convened and led through a 1-

day directed discussion covering a range of topics

related to various aspects of the evolution of the

1
ethanol industry, the forces shaping the present and

future industry, and how information technology may

have influenced that evolution.

The ethanol industry -- then and now

The fuel ethanol industry may very well be in

transition toward an inevitable concentration of ownership into the hands of a few large processing firms.

At present, however, there seems to be a structural

equilibrium among the mid-sized and largest firms.

This equilibrium is supported by an industrywide

adoption of contemporary information technologies

that serves to enhance medium-sized firm access to

both markets and factors and simultaneously diminishes the relative importance of vertical coordination

activities.

While today's industry is fragmented, it wasn't so

very long ago. Fuel ethanol was concentrated among

three major players in 1990 -- ADM held 60 percent of

the market, Pekin Energy (now Aventine, by way of

Williams Bio Energy) and New Energy Co. of Indiana,

each respectively held 10 percent. The entire industry

was comprised of about 20 firms that produced about

1 billion gallons (see Table 1). At that time, construction costs were around $2.50 per nameplate gallon,

conversion efficiency was close to 2 gallons per bushel

of corn, and the average-sized plant required around

50 staff members.

Structurally, today's situation is almost a mirror

image of the past. The top 3 firms produce about 31

percent of the total, and 44 of the remaining 68 firms

are farmer-owned. Over 4 billion gallons of fuel

ethanol will be produced this year. Construction costs

are about $0.98 per gallon. Fuel conversion efficiency is

now almost 3 (2.85) gallons per bushel of corn. A plant

requires only 35 full-time staff members and is operational for 360 days per year.

How did the industry get ”here”?

The transition from a highly concentrated to a

fragmented industry was brought about by several key

drivers: Federal and State policies, natural progression, a

classic “'production push” agricultural business model,

farmer ownership, a crude oil price spike, low-priced

corn, the development of venture capital interests, and

the formation of trade associations.

Federal and State policies

Federal and State policies contribute substantially

to the viability of the fuel ethanol industry. As one

industry participant commented, “State and Federal

incentives cover a lot of mistakes. They provide a safety net.”

Ethanol's exemption/credit against the Federal

excise tax on motor fuels is a long-standing industry

cornerstone. The programs created under the Clean

Air Act Amendments of 1990 enhanced demand for

ethanol. Those included the Oxygenated Fuels

Program, implemented in 1992, to reduce emissions of

carbon monoxide, and the Reformulated Gasoline

Program, taking effect in 1995, to reduce ground-level

ozone (i.e., smog) formation. The Bioenergy Program

(CCC-850), established by Executive Order in 1999

under the Clinton Administration, is a key incentive

for new facilities because it offsets part of the feedstock

costs incurred in starting up or expanding biofuels

production. The long-term extension of the excise tax

credit in the JOBS Act of 2004, together with the Clean

Air Act programs, reduced the “policy risk” associated

with establishing and operating an ethanol facility.

State policies also have had major impacts on the

industry. However, State production incentives tend to

be capped at a certain capacity level and which also

contributes to a fragmented industry structure.

Were it not that methyl tertiary butyl ether

(MTBE) was found to be carcinogenic, the fuel ethanol

industry would not be where it is today. The political

fight between the oil/energy sectors and agriculture

would have continued. The MTBE phase-out has put

both parties on the same side of the issue.

The Minnesota requirement that gasoline be

blended with 10 percent ethanol is regarded as a

model State policy. State bans of MTBE, a competing

additive used to boost oxygen content in gasoline,

expanded ethanol use in recent years. Presently, 20

States have implemented or announced bans of MTBE.

Most notable among them are California and New

York, where bans took effect at the beginning of 2004.

Natural progression

To some extent, fuel ethanol is experiencing what

many consider the “natural progression” of an industry. Most industries follow some form of rising developmental growth pattern, wherein an emerging industry begins with a fragmented look and then proceeds

through a consolidation phase. The ethanol industry

has taken a less predictable growth pattern. It has

effectively begun again several times over the years.

Each time it was on the verge of death, only to be

reborn anew. But the fundamental growth driver has

remained the same--world demand for energy.

2
Panelists point out that while ethanol is, in fact, a

commodity, its development as an industry has had a

social or philosophic component that has carried the

industry through periods that may have marked the

death of most fledgling industries. To paraphrase one

panelist,

...those involved in this business for 25 years still

have the same dream as those who started the

generation before. All are a little too naive to realize the size of the uphill battle being fought. But

before their eyes the industry became real. There

is something about ethanol that makes it more

than a commodity. It seems to those involved to

be more of a religious experience. It's truly emotional. And the industry survived a number of

difficult straits seemingly because of those

beliefs.

The ethanol industry has continued to grow in

the face of several downturns, each time to be rescued

by a new policy or other stimulus that led it to the next

phase of growth.

Former President Jimmy Carter started it when

he turned down the thermostat in the White House,

leading to the first Federal excise tax exemption incentive. The industry soon experienced its first financial

crisis and was headed downward, but lead was

banned as a gasoline additive in the mid-80s, and

ethanol got a second life as an octane enhancer. The

industry was headed down for a second time when it

managed to get an extension of the federal excise tax

exemption, along with the Clean Air Act in the 90s.

Four major events -- excise tax, lead phase-out,

excise tax extension, and MTBE replacement -- have

occurred to snatch the industry back from its downturns. Meanwhile, it kept expanding production without a clear vision of future demand. The consensus

3

Table 1—Summary of changes in ethanol industry over the past two decades

Then (mid 80s to early 90s): Now:

Concentrated structure Fragmented structure

Top 3 firms held about 80 percent Top 3 firms hold about 30

Industry structure of production percent

About 20 firms total 71 total firms (and rising)

(44 cooperatives or LLCs)

Production capacity 1 billion gallons 4+ billion gallons

$2.50/gallon of production $0.98/gallon of production

Plant construction cost capacity capacity

Corn conversion to

ethanol ratio 2.2 gallons per bushel 2.8 gallons per bushel

Plant labor requirements 52 full-time staff members 32 full-time staff members

labor costs $0.15 /gallon (1998) $0.05 /gallon

Operating days per year 310-320 350-360

Energy input/gallon down 50 

percent over 20 years

Pool of management, design, 

Other changes operations talent starting to 

grow

Ethanol buyers focus only on

large lot purchases (500 

million gallon deals)
seemed to be built on that Statement of faith, “It's a

good idea.” Support for increased ethanol production

in the 2005 Energy Bill bears this faith out.

Classic “production push” agricultural business

model

In no small way, ethanol is a case of classic “production push” agriculture. Farmers have a long tradition of planting seed in the ground without having

much of an idea about how much they will produce or

what they will receive for it. The industry philosophy

seems also to have been rooted in that same tradition;

devoid of any real vision or design.

Nevertheless, the industry is not going away.

