United States

Department of

Agriculture

Rural BusinessCooperative

Service

Research

Report 148

USDA =m

Cooperatives and

New Uses for

Agricultural Products:

An Assessment of the

Fuel Ethanol Industry
Abstract This report provides an overview of the ethanol fuel industry and documents involvement of farmer cooperatives in it. The market demand for ethanol is analyzed. Other

factors influencing ethanol fuels development are also discussed, including the impact

on profitability should Federal and/or State processing/production subsidies be

reduced.

This report suggests that potential investors examine the prospects carefully prior to

involving themselves in the fuel ethanol industry at any time in the near future. The virtual existence of the fuel ethanol industry depends upon Government subsidies and

commensurate political support. Neither of these conditions has gone unchallenged.

Keywords: Farmer cooperatives, ethanol, Government policy

Cooperatives and New Uses for Agricultural Products:

An Assessment of the Fuel Ethanol Industry

Anthony C. Crooks

Agricultural Economist

Rural Business-Cooperative Service

FIBS Research Report 148

September 1997
Preface Over the past decade, the notion of energy production using renewable resources has

commanded considerable discussion and excitement. Various programs at the State

and Federal level have provided subsidies to start businesses in this industry.

Simultaneously, technological advances have lowered production costs and continue

to promise economically viable production, “just around the corner.”

Since the early 1970s many farm groups, including farmer cooperatives, have been

studying the economic possibilities of producing ethanol, methane, and oil/fat-based

fuels. A number of representative organizations have been formed to encourage the

use of “renewable fuels,” and to promote policies that would provide an economic climate suitable for the industry’s growth. Currently, a number of new facilities are under

construction, or are in the planning stage, with intentions to produce and market fuel

ethanol as a way of adding economic value to corn and other feedstocks.

Despite the possibilities of renewable energy from the heartland, loan analysts from

the several banks for cooperatives remain cautious. For example, while the St. Paul

Bank for Cooperatives, St. Paul, MN, has assessed the viability of ethanol projects for

15 years, because of the complexities involved, it has chosen to finance very few.

Government policies regarding tax credits and exhaust emission regulations, among

others, remain as important issues of concern. In particular, the sunsetting of the

Federal excise tax reimbursement in the year 2000 creates an aura of uncertainty

around the industry and especially any new fuel ethanol production venture.

Nevertheless, fuel ethanol production continues, albeit as an infant and subsidized

industry. And while the renewable energy field represents new opportunities and challenges for cooperative interests, particular attention should be given to the assumptions that build a case for economic viability and marketing opportunities expected for

any new venture.
Contents Industry Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Prominent Industry Actors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .l

ProductionTechnology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...3

Production Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...4

Future of Fuel Ethanol Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7

Emerging Technologies ............................................7

Market Demand for Fuel Ethanol .................................... .9

Ethanol and U.S. Energy Policy .........................................11

Ethanol and U.S. Agriculture ............................................12

Ethanol and Corn Prices ..........................................12

Farm Bill Implications .............................................13

Ethanol and U.S. Rural Economic Development ............................13

Research on National Impacts ......................................13

Research on Regional Impacts .....................................13

Fuel Ethanol ‘New-Use’ Opportunity .....................................15

Potential Returns ................................................15

Capital Required and Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Market Growth Potential ..........................................19

Competition and Market Access ....................................20

Summary and Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...21

Appendix l-Estimated fuel ethanol costs for 15million-gallon-per-year

dry-mill plant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23

Appendix 2-Pro-forma profit and loss statements for 15million-gallon-per-year

dry-mill-plant . . . _ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24

ii
Highlights Farmer-owned cooperatives held about 397 million gallons per year (mgy) of actual

and potential fuel ethanol production capacity in 1996-l 47 mgy in production, 56 mgy

under construction, and 194 mgy in various stages of planning. Nearly one-third of the

397 mgy was controlled by a single cooperative in two plants in Nebraska and

Minnesota.

Four fuel ethanol production plants, totalling 108 million gallons in capacity, went out of

business in 1995, citing high corn prices and locally weak ethanol prices as the reason

for shutdown. These circumstances reflect national trends.

Presently, the industry depends upon the continued $0.054 per gallon Federal gasoline

excise tax exemption. The exemption is equivalent to $0.54 per gallon of ethanol

produced and essentially the cornerstone of the Nation’s ethanol policy. The policy was

scheduled to expire in 1993 but was extended to December 2000. There is concern

among some in the industry, however, that, given the politically conservative

sentiments that currently prevail among policy makers, the policy may be allowed to

expire.

The future success of the ethanol industry greatly depends on technology that lowers

the cost and improves the efficiency of ethanol production process. In the next 2-5

years, a range of innovations may save from $0.054 to $0.073 per fuel ethanol gallon

produced. Longer term production cost savings ranging from $0.089 to $0.154 are

projected possibilities.

Given a reasonably favorable business climate, i.e., the appropriate mix of higher

petroleum prices, lower corn prices, higher co-product prices, and an extension of the

excise tax exemption, production capacity could expand significantly.

In absence of the excise tax exemption, it has been estimated that oil prices must

exceed $40 per barrel and corn prices remain under $2.50 per bushel to assure

reasonable profitability. Furthermore, if the excise tax subsidy were discontinued,

ethanol would be unable to compete, at any corn price, with crude oil prices below $25

per barrel.

. . . 111
Cooperatives and New Uses

For Agricultural Products:

An Assessment of the Fuel Ethanol Industry

Anthony C. Crooks

Agricultural Economist

Rural Business-Cooperative Service

Industry Overview

The ethanol industry has passed some significant

milestones in the U.S. fuel marketplace. Recent recognition of ethanol and ethyl tertiary butyl ether (ETBE)

as high-quality fuel additives capable of delivering significant environmental, economic, and energy benefits

to the consumer has spurred industry production to its

highest historical levels.

Forty-three plants produced 1.4 billion gallons in

1994, up substantially from the 1979 production of 20

million gallons. Production has increased 420 million

gallons since the onset of the Federal oxygenated fuels

program in 1992. Ethanol-blended fuel now represents

about 11 percent of fuel sales in the United States.

Cooperatives are major players in providing energy products for farm production, having a Il-percent

market share in 1993 (Eversull and Dunn). That year,

more than 2,500 cooperatives sold $5.2 billion worth of

energy products to rural America. Around 29 percent

of the gasolines sold by cooperatives contained ethanol.

Thousands of cooperative members are already producing feedstocks that can be used for biomass fuels

such as ethanol. Farmer-members logically expect their

cooperatives to investigate the potential of producing

these fuels as an alternative feedstocks market.

Prominent Industry Actors

The most influential actors in the ethanol industry are Federal and State Governments. The industry

was created by a mix of Federal and State subsidies

and loan guarantees and today remains dependent

upon that support (LeBlanc and Reilly).

In particular, the industry depends upon continuation of a Federal gasoline excise tax exemption of

SO.054 per gallon, which is equivalent to SO.54 per gallon of ethanol produced. This is essentially the cornerstone of the Nation’s ethanol policy.

While often cited by the American Petroleum

Institute as a “huge special interest subsidy,” the policy has traditionally held widespread public support

(Johnson, 1994). The policy was scheduled to expire in

1993 but was extended to its present sunset date of

December 2000. There is concern among some in the

industry, however, that given the politically conservative sentiments that currently prevail among policymakers, the policy may be allowed to expire.

Other Federal and State subsidy/incentive programs are available to ethanol producers. A Federal

tax credit of SO.10 per gallon produced, up to $1.5 million, is available to producers of less than 30 million

gallons per year (mgy).’ In 1995,15 States provided

additional production and/or blending incentives to

qualified producers in their respective State. These

provisions are generally awarded on a per-gallon-produced basis and are, therefore, potentially quite substantial (table 1).

Supported by such a policy framework, as of

August 1996,42 plants had collective production

capacity of about 1.54 billion gallons per year of fuel

ethanol. About one-half (48.7 percent) of that capacity,

750 million gallons per year (mgy), belonged to Archer

Daniels Midland (ADM) and was distributed among

its four plants in Iowa and Illinois. Minnesota Corn

Processors (MCI’; 115 mgy) and Pekin Energy Co. of

Indiana (100 mgy) were the second and third largest

producers, respectively. The top three producers,

therefore, controlled about 63 percent of all U.S.

ethanol production capacity in 1995.

Farmer-owned cooperatives held about 397 mgy

of actual and potential ethanol capacity in 1996-147

mgy in production, 56 mgy under construction, and

194 mgy in various stages of planning. Nearly onethird of the 397 mgy was controlled by MCI’, in two

plants in Nebraska and Minnesota.

1 Unfortunately, this is no current pass-through benefit available to

member-owners of ethanol cooperatives.

1
Table t- Individual States’ ethanol production and blending incentives with expiration dates

State Production incentive Expiration date Blending incentive Expiration date

Connecticut $.Ol/gal. excise tax

exemption on 10%

blend

none

Hawaii $.04/gal. excise tax

exemption on 10%

blend

none

Idaho $.021/gal. excise tax

exemption on 10%

blend

none

Illinois 2% excise tax

exemption on

10% blend

July 1, 1999

Iowa $.Ol/gal. excise tax

exemption on 10%

blend

June 30,1999

Kansas $O.O9/gal. to qualified

producers

June 30,1997

Minnesota $0.20/gal. to qualified

producers

$0.25/gal. up

to $3.75 mil.

