Ethanol Producer Magazine, ND
06-20-07
Hypothetical Ethanol Plant is an Exercise in Market Volatility
by Todd Neeley
During the latter half of 2006 and the first half of 2007, ethanol producers took a
wild ride on a volatile profit road full of potholes, hills, dips and sharp curves. As a
result, net profitability, or the difference between total costs and revenues,
followed a similar path. In fact, one ethanol plant saw net profits as high as 85
cents per gallon in July 2006 and as low as 2 cents per gallon in February 2007.
This ethanol operation, Neeley Biofuels Inc., is a hypothetical creation
established in DTN's trademarked ProphetX Ethanol Edition program as a way of
tracking ethanol industry profitability. DTN is a real-time market, news and
weather information services company that delivers daily information to
subscribers representing more than a dozen different markets and segments,
including agriculture, refined fuels, and commodities and futures trading.
The Neeley Biofuels example was created because ethanol-industry profitability
matters greatly to a lot of people, including ethanol plants, would-be investors,
lenders, farmers, ethanol buyers and government policymakers. Using the realtime commodity-price data that flow into the "corn crush" in the DTN ProphetX
spreadsheet, along with some industry-average figures for interest costs, labor,
overhead, etc., it's possible to not only determine current profits but how much
Neeley Biofuels would make or lose under an infinite number of what-if
scenarios.
While Neeley Biofuels might not be representative of every plant in the industry, it
does accurately reflect the trends. The plant in southeastern South Dakota has a
50 MMgy capacity, produces about 2.8 gallons of ethanol per bushel from 18.5
million bushels of corn per year, and mixes about 4 percent denaturant in each
gallon of ethanol. The plant sells 17 pounds of distillers dried grains per bushel of
corn.
The profitability trend was established by comparing numbers between July and
November 2006. Net margins were computed using industry-average figures
from Iowa State University economist David Swenson. These included annual
labor and management costs of $2.8 million, transportation costs of $10 million,
debt-servicing costs of $7.8 million, depreciation costs of $8 million and
maintenance costs of $800,000. The calculations included all other costs such as
chemicals, yeasts, electricity, denaturant and water.
Net profitability dropped from 85 cents per gallon in July to 34 cents per gallon on
Nov. 14, providing a glimpse at the volatility of ethanol markets. During that span
the price paid for corn spiked from $2.18 to $3.10 per bushel. The average
ethanol price the plant received dropped from $3.28 to $2.16 per gallon, and
Neeley Biofuels paid $1.36 per MMBtu more for natural gas at $8.05.
In August, the plant gained 21 cents in net profit to 55 cents per gallon, despite
what was the beginning of rising corn prices that at one point topped $4 per
bushel on the New York Mercantile Exchange futures market. Although Neeley
Biofuels paid 20 cents per bushel more for corn at $3.30 on Dec. 20, 2006, the
plant received a welcomed boost with a 39 cents per gallon increase in the
average ethanol rack price for South Dakota at $2.55 per gallon. Along with more
than a $1 per MMBtu drop in the natural gas price, the operation returned to a
comfortable profit margin.
As construction continued on ethanol plants across the country, an increasing
demand for corn made for tight profit margins near the end of January 2007.
What had been a 55-cent per gallon net profitability at Neeley Biofuels on Dec.
20, 2006, dropped like a rock near the end of January. While the corn price paid
by the plant increased from $3.20 per bushel to $3.70 the price received for
ethanol dropped from $2.47 per gallon to $2.07 per gallon and the price of
natural gas shot up 45 cents to $7.46 per MMBtu. On Jan. 29, the plant's net
profitability was down to 7 cents per gallon.
During February, the plant hovered close to break-even, coming in at just 2 cents
per gallon on Feb. 16. At that time Neeley Biofuels paid $3.75 per bushel for corn
and received 3 cents more for each gallon of ethanol produced, but took a hit in
paying $8.91 per MMBtu—a $1.45 increase—for natural gas during a cold spell.
While natural gas spot prices were used in this analysis, many ethanol plants
lock in prices on the futures market so they aren’t as vulnerable to natural gas
market volatility.
By March 1, Neeley Biofuels began climbing out of the basement as natural gas
prices moderated with spring weather and ethanol prices began to rise. While the
hypothetical plant continued to pay $3.75 per bushel for corn, the operation now
sold its ethanol for $2.18 per gallon—an 8-cent per gallon increase since
February—and received a shot in the arm with a $1.67 per MMBtu drop in natural
gas to bring net profitability up to 17 cents per gallon.
As of March 16, Neeley Biofuels' net profitability more than doubled to 36 cents
per gallon as corn prices started to moderate, ethanol began a climb approaching
the driving season and natural gas prices continued to tumble. On that day the
plant paid 10 cents less for corn at $3.65 per bushel, received 16 cents per
gallon more for its ethanol and paid 38 cents per MMBtu less for natural gas.
By April 5, net profitability returned closer to its December 2006 level
approaching at 48 cents per gallon. The big news was a 55 cent drop in the corn
price paid to $3.10 per bushel, improved profitability despite a 60 cents per
MMBtu increase in the price paid for natural gas. Then on May 4, profitability fell
by 7 cents per gallon to 41 cents, based on a 39 cents which increase in the
price of corn paid at $3.49 per bushel.
Although Neeley Biofuels is paying nearly $16 million in debt-service and
depreciation costs on its plant, or about 32 cents per gallon of ethanol produced,
many real plants are not in debt and are more profitable.
Elaine Kub, commodity market analyst for DTN, says the ethanol industry is just
starting to get a feel for the economic swings. "The markets are still learning how
one fluctuation will affect another and until enough experience is developed in
these forces, overreactions will occur and oscillations will be large," she says.
Corn futures contracts continue to price in market expectations for $4 per bushel
corn as far out as 2010, highlighting "the need for the ethanol market to pay very
close attention to the correlations of corn and energy prices," Kub says.
Perhaps the best comparison for the new ethanol market is the behavior of a new
public company's stock prices, Kub says. "When the information is new and
investors still have so many different ideas about how successful or valuable the
company will become, the stock is subject to greater price fluctuations," she
says. "As time goes by, the valuation becomes clearer and prices level out."
Todd Neeley has been a journalist for 12 years and joined DTN in 2004. As a
staff reporter, he works on in-depth reporting projects and covers the crop
insurance and ethanol beats. Reach Neeley at Todd.Neeley@dtn.com.