Support for the continued expansion of ethanol use in

the 2005 Energy Bill ensures that industry growth will

continue The more important question is, “What will it

look like?” The consensus seems to be that unless there

is an engineering breakthrough in energy, the industry

is headed for a substantial long-term positive growth

phase. And the only real distinction among ethanol

plants in the last 5 years has been among those that

made a “nice” return on investment and those that

made a “fantastic” return.

Farmer ownership

The emergence of the “new generation” cooperative and the farmer-owned ethanol plant in the early

1990s played a critical role in the development of the

ethanol industry. The cooperative structure provides

farmers with the opportunity to collectively raise

money to build facilities. The cooperative also serves

to distribute the investment risk over the entire group

of investors and thereby reduces the risk to any individual investor. In addition, because cooperative membership is often tied to a right and an obligation to

deliver corn to the cooperative, corn delivery agreements may have helped the cooperative to survive

market fluctuations, in contrast to a privately owned

plant faced with purchasing corn in a volatile open

market.

However, it's harder to put together a co-op

today, because the farmer group within the typical 60-

mile grain-hauling radius doesn't have sufficient capital base to invest in the equity requirement portion of

the project. The recent history of projects has shown

that within the 60-mile radius, there is a limit of about

$12 to $18 million in capital to be raised through local

equity drives. Nevertheless, some farmer groups are

getting more sophisticated about raising capital -- a

recent success story involves a co-op that raised $28

million.

Generally, farmers will exhaust their ability to

raise equity, then the plant builders, ethanol marketers,

and other outside investors will come alongside as

necessary partners to complete the capital requirements. Recently, a few Wall Street investors have

entered to finish an equity drive in some form of partnership arrangement, or to subordinate the debt.

Crude oil price spike

The most recent impact on the industry is the

present energy crisis and fifty-dollar-plus per barrel

crude oil.In some sense, the industry has become

accustomed to the nurturing effects of world events.

At one time, there was a perception that the viability of the industry was based on subsidies. It was

difficult to get New York investors to discuss ethanol.

Morgan Stanley was forward-looking enough to pursue some interest, but others declinedThe only real

change since then has been the price of oil. Now the

institutional investors and money-center banks seem

to believe in the long-term viability of ethanol as an

energy source.

Low-priced corn

Most producers looked to build ethanol plants to

improve their local corn basis. And many plants were

financed for that reason, without considering the economics of the grain margin. The ideas was simply that

a $20,000 investment in a local ethanol plant could

improve a producer's corn basis enough that it became

a de facto annuity, returning an additional $0.125 per

bushel of corn, in perpetuity. That paradigm drove the

financing and building of the 20- and 40- million gallons per year plants. No East Coast money was invested in these projects; only producer capital. 

Development of venture capital interests

Farmers recognized the economic incentives and

experienced what was called the “back yard syndrome.” Every community wanted 5 or 10 cents more

per bushel of corn. Most weren't sophisticated enough

at that time to understand the risk-management issues

involved or the operating margins. Neither was the

possibility considered that there may be a better place

to locate a plant other than in their hometown, or that

perhaps it should be built by someone other than a

general contractor. The sole consideration was basically the desire to increase the corn basis by 5 to 15 cents

per bushel. The industry production-standard grew

from 15 to 20 million gallons per year to 45 to 50 million gallons.

4
The success of those plants fueled the enthusiasm

to build. Most of the plants now being built in Iowa

are not farmer-investments. Moreover, most investment plans today intend to build two or three additional facilities. The Eastern and Western money is

involving itself, especially as the price of oil has

exceeded $50 per barrel and approached $60.

Formation of trade associations

The information explosion was also a driver

behind the formation of ethanol trade associations.

Producers grew interested in ethanol production during the late 1990s, and started organizing into groups

haphazardly, three groups in one county, two groups

in adjoining counties, and started to approach a few

institutions for information -- Iowa State University,

the Farm Bureau, and the Corn Growers Associations.

These associations recognized the benefit of

bringing the groups together to provide them with the

information they were seeking -- available production

technoogy, different legal structures, sources and availability of financing, etc. They would meet monthly

with several groups and watched each evolve through

the developmental stages -- fundraising, ground

breaking, turn-key, and full production.

The ability to share information was a prerequisite to a distributed and fragmented model. In order to

have multiple facilities and many companies forming,

each had to have an understanding about what to do

and when.

Information needs 

in the ethanol industry

The role of information in the ethanol industry is

no different than that of the other commodity industries: market and price information for marketing

products and procuring inputs; operational controls,

efficiency, performance, and benchmarking; finance

and accounting; forecasts and projection; and policy

analysis.

Pricing and market information deficiencies

Price transparency and the transfer of risk

There are two key functions of the futures

exchange that people use -- one is the transfer of risk

by way of the hedging mechanism, and the other is

price transparency. The basic question is would an

ethanol futures contract help to make the price of fuel

ethanol more transparent?The answer is uncertain

because none of the contracts would be disclosed for

others to see. If a contract is sold to an end user, it

probably won't be executed in its pure form. The end

result would be a negotiated freight arrangement -- a

piece of the transaction that will reflect some sort of

adjustment to the actual price. Only the two trading

parties would be privy to this information. So the

information necessary for price transparency would

not be disclosed.

Furthermore, no one knows what ethanol is selling for in relation to the New York Mercantile

Exchange (NYMEX) or the Chicago Board of Trade

(CBOT). Those indices are published daily, but the

actual price of ethanol is the differential between the

referenced index and the privately negotiated transportation arrangement. As long as this procedure continues, the elements necessary for price transparency

aren't in place.

Customers shy away from pricing ethanol by

way of the indices because they are not tied to gasoline. Ethanol is first and foremost a blend component

of gasoline. And contracts are negotiated to allow

blenders/refiners to determine their final product

price. Ethanol is also traded independently and its

price is uncoupled from gasoline. And while that may

be useful to ethanol producers, it doesn't necessarily

meet the needs of their customers.

The NYMEX gasoline contract has served reasonably well as a risk management tool for the industry,

but its usefulness is eroding. The price of gasoline

moves independently from the cost of ethanol production. The NYMEX provides an instrument in which the

ethanol price can be locked in with respect to gasoline,

but NYMEX doesn't cover enough of the country to do

it universally. And it's necessary to index against

California, Chicago, NYMEX, and a whole pool of

indices. So traders in each region adjusted to that reality and developed their own basis and methodology of

using it.

These indices only provide the elements for

buyer and seller to strike a forward contract to a flat

price. The basis is negotiated with respect to the region

of origin and destination to provide producers with

the ability to lock in that flat price. Without it, they're

left riding the cash market.

If it performs, the transparency function of an

ethanol futures contract will give traders a way to

develop a forward price curve. The industry and all

respective parties can then adjust accordingly -- to

make decisions, to transfer and manage risks, etc.

5
The major remaining issue then is delivery. There is no

clean delivery function because of the way the industry is set up. 