June 30,1995

June 30,201O

$.015/gal. excise tax

exemption on 10%

blend

December 31,

1997

Missouri !$0.20/gal. to qualified

producers

December 31,1995 $.02/gal. excise tax

exemption on 10%

blend

July 1, 1996

Montana $0.30/gal. to qualified

producers up to $1.5 mil.

December 31.2002

Nebraska $0.20/gal. to producers of

no more 25 mil. gal./yr.

January 1,200l $0.50/gal. tax credit

for ETBE made from

ethanol

January 1,200l

North Carolina Income tax credit up to

30% of construction cost if

plant uses agric. or forestry

products, not to exceed

$2.5 mil./yr. or $5 mil. total

none

North Dakota

Ohio

!fXL40/gal. to qualified producers July 1,1997

$O.l5/gal. tax credit to producers none

of less than 2 mil. gal./yr

South Dakota !$0.20/gal. to plants constructed

afler July, 1986

none $O.OUgal.

exemption from

state motor fuels tax

June 30,1994

Wyoming $.04/gal. excise tax

exemption on 10% blend

none

Source: Clean Fuels Development Coalition, Spring 1995.

2
Corn prices rose to and remained at historically

high levels throughout 1995 and 1996, placing the

industry under increasing duress. Consequently, several plants reduced production or ceased operations.

South Point Ethanol of South Point, Ohio, one of

the Nation’s oldest plants and the sixth-largest producer (65 mgy), permanently closed its doors in June 1995.

The plant’s manager cited increasingly higher corn

prices and downward spiraling ethanol prices as the

reason. In August 1995, ADM temporarily closed its

25-mgy wet-mill plant in Wallhalla, ND. A vicepresident for the company said the situation reflected

national trends. Other plant closings in 1995 included

Giant Industries (25 mgy) of Portales, NM, and AlcoTech (2.5 mgy) of Ringling, MT.

As of August 1996, other operational plants had

temporarily reduced or ceased production because of

cost/price pressure-Decatur, IL; Louden, TN; York,

NE; and Torrington, WY.

However, some hope appears to remain regarding the future of fuel ethanol production. Five plants

totalling about 36.5 mgy in production capacity and

employing state-of-the-art technology were scheduled

for startup by early 1997: Spring Green and Plover, WI;

Buffalo Lake and Little Falls, MN; and Blairstown, IA.

Production Technology

The basic technology for producing fuel ethanol

is similar to that used by the traditional beverage and

industrial alcohol industries and, as such, has a long

history. However, the fuel ethanol industry itself only

originated in 1978.

Dry-milling and wet-milling are the two main

processing methods for ethanol production. The drymill process grinds corn and slurries it in water to be

cooked (see figure 1). Enzymes are then added to convert starch into sugar (a process called saccharification,