Consider also that while price transparency may

be considered a good thing, not every party is equally

interested in realizing it. Producers that typically use a

marketer prefer transparency. They want to be assured

that their netbacks (ethanol revenues less marketing

expenses/fees) are comparable to those of their neighbors and that they're getting fair value. Grain firms

want ethanol price transparency because they want to

project crush capacity and demand base. Energy companies want to project demand for natural gas. In the

same way that a calculation is performed for soybean

crushing, flour milling, or corn grinding, they want to

understand the dynamics of the overall market.

But transparency is not desired by everyone, and

particularly not for those connected with the actual

trading of ethanol. Because even though the industry

appears to be fragmented, with 81 plants highly variable in size, there are only about a half dozen marketers of ethanol. And they're quite competitive

against each other. Each marketing firm has its own

strategies and business plan, and they are loathe to

share with each other.

Futures market

The size of an ethanol futures contract is 29,000

gallons, roughly one rail car in volume. The price is

listed in dollars and cents per gallon. Initially, the contract was designed to discourage it from being used

predominately as a delivery instrument -- where buyers look to source ethanol. However, the delivery

aspect is primary to every futures contract.

Transportation differentials allow traders from

different parts of the country to participate in the

delivery process. However, differentials are updated

once per year, and the cash market changes daily,

which limits their accuracy. Instead of differentials, the

delivery mechanism on the ethanol contract is a shipping certificate.

A shipping certificate is a negotiable instrument.

But if it is held and not sold, the ethanol storage costs

must be paid on the shipping certificate. It may be

redelivered to the futures market. A shipping certificate is tradable in the cash market, or the holder may

demand load-out. If load-out is demanded, the buyer

issues shipping instructions to the seller, and the seller

is responsible for loading ethanol into cars and arranging transportation to the buyer's location. In the background, buyer and seller privately negotiate any

freight charges. Absent a successful private negotiation

on the freight charge, the ethanol is delivered to

Chicago to the buyer's terminal. Anyone making or

taking delivery therefore assumes a Chicago origination/destination, so an important prerequisite is leased

storage space at the Chicago terminal.

The Chicago market, just as with other commodities, is priced as the cheapest-to-deliver location, correlates well with other domestic locations and, as such,

may be used with no delivery intentions as a risk management tool. However, Chicago is not a staging area

for California markets, because once ethanol arrives in

Chicago, the State of California considers it a

Midwestern product, and subject to California State

Midwestern ethanol product delivery limitations.

There is no blend facility in Chicago. Blenders

truck ethanol out to their own terminals for blending.

The contract is serial, traded 12 months, every

month, starting up to 6 months. There is a market

maker --.a firm that signs up to make bids and offers at

a specified spread, contracted with the CBOT. The

market maker stands ready either to buy or to sell at a

certain depth on that specified spread. That ensures

the market of liquidity in the initial stages. New contracts tend to have trouble with liquidity.

The nearby pricing time horizon is pretty well

defined by the cash market. Trading is available

through the next year in both distiller's grains and

ethanol.

An international component isn't available at this

time, but will need to be introduced. When one looks

at the other futures markets, soybean meal for example, Brazil affects the price of beans in Chicago significantly. This same circumstance may occur in a largescale liquid ethanol futures market.

“Creating” a futures market is a misnomer

because a futures market is a derivative, in that it is

derived from an active cash market, as opposed to a

typical commodity futures market, such as grain, that

is based on the fundamental value of the commodity.

The challenge with initiating an ethanol contract was

the market's relatively small size and newness. It is so

fragile. Essentially it really doesn't exist. Any liquidity

in the marketplace, if it exists, is derived from physical

cash market conditions. An ethanol market grows

organically out of cash market conditions.

The challenge is that market demand is quite

fragmented and unclear. The NYMEX recognizes some

challenges with the CBOT's initiation of an ethanol

contract:

a) The uncertainty of the underlying demand for

fuel ethanol;

b) The concentration of production; and

6
c) The physical delivery mechanism seems to be

quite difficult to establish.

Prices are very contract-specific, on a transactionby-transaction basis. Other than that, most contracts

are based on discounts and reflect the supply and

demand situation. So there is no transparency: the

information is proprietary between the two trading

partners. This is not a function of lack of information

technology because the structure is in place to provide

the information. More information would encourage

transparency, but at the expense of volume. But that in

itself is not a limitation.

The real problem is that a half-dozen sellers are

trading with a half-dozen buyers, and each seller

trades with every buyer and each buyer trades with

every seller. So, why should they publish their trades?

Their information is commonly held among themselves, and within their collective, is quite robust. A

conversation with any one of the agents involved

could reveal what any or all of the others is

paying/receiving for ethanol at a given time. This

uncertainty has more to do with the cost of

logistics/transportation from the production facility to

a particular market.

Dried Distiller's Grains (DDG) markets are similar to ethanol. There are basically the same groups of

buyers and sellers. However, the markets are more

localized instead of regional or national. If there was a

market reporter, some transparency might exist. But

it's unlikely that more information could be shared

among the people who are buying and selling. Again,

all the available information is commonly held among

every trading party.

USDA does publish for Illinois and California

and perhaps some other locations distiller's grain

prices in Feed and Grain Weekly. That's somewhat

similar to the publication of renewable fuel prices. The

Renewable Fuel Association has published fuel

ethanol prices for years. But it is also widely known

that published prices aren't representative of any individual transaction.

A more representative price might be based on

extrapolating the total production activity of the dry

mill plants. The production volumes of the integrated

plants (ADM and Cargill) are not easily known. Their

production capacity is commonly held and a pretty

good idea of their activity in the market may be

derived, given the sales of everyone else if a total sales

value is known.

An important fact to remember regarding distiller's grains, however, is that every plant produces,

more or less, a different product. And for that reason, a

national market price is even less relevant. But a published monthly average price provides little to no

information to someone who trades commodities. A

series of monthly average prices might be more useful

to a long-term financial planner/model. But in the

trading world, it's not all that certain that a futures

contract price at 9:30 AM is at all relevant at 11:30AM,

much less a monthly average price, because that information is ancient.

But these are two disparate needs regarding price

information -- trading/merchandising and decisionmaking from plant operations standpoint. With respect

to financial planning, for the business model or business plan, a monthly average price may be quite representative and useful. Reported prices in that regard are

benchmarks, from which a manager can sell for up to a

year ahead and that others can base decisions upon.An

entire array of financial decision-making tools is at a

manager's disposal that requires only monthly average

prices for factor costs and product prices. And the risk

management profession makes full use of these tools.

As decision making tools, the creation and use of these

models may be among the greatest technological

advances in this industry.

A little more than half of the producers are forward contracting up to 6 months in advance. But virtually none of them are contracting 12 months ahead.