and common to both dry- and wet-mill process), then

~~~~~ I- Dry-Mill Processing, Products, and Uses

Process

Milled to meal

I

Slurried

and cooked

I

Products Uses

Fermentation b Carbon dioxide Industrial and

beverage

c c

I

Distillation

dehydration

Distilled dried

grains Animal feed

L ),Fuel blending agent,

3
yeast is added to ferment the sugar. This process produces a mixture of alcohol, water, and suspended

solids. The alcohol and water mixture is distilled and

dehydrated (reducing the water content to about 5 percent) to create fuel-grade (anhydrous) ethanol. The

remaining solids are dried and sold as a livestock feed

supplement known as distillers dried grain (DDG).

The wet-mill process removes the entire corn kernel before converting starches to sugar (figure 2). This

procedure generates a greater variety of byproducts,

some of which have high market values.* A more

refined sugar and water mixture (for fermentation) is

also possible by removing the solids early. The ethanol

2 Generally, the solids are used to produce three coproduck corn

gluten feed, corn gluten meal, and corn oil.

wet-mill process is identical to fructose production

through the starch production phase. Wet-mills are

able, therefore, to combine ethanol and fructose production to their financial advantage.

The byproduct streams from both processes

require drying. Carbon dioxide is also a minor coproduct of both processes.

Production Costs

Research on ethanol production suggests that

according to size, location, age and type of technology,

and input costs, As a result, gene

duction estimates for such a heterogeneous industry

are difficult to obtain.

A widely regarded study (Kane and Reilly, 1989)

11 representative ethanol plants provides the basis for estiFigure 2- Wet-Mill PrOCeSSing, Products, and Uses

Process Products Uses

I 1

I

Steeping

I

- Food and industrial

Milling and

separation

W Corn oil, Gluten _+Animal feed

Feed, Gluten Meal A

I

e Animal feed

Starch wash

I

I

Dry starch w Food and industrial

I

Syrup conversion

fermentation

I

High fructose

corn syrup b Food and beverage sweetener

-Carbon dioxide - industrial and beverage

I Distillation 1-q Ethanol w Fuel blending agent

4
mates in this report.3 Kane and Reilly’s cost-of-production estimates are updated for this report by using producer price indices and information obtained from

prominent engineering firms.

As in Kane and Reilly, costs are reported in three

categories-feedstock costs, cash operating costs, and

capital costs, for odd years, 1989-95. Where appropriate, cost estimates are reported for large (greater than

30 mgy) and small firms (30 mgy or less) as well as for

wet- and dry-mill processes.

Feed stock costs are reported net of prices

received for byproducts (table 2). Corn prices ranged

from $2.04 to $2.55 per bushel during the 5-year period. Net feed stock costs ranged roughly from SO.47 to

SO.65 per gallon produced for wet-mill plants and

$0.45 to $0.62 for dry, Distillers dried grain prices

ranged from $96.80 to $120.20 per ton during the same

period.

Table 3 reports cash operating costs for energy,

ingredients, personnel, maintenance, management,

administration, insurance, and taxes.4 Cash operating

costs were less variable than net feed costs for both

3 Six of these plants comprise about 77 percent of the industry’s

operating capacity.

4 Ingredients costs include enzymes, chemicals, yeasts, and

miscellaneous materials. Taxes are non-income, non-fuel, based

taxes, e.g., property tax, general business taxes, etc.

sizes of plant. For plants producing less than 30 mgy,

total cash costs ranged from $0.43 to SO.52 per gallon

produced. Plants producing greater than 30 mgy

incurred about 5 percent less in total cash costs per

gallon at $0.48 to $0.64 per gallon produced.

Small plants had lower cash operating costs for

ingredients, and for management, administration,

insurance, and taxes. Large plants had lower costs on

personnel and energy. Energy was the largest single

cost factor for the large plants (about 30 percent of

cash operating costs). However, large plants still paid

less for energy per gallon than the small plants did.

Investment costs and capital charges on new or

additional capacity for fuel ethanol plants are reported

in table 4. Investment costs include the so-called “soft”

or startup costs associated with a plant after construction or refurbishing. Capital charges (interest costs)

assume that 50 percent of the investment cost on additions, adoption, or construction is financed. Reported

values are updated Kane and Reilly estimates.

Investment costs varied widely among plants in

the original report because of differences in construction and accounting among firms. Some firms overdesigned plant components, but boosted production

above original-rated capacity with minimal additional

investments. Others achieved low initial investment

but were forced to increase their investment after plant

startup to meet planned capacity expectations and to

improve plant operation efficiencies.

Table 2- Net feedstock costs for wet- and dry-mill ethanol processing, selected years, 1987-95

1987 1989 1991 1993 1995

Corn cost ($/bu.) 2.04 2.46 2.45 2.55 2.49

Distillers Dried Grains

price ($/ton) 97.03 119.51 120.20 117.00 96.60

Wet-mill 1 Dollars per gallon

Corn 0.616 0.964 0.960 1.021 0.997

Coproducf credit -0.349 -0.430 -0.433 -0.421 -0.346

Net feedstock cost 0.467 0.554 0.547 0.600 0.646

Dry-mill 2

Corn 0.765 0.946 0.942 0.962 0.956

Coprcduct credit -0.336 6.414 -0.416 -0.405 -0.335

Net feedstock cost 0.449 0.532 0.526 0.577 0.623

1 CO, recovery was not included in wet-milling coproduct recovery credii. High fructose corn syrup (HFC) is not a coproduct of wet-mill ethanol

processing because ethanol is produced during the months that HFC is not. Assumes ethanol yield of 2.5 gal./bu.

2 Assumes fuel ethanol yield of 2.6 gal./bu. One bushel of corn yields 18 Ibs. of distillers dried grains.

Sources: USDA, Economic Research Service and USDA, Agricultural Marketing Service.

5
Table z- Cash operating costs for fuel ethanol processing, net feedstock costs excluded, 1987-95

1987 1989 1991 1993 1995

Dollars per gallon

Plants producing 30 million gallons per year or less

Energy

Ingredients

Personnel and maintenance

Management, administration,

insurance and taxes

0.135 0.141 0.165 0.166 0.154

0.069 0.100 0.101 0.103 0.105

0.156 0.177 0.186 0.201 0.206

0.047 0.050 0.052 0.055 0.060

Total cash operating costs 0.430 0.467 0.504 0.524 0.522

Plants producing greater than 30 million gallons per year

Energy

Ingredients

Personnel and maintenance

Management, administration,

insurance and taxes

0.123 0.129 0.151 0.151 0.140

0.110 0.123 0.124 0.126 0.130

0.116 0.130 0.137 0.148 0.152

0.060 0.062 0.065 0.068 0.070

Total cash operating costs 0.409 0.444 0.477 0.494 0.493

Sources: Kane and Reilly, Economic Report of the President, selected years. Cash operating costs as reported in Kane and Reilly are

updated using the producer price indices from the Economic Report of the President.

Table 4- Investment costs and capital charges on capacity addition for fuel ethanol plants

selected years, 1987-95

1987

Incremental addition to operating facilities

1989 1991

Dollars per gallon

1993 1995

Investment cost 1.50 1.99 1.55 1.31 1.10

Capital charge 0.29 0.33 0.38 0.35 0.30

Adoption of abandoned facilities

investment cost 2.00 2.27 2.65 2.44 2.06

Capital charge 0.31 0.36 0.41 0.38 0.32

Construction of new facilities Dry-mill

Investment cost 2.35 2.34 2.00 1.85 1.75

Capital charge 0.38 0.43 0.48 0.45 0.39

Construction of new facilities- Wet-mill

Investment cost 2.50 2.45 2.45 2.30 2.28

Capital charge 0.48 0.54 0.84 0.59 0.49

Sources: Kane and Reilly, Economic Report of the President, selected years.

6
Capital may be expanded either by incremental

additions to existing capacity, adopting abandoned

capacity, or by building new facilities. Table 4 reports

the investment cost per-gallon-of-capacity-added and

capital charge required to finance the expansion for all

three types.

Investment costs for incremental addition to

operating facilities ranged from $1.10 per gallon of

installed capacity in 1995 to its highest mark in 1989 of

$1.99. Capital charges for incremental addition ranged

from SO.29 per gallon in 1987 to SO.38 in 1991.

Investment costs for adopting abandoned facilities ranged from $2 per gallon of installed capacity in

1987 to $2.65 in 1991; capital charges $0.31 in 1987 to

SO.41 in 1991.

Investment costs for new dry-mill facilities construction ranged from $2.35 in 1987 to its lowest mark

in 1995 of $1.75. Capital charges were highest at SO.48

per gallon of capacity in 1991 but receded to SO.39 by

1995.

Investment costs for new wet-mill facilities construction stayed between $2.28 to $2.50 per gallon of

production capacity during the 8-year period. Capital

charges to finance wet-mill construction peaked in

1991 at SO.64 per capacity gallon but declined to $0.49

in 1995.

Future of Fuel Ethanol Industry

Future success of the ethanol industry greatly

depends on technology that lowers the cost and

improves the efficiency of ethanol production. The

state-of-the-art technology used in ethanol plants in

1997 includes continuous processing in each of the

four production phases, recycled yeast, and fully computerized processing control. The starch conversion

and fermentation phases have also been combined for

higher yields. Large plants can produce enzymes on

site and wet-mills now separate fine fiber from gluten

mill and feed. Standard dehydration techniques are

being replaced with reverse osmosis or molecular sieve

technology.

The most significant design feature in a state-ofthe-art plant, however, involves a completely integrated use of waste energy within the plant. Presently,

some plants are bypassing cogeneration and use direct

steam drive to replace electric motors. Plants using

these technologies can expect to reduce their costs by

as much as SO.10 per gallon compared with vintage

plants.

Emerging Technologies

Opportunities for improving the cost and efficiency of fuel ethanol involve speeding the process

time and lowering operating costs. Such opportunities

arise in the four basic processes of its production-saccharification, fermentation, distillation, and energy

production.

In the next 2 to 5 years, cost-saving innovations

will be available to the industry as it expands and

chooses to invest in new capital (table 5). Near-term

opportunities involve improved enzymes and fermenter designs that reduce the conversion time from

corn (or other feedstocks) to ethanol.

Two such applications in the saccharification

process are currently under trial. The use of gaseous

sulphur dioxide (SO,) and special corn hybrids shorten steeping time (wet-milling). Plants that adopt

gaseous injection may lower production costs between

$0.013 and SO.017 per gallon of ethanol produced.

Special corn hybrids that reduce steeping time are