Price information from a futures market could be

integrated into the existing plant's financing, but that

would probably be used only in the case of an adverse

event -- a breach of confidence or contract obligations,

a change in market circumstances, or a request from

the borrower to change the financing structure. So the

bank then may influence the borrower's behavior if

there was price transparency. Banks would use the

price information to implement secure margins.

Banks can also be viewed as processing companies. They are in the business to make a margin, not to

speculate. That's why banks use financing to hedge

their input, put a risk mitigation strategy in place to

make their margin.

The risk mitigation that's used in several plants

now is performing well given available price information. But it should be enhanced by having the

increased liquidity and price transparency availed by a

futures market. Everyone in the industry stands - and

hopes - to gain from the benefits of the futures market.

The strategy is well known, as are the players

involved. All seek to transfer risk using a variety of

tools, whether it's flat price, a spread to gas, or a

spread to fuel ethanol. And while, presently no one

7
involved is 100 percent covered, a significant portion

of every plant's production and inputs is, in order to

protect the margin.

Asymmetric risk profiles

Another issue involving the market liquidity is

an asymmetric risk profile between the producer and

the buyer. Consider that the future price of ethanol is a

major portion of the risk profile for an ethanol plant.

But for a blender, the future price is a very minor risk

consideration. Blenders consider ethanol a microingredient. From that standpoint, their portfolio is

stacked with many other risks that need to be managed before ethanol becomes a consideration. Blenders

will not allocate the resources, either financial or intellectual, to manage such an insignificant risk.

In past years, ethanol was a third price -- or third

contract. As United Bio Energies, Broin, FC Stone, and

National Energy partnerships developed, the so-called

“gas-plus spread” contract became more of what is

called a "crush margin."A crush margin factors in feedstock and energy procurement costs.

There's a coefficient relationship between the procurement of corn and energy (natural gas) and the production cost of ethanol. Ethanol marketers know that

margin and try to lock in a product price that plant

managers can be comfortable with. It's a short-term

pricing arrangement, 6 months in length. And during a

period of favorably high oil and gasoline prices, there's

a great margin to work with. In recent years, however,

the margin on the corn side was difficult to carry

because there was an inversion in the corn/gasoline

price relationship. For this reason managers avoid

locking in for more than 6 months at a time.

There are two other problems associated with

going beyond the six-month time constraint. The

annual crop cycle is one issue. The other is price variation attributed to the growing cycles in the Southern

hemisphere. However, as the major financial investors

enter the industry, arrangements of 12-, 24- and 36-

month markets in grain side are being struck and at

quite competitive values. Some of this trade is occurring as an alternative to trading with the major grain

traders -- ConAgra, Cargill, or ADM -- because of

those firms' unwillingness to give up liquidity or

transparency.

Research and development

Product innovation and commercializatio -- DDG

product development

Land-grant universities and private corporations

have worked together to significantly enhance the

product value of distiller's grains. Researchers, such as

Vern Kelly and Jerry Shurson at the University of

Minnesota, have served not only to expand existing

markets for distiller's grains as cattle feed, but have

also developed new opportunities in feeding to hogs.

So instead of being an afterthought or even a waste

product as distiller's grains were once considered,

DDG are now significant components of a plant's revenue stream.

Early on, some plants were fortunate enough to

have Farmland Industries as one of their investors.

Farmland's feed division helped market the product.

Farmland also sponsored and conducted research on

how best to use distiller's grains. Farmland's feed division has since merged into Land O' Lakes, which now

markets the DDG, and continued the research in their

own facilities and in collaboration with universities.

The ethanol industry has grown enough that

there is an excess supply of distiller's grains and the

price is tracking downward again. But, all of this was

made possible by feed researchers and development

groups that were able to educate the industry and

develop a customer base. The product is still cheap relative to corn, but feeders will substitute more of it into

their ration.

Initially, the product went almost 100 percent into

dairy rations. It was dried because wet distiller's

grains have a short shelf life and typically weren't as

consistent in quality -- both well-known characteristics

among local feeders who pressured plants to sell

quickly and at a discount. In fact, the best offer most

plants received from feeders early on was, “We'll pay

the freight to haul it off.” But now, after years of

research, some technological developments, and a lot

of education, feeders know precisely the value of wet

feed.

Information technology and the rise of 

the ethanol plant “franchise”

Standardized design technology and the “cookiecutter” ethanol plant

In the early 1980s, a number of people were

exploring the idea of small, portable farm stills and

million-gallon-a-year plants. They were first to discover that besides being expensive to build, these plants

have to be staffed 24 hours a day.

Today, Broin, Fagen/ICM, and others build cookie-cutter plants -- standardized designs that they can

8
put down quite easily in almost any location. They

also provide the financing and the feasibility work,

and will hand-hold the producer-investors through the

entire process. They can offer an entire package -- from

feasibility study to turn-key and beyond.

This prospect didn't exist in the early 1990s, when

there were still a lot of questions on what was the right

way to build a plant. Because there were no standardized designs, builders of a 30-million-gallon-a-year

plant had to go a more traditional construction route --

hiring a process firm, a detailed engineering design

firm, and a construction management firm. A prospective plant had to assume every responsibility. It may

have been the first and only ethanol plant that the

hired construction firm had ever built. So the lack of

experience and the associated uncertainty added significantly to start-up costs and subsequently to each

step in the process.

However, enough plants have been built to

develop a body of knowledge and experience to

reduce that uncertainty. The time and expense associated with everything, from that first planning meeting,

to the training of the start-up crew, to pouring that first

gallon, has fallen for the last 10 years. An estimated 6

to 9 months have been trimmed from total project time

from fundraising to turn-key.

These standardized designs and business models

were pioneered mainly by Broin, Fagen/ICM, and a

few others. These firms began with the recognition

that producer groups were developing an investment

interest in these plants. They also had an understanding of the operating point at which these plants could

be profitable at that time, around 10- or 15-million gallons per year.

Compared with 10 or 15 years ago, standardized

design technology has cut the costs of construction and

the non-energy portion of operations in half. And

while it's unfortunate that higher natural gas costs

have wiped out that savings in operation expenses,

there's no denying that today's plants are built twice as

cheaply and operate twice as efficiently as those of the

1990s.

Several factors have contributed significantly to

lowering operation cost. One is greater product yields

from corn to ethanol, from 2.5 bushels per gallon to

2.85 or even 3.0 on a denatured basis, given the right

variety of corn. Another is the reduced cost of

enzymes and their increased use efficiency -- enzymes

are now half their cost of 10 years ago.

Business processes and information

technology

Distributed control systems

Prior to the mid-1980s, process automation was

comprised of analog loop controls and complex pneumatic controls with individual, large circuit boards

dedicated to each control loop. These systems were

normally located in control rooms, so the sensors and

controller outputs had to be physically connected to

the control room. This resulted in large cable runs full

of wires and tubing. Because the systems were bulky

and required direct interconnections with the process,

there were often several satellite control rooms for

each part (or subpart) of the process. These systems

required sophisticated maintenance by skilled instrument technicians, and data-logging was done on strip

chart recorders. Despite the awkward implementation,

these systems replaced hardwired relays and manual

controls for critical systems, allowing plants to reduce

labor and improve consistency of operation.