quite likely to sell at a premium above standard corn.

If a SO.02 premium is awarded the hybrid corn, then its

use could save a new wet-milling plant from SO.01 to

SO.018 per gallon of ethanol produced (Hohmann and

Rendleman).

Another technique currently being tested would

significantly reduce fermentation time. Membrane filtration allows water and ethanol to pass through a

semi-permeable membrane that traps the starch and

yeast in the fermenter. By retaining the yeast, fermentation proceeds at a fraction of the conventional 40 to

50 hours required. However, reducing the fermentation time also reduces the ethanol concentration and

increases the energy cost per gallon. Nevertheless, continuous fermentation with membranes is expected to

significantly reduce capital costs for new plants

(Hohmann and Rendleman).

Membranes are also likely to be used in the saccharification stage. This technology, which allows glucose and water to passed through as the enzymes and

starch are retained, has two benefits. Saccharification

time may be reduced by as much as 10 to 15 hours.

Enzyme requirements may be reduced by a factor of

10. Consequently, operating costs may be reduced by

SO.012 to SO.015 per gallon (Hohmann and

Rendleman).

Improving the fermenting organism can also cut

operating costs in the fermentation stage. Yeasts are

currently under development that work in higher concentrations of ethanol. Use of these high-tolerance

organisms is estimated to lower the energy costs of
Table &Emerging ethanol production technologies and their estimated cost savings

Cost savings per gallon of ethanol produced

Process Type of mill Feed stock Operating Capital Total

________________________________ do/fars _________________________________

Near-term technology

Gaseous SO, Saccharttcation

Corn hybrids Saccharification

Membrane filtration Saccharification

Fermentation

High tolerance yeasts Fermentation

Yeast immobilization Fermentation

Total near-term savings’

Long- term technology

Z. mobilis bacteria Fermentation

Cellulose conversion All

Pervaporation Dehydration

Total long-term savings’

Wet

Wet

Wet

DryiWet

Dry/Wet

Dry/Wet

0.013-0.017 0.013-0.017

0.00!%0.008 0.01 O-0.01 8 0.092-0.01

0.012~.015 0.01 0.0224.025

0.008-0.012 0.008-0.012

0.020-0.270

0.01-0.014 0.025-0.032 0.019-0.027 0.054-0.073

Dry/Wet

Dry/Wet

Dry/Wet

0.02 0.02

0.02-0.035 0.01-0.04 0.03-0.045

0.01-0.047 0.027-0.034 0.052-0.073 0.089-0.154

1 Near and long-term savings totals are also estimates, not sums of their respective categories.

Source: Hohmann and Rendleman, 1993.

distilling alcohol from SO.008 to $0.012 cents per gallon

produced (Hohmann and Rendleman).

Longer-term research focuses on the use of bacterial fermentation, on technologies that allow the substitution of other cellulose materials for feedstocks,

and development of high-value coproducts from alcohol production.

Substituting Zymomonous mobilis bacteria for

yeast in the fermentation stage is a technology whose

potential has been demonstrated, although at less than

the commercial level. Z. mobilis in laboratory testing

has quickened fermentation, raised alcohol yields, and

allowed fermentation at higher temperatures vis-a-vis

conventional yeast. (Busche, et al.) These benefits

would reduce energy costs and increase feedstock savings. Although the bacteria are presently less stable

than yeast and more sensitive to changes in the pH

and temperature, these problems will hopefully be

resolved in the next 3 to 5 years. Production costs savings from such a breakthrough could be as high as

SO.02 per gallon produced (Texeira and Goodman;

Hohmann and Rendleman).

Converting corn fiber to ethanol is desirable

because current ethanol recovery is approaching the

theoretical limit available from the starch portion of

the kernel. Conceivably, yields may be raised from 2.6

to almost 3 gallons per bushel if the hull and other

fibrous portions of the kernel could be converted into

ethanol. Coincidently, such a process would improve

the quality of the feed coproduct because its protein

content would be increased. However, the fiber acts as

a binding agent in the feed matter. Therefore, drying

the coproducts without the fiber content may present

some integrity problems that must be overcome.

Converting corn fiber to ethanol should lower feedstock and capital costs. Total cost savings have been

estimated to range from SO.03 to $0.075 per gallon produced Hohmann and Rendleman).

Because the value of ethanol is closely tied to the

price of other energy sources, coproduct sales are

potentially the most profitable area of research. This is

particularly true as long as the price of feedstock is

driven by alternate uses, and production cost reductions are constrained by the physical limitations of the

conversion processes under present and nearterm technologies. Coproduct revenues remain

unbounded by such restrictions.

Membrane technology provides greater control

over the production process by allowing greater separation of various components within the product

stream (Hohmann and Rendleman; Kane and Reilly).

And as membrane technology becomes more sophisticated, high-value coproducts, such as citric acid and

sorbitol, may be removed in greater volumes.

8
However, at some point in the production, it may

prove more economical to produce these valuable

coproducts in a separate fermentation.

Semi-permeable membrane technology may

allow plants to recover high-value coproducts such as

lactic acid. Costs associated with drying the coproducts may be reduced by running liquid components

through a micro-filtration unit to absorb excess water.

Coproduct research continues on high-value uses

for carbon dioxide. While carbon dioxide is produced

in quantities nearly equal to ethanol,5 its present market value is less that $0.01 per pound. However, a bacterium has been discovered that converts carbon dioxide and hydrogen into acetic acid (Wood). Presently,

5 As a rule of thumb, a plant will produce about 10 tons of carbon

dioxide for each million-gallons of annual capacity. For example, a

IO-million-gallon plant would produce on average 100 tons of raw

carbon dioxide gas per day. However, the carbon dioxide market

is closely controlled by three national companies who sell 90

percent of the all the gas sold in the United States. It is a very

concentrated business and companies attempting to break into it

on their own should expect difficulty.

acetic acid production costs about $0.75 per gallon of

ethanol produced and returns about $1.50 per gallon.

While price would probably fall under mass production, this process indicates the potential that lies in

coproduct development.

The U.S. Department of Energy, National

Renewable Energy Laboratory conducts research, or

manages the research of others, on a host of projects

with the goal of cutting the cost of fuel ethanol production from biomass. In particular, researchers are

developing biochemical processes that convert cellulosic biomass to ethanol. A list of these goals and their

respective cost savings is shown in figure 3. These

goals anticipate that fuel ethanol production costs will

not exceed SO.70 per gallon when they are attained.6

Market Demand for Fuel Ethanol

Ethanol competes in the transportation fuels mar6 Coincidently, this value is about the same as the expected price of

fuel ethanol when the Federal excise tax reimbursement is allowed

to sunset.

Figure3- Fuel Ethanol Production Cost Goals from Biomass Research

Reference case

Reduce milling power by 25%

Improve hemicellulose hydrolysis from 80% to 90%

Minimize makeup water

Increase xylose yield from 85% to 90%

Increase conversion time from 2 days to 1 day

Improve inoculum preparation-hemicellulose

Improve cellulose to ethanol yield from 72% to 90%

Decrease conversion time from 7 days to 3 days

Improve enzyme activity by a factor of 3

Improve inoculum preparation-cellulose

Improve carbohydrate content of feeds stock by 10%

Decrease feedstock cost from $2.50 to 82.00 mm Btu

Increase onstream time from 91% to 98%

0.00 0.20 .040 0.60 0.80 1.0 1.20

Ethanol production cost--$Jga//on

Source: U.S. Deparfment of Energy, National Renewable Energy Laboratory

9
Figure 4- Octane-Enhancement Cost Relationships, Ethanol v. MTBE

_ Cents per octane number per gallon

0.10

-0.02

-0.04

-0.06

0.7

Ethanol $1.20/gal.

MTBE $l.lO/gal.

Ethanol $O.Wgal.

MTBE $0.70/gal.

1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.6

Unleaded gasoline-$/gallon

Source: Kane, et al.

ket as a blending agent with gasoline (LeBlanc and

Reilly). In the early 198Os, ethanol was marketed as a

fuel extender in response to a perceived demand for a

domestically derived fuel source to substitute for

imported petroleum. While engines designed to burn

gasoline require significant modifications to burn neat

(pure) ethanol, they can tolerate ethanol-gasoline

blends of up to 20 percent ethanol. As a fuel extender,

however, ethanol contains around two-thirds the energy content of gasoline. As a result, it must compete at

two-thirds the price of gasoline, given Federal and

State excise tax concessions (LeBlanc and Reilly).

Ethanol has a 30 percent higher octane rating

than gasoline (110 to 112 versus 87 for regular unleaded) and rates 7 percent higher than its nearest competitor in the octane enhancer market MTBE (methyl tertiary butyl ether). Because octane enhancers sell at a

40-percent premium above retail gasoline prices,

ethanol’s value as an enhancer is significantly greater

than as a gasoline extender/replacement. The actual

octane value reflected in the price of ethanol varies

with the demand for octane and the availability and

pricing of refinery-based octane petrochemicals.

Figure 4 illustrates the competitive relationship

that exists between fuel ethanol and MTBE under present and future economic conditions. For unleaded

gasoline prices less than $1.35 per gallon, ethanol is

less expensive than MTBE when the Federal excise tax

reimbursement of SO.54 per gallon is considered.

MTBE presently sells from SO.70 to $1 per gallon. The

cost difference between the two is increased when

State exemptions are included. For unleaded gasoline

prices above $1.29 per gallon, blending costs are negative for both additives, because both are less expensive

per gallon than gasoline and offer a relatively cheap

way to extend gasoline volume. Ethanol and MTBE

would be closely competitive if the Federal excise tax

expired or if methanol were produced at full cost from

domestic coal.

Ethanol contains 37 percent oxygen when blended with gasoline. Adding oxygen to gasoline reduces

automobile exhaust levels of carbon monoxide and

other polluting hydrocarbons. Fuel ethanol developed

an oxygen value when municipalities began to require

an oxygen content in gasoline to reduce carbon

monoxide pollution during the winter months. In 1990,

the Federal Clean Air Act Amendments required an

oxygen content in the majority of all gasoline sold by