But an even greater contributor to plant efficiency

has been the development of information technology

(IT) systems, the so-called Distributed Control Systems

(DCS), and the electronic automation evolved in the

plant. DCS were introduced in the late 1980s, enabling

centralized process monitoring and control. DCS

replaced integrated circuit board controllers. Inputs

from field instruments and outputs to valves and

pumps were converted to electronic signals. They were

generally run short distances to cabinets in the process

area that contained a manageable number of control

loops. Each DCS cabinet was connected to a main control computer. Process instruments, output to pumps

and valves, and controller settings driven from a computer console (dashboard) were located in a central

control room. This design also enabled monitoring and

control from multiple (and redundant) locations, such

as local control rooms, engineering offices, or even

remote locations.

During the 1990s, these systems grew in capability alongside the geometric growth of IT applications

and abilities. This evolution reduced labor requirements by more than 50 percent over the past 15 years.

As computer control, process monitoring, and laboratory capabilities further improved, sophisticated data

warehousing and analysis systems were adopted to

convert the ever-increasing volume of data into useful

information. These systems can now monitor process

conditions, control settings, as well as laboratory measurements when integrated with a Laboratory

Information Management System (LIMS).

9
Whereas early systems could only retrieve historical information, today's systems perform complex

mathematical manipulations, display graphical results,

and project future outcomes all in “real time.” Data

manipulation and extraction capabilities enable much

narrower process tolerances to further reduce costs

and simultaneously increase yields and productivity.

The advantages of DCS data warehousing and

analysis include: a reduction in manpower by allowing

one operator to monitor and control several processes

at once; the ability to see small changes in production

variables and correlate them to changes in conditions,

raw materials, or ingredients; and an increase in overall plant efficiency, since operators can fine-tune

process parameters using real-time data and sophisticated analysis. Early plants scheduled several maintenance shutdowns during the year to prevent equipment failures. With the data collection capabilities of

DCS, preventive maintenance programs became far

more efficient, reducing downtime. These processes

and technologies continue to evolve and become even

more significant.

Business/bio process metrics and

benchmarking

DCS plants all have the same production and

business processes and share a data collection and

analysis protocol called "benchmarking.”

Benchmarking is an array of performance measures

that are monitored daily, gathered weekly, and summarized monthly to be reported to management and

the board. If, for example, a group of 10 plants of common design are all linked together, the business and

biological process benchmarks for this group are very

well understood. The manager of any one plant is,

therefore, able to adjust and refine the process to

improve his/her performance and thereby raise the

standard of the whole group, in a stair-step fashion.

This business process is possible only with today's IT,

and even now it's time-intensive, to perform. But this

would have been next to impossible 10 years ago.

Firms like Broin and Fagen/ICM were able to

expand to their present capacity level because of IT

employed by the new plants. Both Broin and

Fagen/ICM direct the operations of 20 to 25 plants

each.

The talent pool to manage and operate these

plants has grown with the process. Both firms employ

a cadre of well-seasoned managers who learned during the difficult years how to run a plant efficiently.

Both companies provide management services, marketing contracts, and procurement contracts to midsized plants. This is a far cry from the old days when

managers were still putting contracts out and doing

everything by hand.

And now a group has the ability to manage 20 to

25 plants using IT and business process technology to

manage them as one. Fifteen years ago it would have

been nearly impossible to market the product for that

many plants and do a good job. Now an entire array of

management services is provided.

These plants could not be managed in this way

without the new technology. The plants themselves are

physically too far apart. It would be impossible to

cover enough of everything in different parts of the

country. The necessary staffing wouldn't be available

because of the expertise required at the control points.

Mobilizing business functions across many

enterprises

Dynamic specialization I -- Consolidated

marketing “partnerships”

An important development is the rise of marketing firms. Ethanol is not marketed at the processing

plant. Buyers (the refiners and blenders of gasoline)

are not inclined to deal with a multitude of plants

whose annual production volume amounts to a tiny

fraction of the buyer's ethanol requirement. Instead,

buyers demand bulk purchasing in hundreds of millions of gallons at a time. Ethanol buyers want to sign

delivery contracts for 50 to 180 million gallons and

want to trade with someone that sells at least 500 million gallons per year.

IT's first impact on the ethanol industry was as a

horizontal coordinator. Many mid-sized firms consolidated their marketing activities out of necessity to bargain with the handful of fuel ethanol buyers who traded in quantities of hundreds of millions of gallons at a

time.

Successful consolidated marketing efforts led to

innovative applications of these powerful new technologies to coordinate horizontally other activities -

procurement and logistics, risk analysis, and eventually plant management, among several plants simultaneously. This horizontal coordination/consolidation role

across enterprises, companies, time, and space is now

performed by five to six firms in contracted services to

a substantial majority of the mid-sized, farmer-owned

plants.

Over the last few years, the major producer's

(ADM) market share has dropped from 60 percent of

10
the industry to around 30 percent. The balance was

taken by the marketing firms -- United Bio Energy,

Ethanol Products, and a few others.

The marketing of DDG is also done primarily by

a few firms with a few buyers. The traders on both

sides are well informed, but the price reporting is of

limited use because the product traditionally is highly

variable in quality and there are no specified trading

standards. DDG quality varies because of corn quality,

the heating/drying process, and an inconsistent blending of the DDG with solubles. Each of these problems

will result in a highly variable analysis of DDG. The

market discounts the price of DDG because of this

variability.

Universities provide excellent information on the

feeding of DDG to beef cattle, swine, and poultry.

Some research indicates that DDG has a nutritional

value equivalent of 120 to 130 percent of corn, but it

sells at a much lower price.

However, while the potential to feed DDG is

large, the feed industry will not incorporate any ingredient into their rations until there is a ready supply in

the amount needed to serve their markets. A case in

point is ConAgra's consideration of the use of DDG

products in their poultry division. They tested products from all over, were pleased with DDG nutritional

attributes and its cost, and wanted to incorporate it

into their rations. Eventually, however, reliability was

the restricting factor. The whole exercise stopped dead

when ConAgra asked the simple question, “Can you

provide us 3 million tons of it?”If not, they can't be

interested because ConAgra makes changes in increments of millions and restricts their business activities

to those who can provide consistent and reliable supply subject to their specifications.

DCS benchmarking enabled plants to overcome

these problems by collectively standardizing their distiller's grains products to the quality and consistency

required by their customers. DCS also gives opportunity for consolidated marketing efforts among partnering plants to have a presence in regional and (soon)

national markets because they now have a consistently

reliable product, available in sufficient volume, and

offered at a very attractive price relative to corn.

Consequently, very large feeders such as Tyson Foods,

Inc., and ConAgra, are beginning to include DDG in

their rations.

Dynamic specialization II -- procurement

“contracts”

Corn procurement is not as concentrated as fuel

ethanol marketing, although many plants do have procurement alliances with their ethanol marketing partners, e.g., supply agreements and risk management

contracts that work in concert with the marketing contract to provide a reasonable assurance to the plant of

a working “crush margin.”Corn trading/procurement

is more fragmented because it's not necessary for a

plant to align itself with a major grain trading company. One reason for that is farmer-owned plants have

delivery agreements with their producer members to

source a significant portion of the required feedstock

locally.

A more important reason, however, is the trading

history and market transparency in corn because of the

CBOT and futures markets. There's a local corn

“basis,” and a historically well known set of transportation differentials. So it's not necessary to align

one's self with a major company to procure feedstock

efficiently.

Nevertheless, lenders offer incentives to new

plants to contract for risk management services as a

way of mitigating their own risk in the project.

Moreover, each of the project design firms provides to

a prospective plant a list of preferred lenders and other

specialty service providers to work with, almost all of

which are collaborative partners and/or subsidiaries

of the project design firm itself.

Dynamic specialization III -- consolidation of

process management

The appearance here is of a virtual consolidation

taking place. Instead of consolidation through ownership, management is becoming more centralized and

concentrated. Companies like Land O' Lakes and

Purina, CFC, United Bio Energy, and even integrators

like Cargill are offering management services to facilities besides their own. IT has altered the ethanol

industry structure by shifting the ownership and control emphasis from the acquisition of physical production assets to the aggregation of IT assets.Economic

power in the industry no longer arises from ownership

of production capital (plants and equipment), but in

the control and manipulation of intellectual capital

and property rights.

11
Summary and conclusions

The impact of IT on the ethanol industry

IT is a key driving force in fuel ethanol business -

- operations, strategies, structures, ownership, and

performance. IT innovations and applications have cut

across the ethanol industry, forcing changes that have

significant economic and social impacts in rural communities.

In plant operations, IT serves to strip costs out of

the system, promotes standardization, and mitigates

production risks. IT squeezes time out of the system by

speeding up construction time, from groundbreaking

to turn-key, and by reducing operational downtimes,

increasing the days of operation from 340 to 361. IT not

only gets plants up and running as much as 6 to 12

months sooner than they might otherwise, but also

keeps them running to increase plant production efficiency. IT facilitates the inflow of capital into the

industry by helping to quantify the risks associated

with plant investment/operations to prospective

investors.

IT has altered the nature of the firm by digitizing

and decomposing on-site activities to be outsourced,

off-shored, and otherwise moved around. This changes

the economics of plant location by impacting where

various assets are deployed. IT changes labor mobility

by moving jobs to labor as well as labor to jobs. IT

alters the skill sets needed for plant management and

labor. IT further separates ownership from management, allowing firms to transform themselves faster.

IT has altered the firm's relationships to business

and industry because it supports a contract-based

industry structure that creates significant linkages/collaboration and enables coordination across enterprises,

companies, and specialties. IT gives rise to the ethanol

franchise and has used the standardization of that

model to narrow the bounds of uncertainty. A better

understanding of the associated risks allows the financial community to reduce lenders' equity participation

requirements, to reduce interest rates and the overall

cost of capital, and to invite participation among outside investors. IT has altered our view of the traditional market structure. Economic power now lies in

aggregating information assets, not in the physical

assets of plant and equipment associated with production.

With regard to IT and the future dynamics of the

industry, as IT applications within the ethanol industry

continue to evolve, competitive forces will spur efficiencies and dynamic growth. Work activities will

increasingly be dispersed across geography, institutions, and dimensions as managers and decisionmakers ask, “What else can be digitized, decomposed, and

outsourced?” The balance of economic power within

the industry shifts daily from the traditional aggregation of physical asset ownership to the aggregation

and integration of information services. However,

competitive advantage held today is more easily eroded and replaced. This understanding raises the question, “Will the emerging price discovery mechanisms

(futures market and market transparencies) change the

comparative advantage of the information aggregators?” The dynamic intellectual-property nature of IT

continues to shape the competitive structure of the

industry. From where will the talent to continue operations in this environment come?

IT has eroded and distributed the market power

once held exclusively by global giants. Enhanced

access to factor and product markets among mid-sized

fuel ethanol firms arising from the adoption of IT may

inspire similar developmental opportunities in rural

America. The notion that firms may achieve competitive advantage from an efficient, internalized information system instead of the high levels of vertical and

horizontal coordination typically garnered solely with

”largeness” provides both an encouragement for the

relative success of mid-sized firms and a developmental template for similar enterprises in rural areas.

References

Carr, N., Does IT Matter?: Information Technology and

the Corrosion of Competitive Advantage, Boston:

Harvard Business School Press, 2004.

Friedman, T., The World Is Flat: A Brief History of the

21st Century, New York: Farrar, Straus and

Giroux, 2005.

Hale, J.H. III and J. Brown, The Only Sustainable Edge:

Why Business Strategy Depends on Productive

Friction and Dynamic Specialization, Boston:

Harvard Business School Press, 2005.

Informa Economics, “The Role of Information

Availability and Technology in the Ethanol

Industry,” prepared for U.S. Department of

Agriculture, Rural Development, Memphis, TN,

May 2005.

12
Novozymes and BBI International, “Fuel Ethanol: A

Technological Revolution,” BBI International

Publishing, Grand Forks, ND, June 2004.

Smith, H. and P. Fingar, It Doesn't Matter, Business

Processes Do: A Critical Analysis of Nicolas

Carr's IT Article in the Harvard Business Review,

Tampa: Meghan-Kiffer Press, 2003.

Appendix 1: Emerging biotechnologies

Biorefineries

The biorefineries concept is similar to the petroleum refinery concept. Feedstock (biomass, in the case of

a biorefinery) is converted to a wide range of products

based on market consideration and contractual

arrangements. The biomass feedstock is typically fractionated into its various components. Those components are then processed into intermediate and final

products. Intermediate products may be combined to

produce additional products. The basic concept incorporates multiple products and possibly multiple feed

stocks. Flexibility to meet market demands is an

important element of the biorefinery concept.

Biorefinery feedstocks may include agricultural

crops and agricultural residues, trees, grasses, animal

wastes and municipal solid waste, which are organic

materials that capture and store solar energy. They

may also use various combinations of processing technologies, including mechanical, thermal, chemical, and

biological processes. The products produced are nearly

limitless. They include fuels, electric power and heat

energy, food and feed, and a host of chemicals including plastics, solvents, adhesives, fatty acids, organic

acids, paints, dyes, inks, detergents, and more. The

extended view of this concept is to develop biorefinery

complexes or “biorefinery parks” that produce a wide

range of products and use products that were produced by others in the park. This concept would aid in

the economic efficiencies of collection, storage and

handling of feed stocks, and production of energy, as

well as help support the required transportation and

distribution infrastructure.