1995.7 Crude oil and gasoline do not contain any oxygen. Ethanol, methanol, and their respective derivatives are presently considered to be the only economical sources of oxygen.

In December 1993, the U.S. Environmental

Protection Agency (EPA) proposed the Renewable

Presently, 39 metropolitan areas have high levels of carbon

monoxide pollution. Gasoline sold during the winter in these areas

must contain a minimum of 2.7 percent oxygen.

10
Oxygenate Standard (ROS) rule to require that 30 percent of all oxygenate used in the ozone non-attainment

areas be derived from renewable sources. The ROS

became a final rule in June 1995 and called for a l-year

phase-in with 15-percent oxygenate level mandated for

January 1,1995, and the full 30-percent requirement to

begin January 1,1996.

The American Petroleum Institute and the

National Petroleum Refiners Association filed a lawsuit against the EPA in response to the ROS. The

appeals court ruled that the EPA had exceeded its

authority under the Clean Air Act. It said EPA has no

authority to mandate “the manner of compliance or

the precise formula for compliance (Sutherland,

Washington Post, May 16,1995).” The oil industry has

invested heavily to reconfigure refineries to produce

reformulated fuels using MTBE. Consequently, the

reformulated gasoline market is presently dominated

by MTBE. The ROS-ruling was estimated to have provided an assured market of about 500 million gallons

of ethanol or about one-third of the 1.5 billion gallons

of ethanol presently produced annually in the United

States (Milling and Baking News, May 9 1995).

On March 18,1996, the EPA finalized a ruling

that increases the oxygen content in summer reformulated gasolines to 3.5 percent of weight, up from 2.7

percent. Fuel ethanol at the 10 percent-by-volume level

equals 3.5 percent oxygen by weight. Some suggest

this allows ethanol to be used at its most effective

blend level and allows gasoline marketers to take full

advantage of ethanol’s octane, oxygen, and toxic displacement benefits (Minnesota Department of

Agriculture, 1994). Presently, no legislative assurances,

such as the ROS, are under consideration or review.

An export market for ethanol has been under

development since 1991 when Brazil could no longer

produce sufficient neat ethanol to satisfy its domestic

demand. Brazil’s primary feedstock, cane sugar, has

since been principally directed toward the world

sweeteners market, creating local shortages of fuel

ethanol. In addition to Brazil, Mexico, the Republic of

Korea, Japan, and many European countries are

expressing an increased interest in oxygenated gasoline (Johnson 1994; Minnesota Department of

Agriculture).

Despite these marketing opportunities, the fuel

ethanol industry may have sufficient cause for concern

regarding a breakthrough motor fuel innovation. The

so-called “A-21” fuel (aqueous fuel for the 21st century), which is comprised of naptha, tap water, and a

blending agent, has passed rigorous testing. Results

indicate that it outperforms gasoline and diesel as a

clean, cheap, and safe fuel. A-21 can be used in most

combustion engines.

In November 1995, the State of Nevada certified

the water-based fuel as a “clean alternative fuel,” i.e., it

may be used to satisfy Federal mandates requiring

clean fuels in municipal fleets and other similar vehicles. Nevada emission trials demonstrated that A-21

passed not only EPA standards for that State, but also

the much tougher standards set by the California Air

Resources Board for well into the 21st century. It also

improves mileage. Should A-21 enter the marketplace,

and disinterested outsiders who have tested it say it

has a strong chance, it could cut the price of gasoline

in half. Because naptha is a clear liquid produced in

the early stages of oil refining, it is more available and

cheaper to produce than gasoline (Miller).

The most frequently cited concern about A-21 is

that it can freeze in cold weather. A potential blending

opportunity for the ethanol industry may develop in

this regard. If A-21 replaces gasoline as the motor fuel

of convention, ethanol’s role as fuel extender will be

suspect, it’s use as an octane enhancer will be unnecessary, and its value as a fuel oxygenator will be trivialized by the water content of A-21. So, the widespread

adoption of A-21 as a motor fuel will almost certainly

reduce ethanol’s future role from a significant fuel additive to that of ‘fuel anti-freeze’. Ethanol’s market could

be substantially reduced, although not totally lost.

Ethanol and U.S. Energy Policy

The principal goal of U.S. energy policy is “energy security,” the assurance of a stable and reliable supply of energy in both the near- and long-term. Energy

security embraces not just the Nation’s ability to

defend itself in time of war but also the broader concern of reducing our dependence upon foreign energy

sources and the implicit threat of a disrupted supply.

Ethanol subsidies reduce foreign oil dependence by

encouraging ethanol’s production and gasoline substitution.

Fuel stockpiles offer the most effective energy

security strategy. In 1982, Congress authorized a stockpile program for ethanol Strategic Alcohol Fuel

Reserve. However, a petroleum reserve is the primary

response to energy security threats. And while a fuel

ethanol reserve is considered feasible, its cost effectiveness has been questioned (US.GAO, 1984).

The major policy initiatives for long-term security involve research and development on and assuring

a commercial supply of alternative fuels (mainly shale

11
and coal). Near-term policy initiatives are directed

toward minimizing the impacts of global energy market disruptions to the U.S. economy. Significant production subsidies to all energy industries, including

ethanol, result from our national policy to foster energy security (LeBlanc and Reilly).

The value of energy independence is limited

when pursued for its own sake. However, the development of cost-effective, fuel-producing technologies

may offer significant advantages for overall U.S. competitiveness. Support for ethanol, synfuels, and other

advanced energy technologies when viewed from this

perspective do not appear unreasonable.

From a national economics standpoint, however,

the relative level of support for any particular fuel-producing technology should be a function of its potential

supply availability and its cost-of-production structure. In this regard, a number of fuel technologies may

compare favorably to ethanol.8 Nevertheless, the fuelethanol industry does operate commercially, employs a

known technology, and produces in a relatively certain

cost environment (at least, when compared with liquid

coal and shale oil).

However, the more successfully ethanol contributes to long-term energy supplies, the more it

drives up feedstock prices and consequently its own

cost. Ethanol production, in this regard, will limit itself

to the role of a small fuel contributor that uses temporary agricultural surpluses and organic waste.

Public-sector support for the ethanol industry

depends on the Nation’s interest in the production and

use of the fuel and is unrelated to the market prices.

Fuel prices are set by worldwide supply and demand

conditions. U.S. energy policies have a negligible

impact on world fuel prices (LeBlanc and Reilly).

While the Federal Government provides significant subsidies toward the development of all energy

resources, ethanol production is highly subsidized

when compared with other fuels. Tax expenditures

related to ethanol production were nearly $1 billion in

1986 and surpassed all research expenditures toward

synthetic fuels or nuclear fusion. In 1984, the ethanol

industry received almost $15 per million Btu. In the

same year, petroleum, natural gas, and coal received

less than $1 per million Btu.

8 Liquid fuels from coal and shale oil are considered by some to be

less expensive than biomass fuels and supplies are unlimited

(LeBlanc and Reilly).

Ethanol and U.S. Agriculture

Commodity market conditions, the nature of

farm policy programs, and the relative size of the

ethanol industry will determine how important

ethanol production is to the future of U.S. agriculture.

In times of corn scarcity, ethanol production will have

relatively more influence on commodity prices than

when corn stocks are large and prices low. When the

export and domestic demand for corn is low, ethanol

production may increase in importance as an alternative use for corn.

Ethanol production mainly affects the corn and

soybean markets. Increased ethanol production will,

generally, raise corn prices and depress oilseed and

protein market prices (as more corn oil, DDG, corn

gluten feed, and meal are supplied). Because the production decisions for livestock and other crops are

linked by interrelated markets, they are also affected,

albeit much less significantly, by ethanol production. It

is estimated, however, that until annual ethanol production exceeds 3 billion gallons, livestock production

and prices will remain largely unaffected by the

impacts of ethanol production on corn and oilseeds

markets @Blanc and Reilly).

Ethanol and Corn Prices

An expanded ethanol industry was once suggested as a partial substitute for traditional agricultural

programs to manage corn supplies and prices (LeBlanc

and Reilly). In general, it was believed that increased

ethanol production may slightly offset farm program

costs. As corn prices, raised by increased ethanol production, approached the target price, farmers would

be paid lower deficiency payments, would be less likely as a consequence to default on non-recourse loans,

and would be less willing to participate in Government set-aside programs. And because increased corn

prices generally push other grain prices up, program

outlays would also have been reduced for wheat,

sorghum, oats, and barley.

However, it was estimated that fuel ethanol production had to exceed 2 billion gallons annually (which it

never did) before it would notably influence corn prices

and would have had to exceed 3 billion to 4 billion gallons annually (almost three times the highest production

level) to raise traditional corn prices above historical target levels (LeBlanc and Reilly). Given the production,

market, and policy circumstances of marketing year

199596 and the foreseeable future, fuel-ethanol production’s influence on corn prices is at best insignificant.

Corn prices are expected to remain at historically high

12
levels because of reduced carryover, increased export

demand, and no anticipated increases in production.

Therefore, any farm program savings resulting

from increased corn prices from ethanol production

are nil, and will certainly be offset by lost tax revenues

associated with ethanol use. Until the year 2000, or a

change in the law, every gallon of fuel ethanol consumed amounts to $0.054 in lost revenue to the Federal

Highway Trust Fund. (The trust receives $0.13 per gallon in taxes for fuel ethanol instead of $0.184 for gasoline.) At current use (1.6 billion gallons per year), this