Further improvements in technology may play an

important role in increasing efficiency of ethanol

plants. New “upfront” technologies that fractionate

the grain into starch, cellulose, hemi-cellulose, oil, protein, and lignin may enable ethanol plants to produce a

wider set of byproducts and to increase the market

value of the byproducts. This change is expected to

increase the energy efficiency of the ethanol plant, and

reduce other processing costs per gallon of ethanol

produced. A major concern, however, when developing a new product is the necessity of simultaneously

developing a new market. The balance between sufficient production to supply the market, but not so

much as to ruin its profitability, is a delicate one. IT

will be used increasingly to coordinate these activities

among the marketing firms and their represented

plants.

Appendix 2: Relationship of the industry 

to the educational system

Panelists were asked what role private information flows played in the structure, conduct, and performance of the industry and what role has public information played and how strong are those two

information flows in the future. What would be sort of

a preference in terms of the overall health and robustness of the industry? So in that sense, let's just talk a

little bit about the public versus private information

flows. Public information, even if it's reported in the

newspapers, tends to come from government sources.

Which has been the dominant sort of information flow

or source for the industry over the past 10 or 15 years?

Fifteen years ago, the ethanol industry was dominated by private information in terms of what

occurred day by day. Now plants are being built based

strictly on public policy. The primary source of public

information is government departmental sponsored

research and development (USDA and Department of

Energy) and that of the land-grant universities. This

type of project information wasn't available to some of

these developers or farmer groups 10 or 15 years ago.

The land-grant universities also provide information

sponsored by the growers' associations for producers

to choose the entrepreneurial path. So there has been

sort of a growing cumulative body of knowledge that

the industry developed a body of experience that's

been published and discussed.

A lot of cooperation goes back and forth between

public and private institutions. For example, Land

O'Lakes is involved in proprietary research on distiller's grains, but a majority of the large integrators

also want to look at information available from the

University of Minnesota. Feed buyers and sellers seem

to want two sources.

Land-grant information has significantly contributed to the development of the industry. And that

information has been of a technical as well as financial

nature.

13
Public information developments

A related question might be, how well does the

research information diffuse out and benefit the entire

industry?

Iowa State has a tremendous web site that is a

resource to a large number of users, particularly those

wanting fuel ethanol industry financial and economic

information given present technology. But the economic and financial implications of the next technological

breakthrough, cellulose processing, which will put the

industry into a whole new supply situation, have not

been considered. The industry has anticipated cellulose processing for 20 years. And the transition is

inevitable because of high energy prices. But how well

prepared is the industry for this transition? Here is an

excellent opportunity for public information and leadership to look ahead and direct the way.

Hundreds of millions of Federal Government tax

dollars are invested in the cellulose research that will

eventually be used by the industry. However, the

information itself has been incorporated into the discussion in less than 1 percent of the any planning for

the industry's future

The DOE and American Petroleum Institute publish storage and statistics for a number of different

energy products. Are similar statistics published for

ethanol and related products? If this information

exists, it is certainly difficult to find.

And on another issue regarding storage, there is

widespread interest in DSP facilities. But such information is privately held and unavailable. This information is typically available in other agricultural markets and energy markets. And its availability allows

participants to assess market conditions, offer prices,

or generate other activity because it provides a higher

level of understanding and confidence in market conditions. Credibility obviously would be pretty important and that could only be established with a track

record, but a published statistic of “Stocks as of the

first of the month” made available on the tenth of the

month, would have a significant impact on the industry operations.

Making much of this information public would

be helpful for plant decision makers. An understanding of inventories, accurate to within 10 or 15 days,

would provide a clearer idea of both present and

future prices. This could be a useful tool to plants,

marketing companies, and purchasers.

Training future professionals

Is there a consensus with this group then that

there probably is not any significant amount of undergraduate/graduate level training in the land grant universities in bioenergy? What education/training is

going on that is going to provide the leadership that is

needed by this industry?

Not unless it's funded by the industry and the

funded research is also used to train scientists. Land O'

Lakes does a lot of dual-purpose research, and plants

are encouraged to fund it.

There is a history lesson here. Seventy-five years

ago, there wasn't such a thing as chemical engineering.

A certain amount of chemistry knowledge was emerging out of the fledgling oil industry. But the information itself was not flowing. And to be frank, a lot of

things were done badly because information was being

created and passed simultaneously by chemists and

engineers who each did very well in their respective

field, but had no common language by which they

could speak to each other much less work together. So

chemical engineering had a very difficult start.

Unfortunately, the ethanol industry is enduring the

same type of growing pains. Eventually, the industry

will partner with the university system to develop a

“biochemical-biomechanical engineer-- a variant on

the chemical engineer concept.

From the three disciplines, a language needs to

be created so that each may understand the other. But

for now, there is no equivalent language for the

ethanol industry. It's a construct of biology and chemical process engineering. There's also research, development, and commercialization. There's no real transfer

of information from research to development because

the bridge of people needed to communicate across

each platform isn't there yet. There are people who

think research, and those who think commercialization, but the education necessary to inform both sides

from the middle isn't there.

So the oil industry's past is somewhat similar to

what some think may be ethanol's future. Particularly

with regards for bioengineering refineries, there are

biomechanical engineering programs here and there.

But as a fundamental discipline like chemical engineering, it doesn't truly exist. And as a consequence,

information is not flowing out of public sources.

Research information is flowing out of the hundreds of

millions spent on government research, but it's not

coming out of the universities.

The future of the ethanol industry is hindered

because information trickles out in pieces from here

and there. Every year or two, a little is discovered on

the technical side because there is no overarching

understanding.

14
Now this haphazard development is great for

consulting and technical engineering companies,

because when no one knows anything, it's easy to sell

knowledge. But there is no public system in place to

generate the information needed by the industry, nor

are people being trained to enter the industry in a

functional way.

To summarize, with respect to public information

from a technical standpoint information is being generated by the land-grant universities and Federal

research institutions, and that information is getting

out to the industry. However, not all of what is needed

by the industry is being passed, and there are no professional training programs in place to develop the

next generation.

Appendix 3: Impediments to rapid 

industry growth

A “Marshall plan” for fuel ethanol

The panel was asked to imagine a scenario under

which it suddenly became in the national interest to

have a substantially greater fuel ethanol supply. A

range from 8 to 50 billion gallons (from 2 to 12.5 times

current production) was discussed. The specific question, “What would it take, in almost a “Marshall Plan”

type of effort, to grow the industry by such an order of

magnitude?” was asked. This exercise is intended to

explore what would be necessary to take the industry

beyond incremental growth and address the constraints that might impede production, distribution,

and even consumption.

It should be noted that panelists indicated a

shock of such magnitude to the world energy complex

as implied under this scenario would encourage a

whole range of alternative energy technologies not

presently competing with ethanol.

The workshop panelists discussed four logistical

impediments to a rapid scaling up of the industry:

The present capacities/capabilities of knowledgeable and experienced firms in plant design and construction are already pressed by the current rate of

industry expansion at 1 to 1.5 billion gallons of production capacity each year. And while there are several

companies not currently involved in ethanol construction with capabilities in chemical plant production, an

aggressive sharing of design and expertise would be

required to expand the present build rate.

The permitting approval process for building

new plants is an evolving hodgepodge of local, State,

and Federal regulations and procedures. Each locality

presents a prospective builder with a different set of

regulatory and permitting challenges. While some time

savings have accrued with builders' accumulated

experience in this process, a more standardized or uniform set of procedures among all principalities would

significantly reduce time lost and ultimately construction costs.

While plant management and operational expertise is improving, the pool of well-trained, knowledgeable, and experienced plant operators remains small.

This human capacity constraint would hamper a

rapidly growing industry from performing effectively.

The logistical constraints/bottlenecks in the

transportation system for corn, ethanol, and distiller's

grains present a formidable impediment to any significant expansion in the production or use of fuel

ethanol. The rail system is stressed under present

loads. How will it manage an industry expansion of 12

to 13 times its current size?

Other ancillary constraints to an ethanol expansion were also identified:

Some States restrict the ability of ethanol to be

blended with gasoline. For example, the State of

California requires a 5.7 percent blend instead of the

nationally accepted 10 percent rate because California

producers are presently unable to meet a 10- percent

demand level, and there is a political perception that

Midwest producers would benefit at the expense of

California producers. To expand Californian production, the state is offering tax credits, but a 10-percent

blend requirement would provide a much greater

expansion incentive despite any temporary benefit to

be realized by Midwest producers.

The oil companies' seeming reluctance to install

and promote E-85 or other ethanol blends also

impedes expansion. How will consumers use blended

fuel if they are unaware of E-85 fuel pump locations?

Are there enough fuel pumps to dispense E-85? Do the

automobile companies offer an E-85 model for every

car they manufacture? Do the other transportation systems (modes of transportation, e.g., buses, trucks, etc.)

have E-85 engines available?

While not an immediate impediment, another

significant issue to confront will be the traditional

“fuel v. food” concerns in the event of a crisis. An

ancillary concern is the market impacts and adjustments after a tremendous demand base for corn is created that cannot be undone. And while an 11.8-billion

bushel corn crop relieves some of the immediate pressure of that concern, fuel ethanol production levels of

8, 12, or 15 billion gallons will require from 20 to 35

percent of average annual corn production. Moreover,

15
the coproduction of DDG will also have to be accommodated by the marketplace as ethanol production

increases 8 to 15 billion gallons per year. There is particular concern because DDG are integrated back into

the animal feeding system, regarding the saturation

point for the DDG market and will certainly be an

issue at 12 or 15 billion gallons. And while it is also

true that a number of intermediate uses for the coproduct are yet to be explored, there are still a finite number of rations that may be formulated with DDG.

Another significant logistical impediment is the

rising cost of natural gas. The oil prices exceeding $60

per barrel, the days of cheap natural gas are behind us.

The huge demand base built when gas was cheap and

every project was powered by natural gas is largely the

main reasons for today's circumstance. Most new

ethanol plants are going in with the coal-fired or a

cogeneration plant to take advantage of $2 to $2.50, in

some cases less, in British thermal unit conversion

rates. However, 85 percent of the Nation's ethanol

plants use natural gas for the production of processing

steam and coproduct drying and remain at a significant disadvantage.

The 10 percent mandated Reformulated Fuel

Standard (RFS) is now law in the United States. The

importance of decisionmakers and authorities to begin

taking steps toward lifting the encumbrances that

presently block the way is an important consideration.

But perhaps a more important issue is how will a 10

percent RFS affect the price of oil and gasoline? There

is a belief that a relatively small supply change can

have a significant price impact, perhaps more than

people realize. Because supplies are so tight, the

Nation has a 57-day supply of unleaded gasoline, on

the margin, small changes in supply can impose significant price adjustments. Even a two-day adjustment in

the oil inventory has traditionally had a major impact

on the oil prices.

Another looming concern is China's growing

influence in world energy markets. The Chinese economy is growing in leaps and bounds and its energy

demands are increasing commensurately. China's

activities are already profoundly felt in world energy

markets. By some estimates, the Chinese have less than

a 20-day strategic reserve of oil. The nation has accumulated cash with the expressed intent to purchase its

own oil company. In the immediate term, the Chinese

are expected to build their strategic reserve with any

favorable movement in crude prices.

An additional 5 or 10 billion gallons to the

domestic fuel supply may provide some relief. Some

have Stated that a realistic look at the Nation's strained

refining capacity and rising world crude oil prices can

easily portend a return to energy prices of the world

crisis of 1979-81. And while the domestic circumstances are nowhere near such a point of crisis, prices

can rise considerably higher. A harbinger of such a

development would be when the oil companies begin

to acquire ethanol assets in a significant way.

16
Appendix 4: Discussion panel members 

and interviewees

Minneapolis and Omaha panel members:

Randy Aberle Ag Country FCS

Chuck Adair Nesbit Burns

Sean Broderick Commodity Specialists Corp

Scott Cavey E-Markets

Scott Charbo USDA, Office of the Chief

Information Officer

Pradip Das Monsanto

Mark Hanson Lindquist & Vennum, PLLP

Bob Harris TVA Public Power Institute

Pat Hemsworth NYBOT

Larry Johnson Delta T

Tom Kell Nebraska Energy

Pete Kitzman Land O'Lakes Feeds

Ejnar Knudsen Kruse Investments

Greg Krissek United Bio Energy

Phil Madson KATZEN

Ron Miller Aventine

Lucy Norton Iowa Renewable Fuels Assn

Tom Solon Cascade Grain

Fred Seamon CBOT

Jeremy Wilhelm FCS America

Firms/associations interviewed in follow-up interviews:

Abengoa Bioenergy Corp.

Ag Processing, Inc.

Al-Corn Clean Fuel

Aventine Renewable Energy, Inc.

Clean Fuels Development Coalition

Commercial Alcohols, Inc.

Corn Plus, LLP

Iogen Corp.

Little Sioux Corn Processors, LP

MGP Ingredients, Inc.

National Corn-to-Ethanol Research Center

Nebraska Ethanol Board

Renewable Fuels Association

Renewable Products Marketing Group

Tate & Lyle PLC

Appendix 5: Study team members

John R. Dunn, Chair USDA, Rural Development

Tony Crooks USDA, Rural Development

Peggy Caswell USDA, Economic Research

Service

Vernon Eidman University of Minnesota

Jim Hrubovcak USDA, Office of the Chief

Economist

Hosein Shapouri USDA, Office of the Chief

Economist

Scott Richman Informa Economics

Tom Scott Informa Economics

17
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