amounts to about $810 million annually or $4.05 billion for 1996 thru 2000 in lost tax revenue.

Farm Bill Implications

The argument for encouraging ethanol production

as a way to reduce farm program costs has been moot

since the Federal Agriculture Improvement and Reform

(FAIR) Act of 1996 was enacted. More commonly

known as “Freedom to Farm,” the Act largely “decouples” the connection between market price movements

and the level of crop payments. Planting decisions for

wheat and feed grains are now made irrespective of

crop acreage base. The legislation also eliminates the

U.S. Secretary of Agriculture’s ability to use acreage

reduction programs or annual set-asides as a condition

for receiving program benefits (Ray, et al., F.A.P.R.I.).

When compared with continuing the former policy, these bills are expected to increase both planted

acreage and crop prices. Overall acreage planted for

wheat, corn, and soybeans is expected to increase over

the next several years as contracted acreage in the

Conservation Reserve Program (CRP) expires and

domestic and world demand expands. Corn and wheat

prices are expected to increase, relative to baseline projections, by as much as SO.10 per bushel, while soybean

prices are projected to decline between $0.57 and SO.81

per bushel depending on the portion of CRP acres that

will return to production (Ray, et al., F.A.P.R.I.).

Ethanol and U.S. Rural

Economic Development

A number of reports are presently available that

discuss the rural economic development implications

of increased ethanol production. These studies, both

national and regional in scope, describe the impacts

on employment, business and personal income, and

indirect economic influences of increased production

and capacity.

Research on National Impacts

In general, national studies base their economic

estimates on U.S. Government Accounting Office

(GAO) projections of 2-billion-gallons-per-year ethanol

production by 1995. This level would have required

production to double between the years 1990 to 1995

(table 6). Actual production in 1995 was less than to 1.5

billion gallons.

House, et al., using the 2-billion-gallon-per-year

fuel assumption, estimated that U.S. farm income

could increase by as much as $172 million. Income

gains would largely be distributed in the Corn Belt

region ($102 million), the Northern Plains ($39 million), and the Lake States ($31 million).

Petrulis, et al., examined the job creation implications for increasing fuel ethanol production to 2 billion

gallons by 1995. Employment gains were based on full

use of existing or idled plants and the construction of

new capacity. Increased production was projected to

create jobs-first among plants currently operating at

excess capacity (4,580 jobs); then among reactivated

plants now idle (4,000 jobs); then among plants now

planning expansion (9,860 jobs); and finally, among

new plants being proposed (9,200). The report projected 27,640 employment opportunities-2,770 construction related, 9,570 in plant operations, and 15,300 agricultural (including nonfarm employment from

increased grain production and decreased soybeans).

Research on Regional Impacts

An assessment of the economic impacts of a 50-

million-gallon fuel ethanol plant in an “average”

Midwestern State was jointly performed by the

Western Regional Biomass Energy program and the

Great Lakes Biomass Energy program (ENERGETICS,

1994).9 An estimated 3,000 jobs would be created directly and indirectly by the construction (1,608) and operation (1,264). The plant is expected to generate more

than $47 million in direct and indirect income and tax

revenue exceeding $7 million to the State and local treasuries and $11.5 million in Federal tax revenue.

A study performed for the State of Illinois summarized the major impacts (not all of them economic)

of ethanol production in the State. Eight hundred plant

operation jobs and 4,000 additional jobs (in industryrelated services) were created by the State’s $I-billion

9 The “average” ethanol producing State being an approximation by

use of a simple average of the economic multipliers of those States

involved with the analysis: Colorado, California, Illinois, Indiana,

Iowa, Kansas, Minnesota,JVebraska, New Mexico, North Dakota,

South Dakota, and Texas.

13
Table 6 National and regional impacts of increased fuel ethanol production on employment,

income, and taxes

Employment income Taxes

Source

Construction Operations Direct Indirect State/Local Federal

------- Numberofnewjobs ------- _______________________________ $ mi//ions _______________________________

National impacts

GAO’ 415 7,400

House, et. al.* 172 7

Petrulis, et. aL3 2,770 24,870

Regional impacts

ENERGETICS4 1,608 1,264 3.1 44 7.3 11.5

Illinois 5

4,800

Nebraska 6

2,872 2,509 325 23 2.4

Iowa’ 51 1,380 55 246.2

Indiana8 - 5,604 - -418.2 - 16.5

Minnesota9 4,597-5,576 111-135 431-435 19-21

Sources:

1 U.S. Govt. Accounting Office, RECD-90-156, July 1990.

2 U.S. Dept. of Agric., Economic Research Service, AIB-667, May 1993.

3 U.S. Dept. of Agric., Economic Research Service, AIB-678, July 1993.

4 “Economic Impact of Ethanol Production Facilities: Four Case Studies,” June 1994.

5 “Benefits to Illinois in Developing and Utilizing Ethanol Fuels,” March 28,1992.

g Nebraska Dept. of Economic Development, “Nebraska’s Ethanol Industry.” October 1993.

7 Iowa State University, Dept. of Economics, Staff Paper no. 238. December 1991.

B Indiana Dept. of Commerce, April 1992.

9 Minnesota Dept. of Agriculture, May 1995.

investment in the industry. An estimated 2,250 new

rural jobs were created for every 100 million bushels of

corn used for ethanol production.

The Nebraska Department of Economic

Development (October, 1993) used an input/output

economic model to provide information on the ethanol

industry in their State and linkages with other

Nebraska companies. Expansion of fuel ethanol production capacity from 63 million gallons in 1993 to 213

million gallons per year in 1995 was estimated to create 5,381 jobs in plant construction and operations.

This would also generate an additional $348 million in

income (both directly and to other Nebraska firms),

and add $2.4 million to the State and local treasuries.

Otto, et al., describe the economic and employment impacts of the fuel ethanol industry in Iowa as

significant. About 2,550 people are employed by wetcorn mills and 620 by dry-corn mills in the State. A

total of $2.4 billion in products and $1.09 billion in

value-added-product processing is also related to Iowa

ethanol production. A plant using 75 million to 100

million bushels per year would require 300 employees

and add 1,431 jobs, $55 million in personal income,

and $246.2 million in indirect income to the State.

Littlepage (1992) examined the economic impacts

of ethanol production by estimating the revenues

expected to be generated by a plant planned in South

Dakota. A wet-mill plant of about 50 million gallons

annually in capacity would cost $117 million to construct and create $418.2 million in earnings, 5,604 jobs,

and increase State and local revenues by as much as

$16.5 million.

A report prepared by the Minnesota Department

of Agriculture describes the economic and fiscal benefits of a statewide production of 200 million gallons

annually.‘0 Estimates of increased employment,

income, and tax revenue were developed to account

for both wet- and dry-mill production processes.

lo Two hundred-million-gallons per year is the supposed level that

gives ethanol a “full market penetration” of a 10 percent blend of

ethanol with gasoline sold in Minnesota filling stations.

14
Between 4,597 and 5,576 new jobs, including construction, operations, and support/service related, would

be created (the range accounts employment differences

required by dry- and wet-mills). Between $111 million

and $135 million in direct income would be added.

Indirect income would range from $431 million to $475

million depending on the dry- and wet-mill process,

respectively. Furthermore, State and local revenues

would increase from $19 million to $21 million.

A strong argument can be made for the economic/community development contribution of a fuelethanol processing plant. Reports suggest construction

and operation of a plant may bring nearly 5,600 fulltime jobs, $135 million in direct and $435 million in

indirect income, and up to $21 million in State and

local tax revenues to a region. To date, however, no

report compares the relative regional contribution of a

fuel ethanol plant vis-a-vis another processing plant of

similar magnitude and scope. Nor has the relative contribution of an ethanol plant been compared with several businesses whose total capital investment is

equivalent to that of a single fuel ethanol plant.

Prudent regional planners and other community

development leaders will want to research information

on these types of comparisons to get the best return on

their investments.

Fuel Ethanol ‘New-Use’ Opportunity

Some guidelines for evaluating potential opportunities follow. Potential investors will want an objective assessment, to the extent possible, of the risks and

uncertainties associated with the project. They will

also need to understand the growth potential of the

market they plan to enter. They have a right to expect

accurate capital estimates required to begin operations

and of how much they reasonably can expect to

finance. Finally, potential investors will need to

appraise their potential competition and the relative

access they can expect to the marketplace. Particular

attention should be paid to discover and disclose any

potential barriers that might impede market entry.

Potential Returns

An assessment of the potential returns of a

prospective fuel ethanol venture involves comparing

total expected receipts against total expected expenses.

This exercise not only amounts to examining input

costs and output prices (corn/ethanol, net of coproduct credits), but should also include an accounting of

Federal and State incentives.

A 15-million-gallon-per-year dry-mill ethanol

plant is used to illustrate the patronage returns paid

given relative price changes of fuel ethanol, corn, and

the coincident price changes in DDG. Patronage

returns were generated by calculating a series of proforma profit and loss statements after assuming a

range of output and input values for fuel ethanol and

corn, respectively. Production information was

obtained from three separate source# (appendices 1

and 2). Constant prices were assumed for each commodity; $1.20 per gallon for ethanol and $2.25 per

bushel for corn, when not used to generate its own

patronage schedule. DDG prices are typically set at

between 120 percent and 130 percent of the price of

corn (dry basis). In this analysis, DDG prices were calculated using 124 percent of the price of 10 percent

moisture corn.12

Table 7 demonstrates the potential profitability of

a 15-mgy-dry-mill ethanol plant (producing 17,067,OOO

gal. of denatured ethanol; yielding 15 mgy undenalured ethanol), when the price of fuel ethanol varies

from $0.90 to $1.50 per gallon in $0.15 increments.

Corn and DDG prices are set at $2.25 and $106.11 per

ton, respectively. The plant is assumed to yield more

than 17 million gallons of fuel ethanol and 58,497 tons

of DDG. Sales costs, general administration, and overhead are set at SO.0789 per gallon.

Annual corn use, 6.5 million bushels, is valued at

the corn price. Operating costs, ingredients, and depreciation are fixed at $5,193,000, $1,625,000, and

$1,867,000, respectively. (Total operating costs equal

!#3,685,000.) Per-bushel returns before interest, taxes,

and incentives range from $0.45 to $0.63. A separate

schedule demonstrates the impact of production and

tax incentives provided to ethanol producers. When

the $0.20 per gallon (up to $3 million per year) is combined with the Federal small business tax credit of

$0.10 per gallon, up to $1.5 million per year, per-bushel

returns range from $0.21 to !$0.97.13

I1 Economic Research Service, Kane and Reilly, March 1988,

updated, see tables 3-5; Minnesota Ethanol Commission, Larry

Johnson, March 18,1994; Carroll Kiem estimate, for the Iowa

House Agric. Committee on Feb. 8,1994.

** The DDG price is calculated by multiplying a coefficient of 47.16

by the corn price (Johnson, Minnesota Department of

Agriculture).

I3 Ethanol plants organized as cooperatives are exempt from double

taxation and would not be subject to the 38 percent Federal

income tax. They may also be exempt from State income tax

obligations depending upon the State in which they are

incorporated. Cooperatives must, however, pay taxes on all

business with non-members. All tables will therefore present tax

obligations in the interest of full disclosure.

15
Table -r-Potential profitability of a M-million-gallon/year dry-mill ethanol plant, ethanol price variation

Price assumptions

Ethanol price $/gallon 0.90 1.05 1.20 1.35 1.50

Corn price $/bushel 2.25 2.25 2.25 2.25 2.25

Distillers dried grains price $/ton 106.11 106.11 106.11 106.11 106.11

Ethanol sales (17,067,OOO gat/yr

@ ethanol price/gal.)

Coproduct sales (58,497 tons

@ DDG price/ton)

Total plant sales

17.920.350 20,480,400 23,040,450 25,600,500 25,600,500

6,207,435 6,207,435 6,207,435 6,207,435 6,207,435

24,127,785 26,687,835 29,247,885 31,807,935 31,807,935

Corn cost (18,OOO/day @ corn price/bu.)

Operating costs (personnel, maint..

mgt., insur., etc.)

Cost of other ingredients

Depreciation

12,025,OOO 14,625,OOO 17,225,OOO 19,825,OOO 21,775,oOO

Total plant costs

5,193,OOO 5,193,OOO 5,193,OOO 5,193,ooo 5,193,oOO

1,625,OOO 1,825,OOO 1,625,OOO 1,625,OOO 1,625,OOO

1,867,OOO 1,867,OOO 1,867,OOO 1,867,OOO 1,867,OOO

20,710,OOO 23,310,OOO 23,310,OOO 23,310,OOO 23,310,OOO

General admin., sates, and overhead

Net returns before interest, taxes, and

incentives

1347,000 1347,000 1347,000 1347,000 1347,000

2,070,785 2,030,835 4,590,865 7,150,935 7,150,935

Returns per bushel before interest, taxes,

and incentives

Interest expense

0.32 0.31 0.71 1.10 1.10

1,287,531 1,287,531 1,287,531 1,287,531 1‘287,531

State producer’s incentive (!$0.20/gal

up to 15 mgy)

State income tax (8%)

Federal income tax (38% )

Small producer tax credit (SO.1 O/gal up

to $1.5 million)

3,000,000 3,000,000 3,000,000 3,000,000 3,000,000

0 94,860 299,464 504,268 709,072

0 449,637 1,422,456 2,395,275 3,368,094

0 449,637 1,422,456 1500,000 1,500,000

Returns to producers after interest,

taxes, and incentives (1,376,796) 1,088,594 4,903,811 6,286,238

Returns per bushel after interest, taxes,

and incentives

Returns per bushel - No small business credit

Returns per bushel - No producer incentive

(0.21) 0.17

(0.21) 0.10

(0.67) (0.29)

3,443,840

0.53

0.31

0.07

0.75 0.97

0.52 0.74

0.29 0.51

16
Figure s--- Ethanol Prices and Patronage Returns l

Patronage--$/bu.

0.06

MN Producer incentive

0.65 0.95 1.05 1.15 1.25 1.35

Ethanol price--$/gallon

No Producer Incentive

1.45 1.55 1.65

l 15 million gallon/year dry-mill ethanol processor including Stafe and Federal incentives:

Corn pric+$2.25/bu.; Minnesota producer incentive-$O.o9675/bu. on 6.5 million bu.;

small business fax credit - $O.O3875/bu. on 6.5 million bu.

Credit

Figure 5 graphically illustrates the patronage

returned to Minnesota producers on a per-bushel basis

from a 15-mgy-dry-mill plant as fuel-ethanol prices

vary from $0.85 to $1.50 per gallon. The Minnesotaproducer incentive amounts to $0.09675 per bushel on

6.5 million bushels of corn. The effect of the small business tax credit is progressive and amounts to almost 4

cents a bushel on the 6.5 million bushels of corn needed for the 15-million-gallon plant.

Table 8 demonstrates the potential profitability of

a 15-mgy-dry-mill ethanol plant when the prices of

corn and DDG are varied from $1.85 to $3.45 per bushel

and $87.25 to $162.70 per ton, respectively, and fuel

ethanol is fixed at $1.20 per gallon. Annual operating

costs, ingredients, and depreciation remain fixed, as

before, at !&685,000. Per-bushel net returns after interest, taxes, and incentives range from $0.06 to $0.67.

Figure 6 illustrates the relationship between

patronage returned to investors (per bushel) and the

price of corn. Per-bushel patronage ranges from $0.46

to $0.97 and -$l.Ol to $0.51, for subsidized and unsubsidized production, respectively, as the corn price

ranges from $1.55 to $3.15 per bushel

In absence of the small business tax credit, annual

patronage returns are reduced by almost $0.03 per

bushel for corn prices less than $2.05 per bushel. When

the effects of the Federal excise tax subsidy are excluded (fuel ethanol is priced at $0.90 per gallon), annual

patronage returns are reduced by almost $0.75 per

bushel compared with their full incentives level.

It is important to note that each of these schedules

assumes no price variability, once the levels have been

set for an entire year’s production. In actuality, ethanol

and corn prices vary greatly over time, while DDG

prices remain tied to their relative corn value. For

example, while average annual prices of $1.20 per galion and $2.25 per bushel were assumed for ethanol and

corn, respectively, actual prices during the time this

report was prepared ranged from $1.00 to $1.20 per gailon for ethanol and $2.78 to $4.25 per bushel for corn.

Capital Required and Financing

The permanent assets to be financed in a new

fuel-ethanol venture generally include land, plant,

equipment and other assets, startup losses, and minimum operating capital. Investment in these assets is

generally equally shared among owners and lenders,

i.e., 50-percent equity and 50-percent debt financing.

Lenders look favorably upon risk-reducing activities

such as project feasibility studies, firm marketing contracts, grower-pooling, turn-key construction costs,

and quality management and may sometimes lower

their equity requirements. However, the equity portion

of the total financing package will almost always be at

least 35 percent.

It is also important to have sufficient working

17
Table 8- Potential profitability of a 15-million-gallon/year dry-mill ethanol plant, corn price Variation

Price assumptions

Ethanol price $/gallon 1.20 1.20 1.20 1.20 1.20

Corn price $/bushel 1.85 2.25 2.85 3.05 3.35

Distillers dried grains price $/ton 87.25 198.11 124.97 143.84 157.99

Ethanol sales (17,067,OOO gal/yr

@ ethanol price/gal.)

Coproduct sales (56,497 tons

@ DDG price/ton)

Total plant sales

Corn cost (16,00O/day

@ corn price/bu.)

Operating costs (personnel, maint.,

mgt., insur., etc.)

Cost of other ingredients

Depreciation

Total plant costs

General admin., sales, and overhead

Net returns before interest, taxes,

and incentives

Returns per bushel before interest,

taxes, and incentives

Interest expense

State producer’s incentive (!$0.20/gal

up to 15 mgy)

State income tax (6%)

Federal income tax (38% }

Small producer tax credit ($0.1 O/gal up to

$1.5 million)

Returns to producers after interest,

taxes, and incentives

Returns per bushel after interest, taxes, and

incentives

20,480,400 20,480,400 20,480,400 20,480,400 20,480,400

5103,891 6,207,435 7,310,979 8,414,523 9,241,707

25,584,291 26,687,835 27,791,379 28,894,923 29,722,107

12,025,000 14,625,OOO 17,225,OOO 19,825,OOO 21,775,oOO

5,193,ooo 5,193,ooo 5,193,ooo 5,193,ooo 5,193,ooo

1,625,OOO 1,625,OOO 1,625,OOO 1,625,OOO 1,625,OOO

1,867,OOO 1,867,000 1,867,OOO 1,867,OOO 1,867,OOO

20,710,OOO 23,310,OOO 25,910,OOo 28,510,OOO 30,460,OOO

1,347,ooo 1347,000 1,347,OOo 1,347,ooo 1,347,ooo

4,874,291 3,377,835 1,881,379 384,923 (737,893)

0.44 0.37 0.24 0.06 (0.12)

1.287,531 1,287,531 1,287,531 1,287,531 1,287,531

3,000,000 3,000,000 3,000,000 3,000,000 3,000,000

419,181 299,464 179,748 60,031 0

1,991,109 1,422.456 853,802 285,149 0

1,500,000 1,422,456 853,802 285,149 0

4,329,471

0.67

3,443,840

0.53

0.31

0.07

(0.21)

2,067,100 690,361 (372,424)

0.32 0.11 (0.06)

0.19 0.06 (0.06)

(0.14) (0.36) (0.52)

Returns per bushel - No small business credit

Returns per bushel - No producer incentive

Returns per bushel - No Fad. excise tax

reimbursement

0.44

0.20

0.00 (0.44) (0.67) (0.85)

18
Fgure+Corn Prices and Annual Patronage Returns 1

Annual Patronage--$/bu.

0.80

0.80

0.40

0.20

0.0

-0.20

-0.40

-0.80

-0.80

reducer Incentive

No Small

Business Tax

No Producer

Payment

No Excise Tax

Reimbursement

1.75 1.95 2.15 2.35 2.55 2.75 2.95 3.15 3.35

Corn price-$hu.

1 15-million gallon/year dry-mill ethanol processor including State and Federal incentives:

Ethanol-$1.2O/gal with motor fuel excise tax subsidy; $O.gO/gal. without subsidy; DDG-$12O/ton; Minnesota producer

Incentiv~$O.O9675/bu. on 6.5 mil. bu.; Small business tax credit-$O.O367/buon 6.5 mil. bu.

capital necessary to either “zero out” for 30 days, or to

margin loan advances of about 65 percent of acceptable inventories and 80 percent of receivables. Shortterm seasonal loans are often used to finance fluctuations in current assets. However, seasonal loans are

generally no greater than three times the level of permanent working capital.

Term loans for new plant and equipment are generally repaid within 15 years. Annual principal repayments should amount to no more than 65 percent of the

new venture’s annual cash flow (after tax earnings less

patronage refunds received plus depreciation). Interest

rates are generally 2 percent to 2.5 percent above the

prime rate for capital borrowed for new venture construction projects. Some fixed-rate options and ratereduction incentives may also be offered to a project for

successful construction management and startup.

Market Growth Potential

Assessing a prospective venture’s potential for

market growth involves shifting from present circumstances to reasonable expectations for the future. In

addition to noting current trends, it will be important

for the market growth discussion to emphasize any

changes that might occur in preferences, technology, or

prices of inputs and/or competing products.

Expanding the ethanol industry will depend on

the relative cost competitiveness of ethanol as a gasoline blending agent. Both petroleum prices and the factors that affect net ethanol costs are subject to variability. Net ethanol costs are determined largely by corn

prices, Federal and State ethanol subsidies, coproduct

prices, and technology.

As of August 1996, four new ethanol plants with

a combined capacity of 36.5 million gallons per year

were under construction. This is considerably less than

the expansion pace of 1995 of 250 mgy or 0.15 percent

total industry capacity at the time.

The reason for this dropoff may lie beyond present concerns of higher feedstock prices. More ominous issues lie ahead:

the industry’s anticipation of the sunsetting of the

Federal motor fuel excise tax exemption in 2000;

expectations that petroleum prices will increase only

slightly in the next 10 years; and

corn prices are likely to be increasingly volatile

given the absence of any Government storage programs.

When taken together, these concerns provide less

than favorable conditions for any significant expansion

in production capacity. Unless the excise tax exemption is extended beyond 2000, it is estimated that

petroleum will have to increase above $40 a barrel and

corn prices decline below $2.50 per bushel to reason19
ably assure industrial profitability (LeBlanc and

Reilly).

In general, industry expectations include modest

increases in crude oil prices and only slightly higher, if

somewhat more volatile, corn prices. These conditions,

while not altogether favorable to industry expansion,

would not necessarily hinder it. The biggest hindrance

to ethanol competitiveness and industry expansion,

however, is the anticipated sunsetting of the Federal

excise tax exemption in 2000. Under current industry

norms, a plant would open in 1997, operate profitably

for 3 years, and endure losses until crude oil prices

rose again around the year 2007 (LeBlanc and Reilly).

Competition and Market Access

Entry into a market or industry is generally

regarded to be “barrier free” (sufficiently competitive)

if there are no artificial restrictions on entry (such as

patents or Government restrictions) or if the capital

costs of entering the market are not exceedingly high.

And while the $60 million necessary to turn the key on

a 20-million-gallon-per-year ethanol plant is not

insignificant, when compared with the petroleum

industry, entry into the fuel ethanol market is relatively unimpeded.

Despite the relative ease of market entry, the fuel

ethanol industry is heavily concentrated. Seventy-one

percent of the industry’s production capacity of 1.4 billion gallons per year is controlled by four firms.

Moreover, the top two firms control 60 percent of the

industry’s capacity.14

Although ethanol production is heavily consolidated, the marketing of ethanol and coproducts is

dominated by the cost of transportation. Distillers

dried grain has long been valued as a relatively cheap

substitute for high-protein meal and has a number of

significantly valuable nutritional attributes. Given that

coproduct prices are essentially bounded by shipping

costs, spatial markets for distillers dried grain and

other coproducts may exist and prove profitable even

to managers of relatively small ethanol plants.

Other potentially profitable marketing opportunities for ethanol plants may lie in forming supply

alliances with local gasoline refineries. If refinery

14 Plants owned by the prominent producers, however, are wet-mill

processors which are dedicated to the production of high-fructose

corn syrup (HFCS). HFCS is principally used by the carbonated

beverage industry and its demand is quite seasonal, falling off in

the winter months. Wet-mill plants produce fuel ethanol during

slack demand periods for HFCS.

requirements exceed the supply capacity of the local

fuel ethanol plant, marketing alliances may be formed

among additional plants to provide a consistent supply in support of refinery needs. This also presents

opportunities for plants to consolidate market territories, share services and purchasing, and possibly, provide for the formation of a common marketing agency

with a membership comprised of cooperatives.

Each of these ideas is a response to the single

basic fact about the ethanol industry-fuel ethanol

competes with gasoline and gasoline-blending agents.

Market entry and market expansion are tied directly to

the cost competitiveness of ethanol as a gasoline

blending-agent (USDA, AER-585). Gasoline prices and

blending agent prices are linked closely to the uncertain price of crude oil. Wholesale gasoline sells at

about 25 percent above the crude oil price.

Summary and Conclusions

Cooperative involvement in the biomass fuels

industry is currently substantial and growing. Given

the right set of circumstances of low corn prices, and

higher ethanol and DDG prices, profit opportunities

may still exist. The fact remains, however, that the economic landscape of this industry is fraught with uncertainty.

And despite a growing interest in fuel ethanol

plants as a value-added opportunity among Midwest

corn producers, industry plans for capacity expansion

have remained modest for at least 5 to 8 years.

Expansion plans have generally been dampened by

anticipation of the scheduled sunsetting of the motor

fuel excise tax exemption in 2000. Given a reasonably

favorable business climate, i.e., the appropriate mix of

higher petroleum prices, lower corn prices, higher

byproduct prices, and an extension of the excise tax

exemption, production capacity could expand significantly.

However, in absence of the excise tax exemption,

it has been estimated that oil prices must exceed $40

per barrel and corn prices remain under $2.50 per

bushel to assure reasonable profitability. Furthermore,

if the excise tax subsidy is discontinued, ethanol is

unable to compete at any corn price for crude oil prices

below $25 per barrel.

Therefore, this report urges potential investors to

take a hard look prior to involving themselves in the

fuel ethanol industry.

20
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and Lee R. Lynd. “The Ultimate Ethanol:

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Industry: A History and Rationale,” St. Paul,

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15,1994.

“Estimated Fuel Ethanol Costs-15 mgy

dry-milling plant,” St. Paul, Minn., Minnesota

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Coproducts Feeding Seminar, Iowa State

University, Ames Ia., March 7,1995.

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607, March 1989.

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unpublished report, July 29,1994.

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nears market,” Potomac News, reported by

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22
Appendix I-Estimated fuel ethanol costs for 15-million-gallon/year dry-mill plant

ERS’ MEC2 CK3

Total Investment- millions of dollars 44 28 36.4

Investment- dollars/gallon 2.58 1.64 2.13

Corn processing requirement- k/day 18 18 18

Production rat+- gallons/bushel 2.709 2.709 2.709

Annual production capacity- gallons/year 17,067 17,067 17,067

Thousands of dollars

Total annual corn cost

Co-product credit for distillers

dried grains

Net annual corn costs

Energy costs

Ingredient costs

Personnel & maintenance costs.

15,687 14,175 13,230

5,489 7,088 6,133

10,198 7,087 7,097

2,628 3,023 3,023

1,792 1,625 1,625

3,516 1,610 2,378

Management, administration,

insurance, and taxes

Total cash costs

Depreciation (15 year)

Total plant costs

973 560 728

19,107 14,393 15,339

2,933 1,867 2427

22,040 16,260 17,766

Dollars

Plant cost per bushel used 3.39 2.50 2.73

Plant cost per gallon produced 1.29 0.95 1.04

1 Economic Research Service, Kane and Reilly, March 1988, updated, see tables 3-5.

2 Minnesota Ethanol Commission, Larry Johnson, March 18, 1994

3 Carroll Kiem estimate, as presented to Iowa House Agric. Committee on February 8, 1994.

23
Appendixz-Pro-forma profit and loss statements for 15-million-gallon/year dry-mill plant

ERS’ MEG

Thousands of dollars

Ethanol sales 20,480 20,480

Less:

General administration, and overhead 1,000 1,000

CK3

20,480

1,000

Total plant costs

Pm-tax margin

State producer incentive

(MN-$0.25/gal on 15 mgy)

Federal small producer tax credit

($0.1 O/gal up to $1.5 mil)

Subtotal

Less:

State tax (8%)

Federal tax (36%)

After-tax income

Statement of cash flow:

Depreciation add-back (15 yrs.)

Less loan Payment

Net Cash flow

2,204O 16,260 17,766

(2,560) 3,220 1,714

3,750

428 1,500 911

1,190 7,188 3,661

95

428

667

2,933 1,867 2,427

2,200 1,400 1,820

1,400 5,316 3,137

3,750

455

1,500

4,849

3,750

220

911

2,530

Dollars

Net cash flow per gallon produced -0.08 0.31 0.18

Net cash flow per bushel used -0.22 0.84 0.50

1 Economic Research Service, Kane and Reilly, March 1988, updated, see tables 3-5.

2 Minnesota Ethanol Commission, Larry Johnson, March 18,1994

3 Carroll Kiem estimate, as presented to Iowa House Agric. Committee on February 8, 1994

24
U.S. Department of Agriculture

Rural Business-Cooperative Service

1400 Independence Ave., SW, Stop 3257

Washington, DC. 20250-3257

Rural Business-Cooperative Service (FIBS) provides research, management, and

educational assistance to cooperatives to strengthen the economic position of farmers and

other rural residents. It works directly with cooperative leaders and Federal and State

agencies to improve organization, leadership, and operation of cooperatives and to give

guidance to further development.

The cooperative segment of RBS (1) helps farmers and other rural residents develop

cooperatives to obtain supplies and services at lower cost and to get better prices for

products they sell; (2) advises rural residents on developing existing resources through

cooperative action to enhance rural living; (3) helps cooperatives improve services and

operating efficiency; (4) informs members, directors, employees, and the public on how

cooperatives work and benefit their members and their communities; and (5) encourages

international cooperative programs. RBS also publishes research and educational

materials and issues Rural Cooperatives magazine.

The United States Department of Agriculture (USDA) prohibits discrimination in its

programs on the basis of race, color, national origin, sex, religion, age, disability, political

beliefs and marital or familial status. (Not all prohibited bases apply to all programs.)

Persons with disabilities who require alternative means for communication of program

information (braille, large print, audiotape, etc.) should contact USDA’s TARGET Center at

(202) 720-2600 (voice and TDD).

To file a complaint, write the Secretary of Agriculture, U.S. Department of Agriculture,

Washington, D.C. 20250, or call l-800-245-6340 (voice) or (202) 720-l 127 (TDD). USDA

is an equal employment opportunity employer.