Beyond The Correction

As a result, those in the ethanol and related agribusiness industries, as well as investors — whether invested in the handful of public ethanol companies or privately owned ethanol plants and companies — wonder about the outlook for the ethanol industry.

Before I attempt to answer that simple but complex question, let me first revisit my historical perspective on the future of the ethanol industry to provide some context.

My outlook since the start of this latest ethanol boom in early 2006 has changed very little: The ethanol industry’s business model was and is unsustainable. The ethanol buildup would trigger irrational exuberance in spite of guaranteed markets in the form of the renewable fuels standard and federal and state subsidies.

The result? A dot-com boom/bust in the corn fields, followed by a dramatic industry consolidation, leading to the selloff of distressed plants for no more than 25 cents to 50 cents on the dollar.

In my mind, the key to building a viable long-term biofuels industry has always been market-driven sustainability. That is, a market without the need for long-term subsidies that can exist in a volatile oil pricing environment, in which costs would have to be driven down to levels competitive with oil as low as $25 to $30 per barrel.

Unknown Severity

I could have never forecasted the severity of the current global economic meltdown, which has contributed to the freefall in oil prices from a high of $147 per barrel during mid-2008 to current $30 to $45 per barrel levels. But it had been my view that oil prices at $50 to $60 per barrel and rising in mid-2006 — let alone $100+ in the first half of 2008 — were unsustainable. The dramatic surge in oil prices was being driven by the synchronicity of global economic growth, fueled by global financial liquidity and the impact of global financial speculation on crude oil as a financial asset class.

My experience as a Wall Street analyst during the 1970s, watching the impact of the first and second oil crises when oil jumped from $3 to $36 per barrel in two stages, taught me that it takes time for energy/oil supply increases and demand decreases to adjust to a quantum jump in oil prices.

As a side note, consider this: Crude oil prices never reached $100 per barrel in the late 1970s and early 1980s, which was the consensus forecast at the time. Similarly, we never reached $200 per barrel last year, the forecast that many oil experts were championing in early 2008.

‘Energy Independence’ And Ethanol

I want to make it explicitly clear that I have been and continue to be a fervent believer in the long-term strategic value of renewable energy, in which biofuels could play a major role to enhance U.S. energy security and potentially redefine U.S. competitive position.

In my opinion, those who have waved the flag of “energy independence” to support the buildup of ethanol have severely underestimated the dramatic implications and market changes necessary to accomplish such an aggressive goal. Taking this one step further, there is a real question over whether the goal of “energy independence” is in the country’s best interest from a resource allocation perspective, given the dynamics of energy globalization.

Second, whether you are talking about ethanol currently produced from corn or potentially from cellulosic ethanol, the challenge of creating a sustainable and market-driven industry has been approached much too simplistically.

The development of a successful and profitable ethanol industry has lacked a focus on risk analysis to mitigate potential risks from an economic, business, and investment perspective, let alone a higher standard that is necessary when it comes to enhancing U.S. energy security.

The strategic bet being made by the government and the American public is that biofuels will become a major sustainable source of our transportation fuel supplies, which will reduce our
energy security risks.

In my view, this strategic bet requires a higher standard of success in comparison to the risks taken on in the development of other embryonic industries whose success or failure does not impinge on U.S. national/economic security.

Whether one is talking about corn-based ethanol or cellulosic ethanol, business strategies are needed to deal with a combination of expected oil price volatility (which ultimately determines ethanol prices), as well as potential volatility in crop/biomass prices. This expected volatility is due to the interdependence of global energy markets and crop markets, especially since the U.S. is a major exporter of all the major row crops that dominate U.S. agricultural acreage.

If the U.S. is to be successful in developing and creating a sustainable market-driven biofuels industry in which ethanol plays a major role, the industry needs a makeover — not only to develop long-term sustainability, but also to provide a very favorable long-term investment environment for both public and private companies including farmer-owned ethanol companies.

In addition, while initial subsidies and significant government-funded R&D support are clearly needed to develop cellulosic ethanol, successful long-term investment will occur in company business models that do not need long-term subsidies to assure sustained profitability, taking into consideration broad volatility in oil/ethanol prices and biomass/ag-related raw material prices. 

Risk Mitigation Is Key

Viable Biofuel:
Three Big Factors

The challenges to creating a large-scale, low-cost, cellulosic-based ethanol industry are significant, and will take a long time to develop despite best industry efforts.

A corn-based, cellulosic-based, or mixed feedstock-based ethanol company will require a business model to create a low-cost position, including the following three factors:

1. Multiple plants geographically dispersed with large, flexible, regional feedstock procurement capabilities.
2. Vertical integration with feedstock flexibility and risk mitigation supply/pricing strategies
3. Feedstock supply and procurement strategies to mitigate regional, weather-induced feedstock supply risks. This includes risk tied to “natural variability,” which could be intensified by larger global warming-driven erratic weather impacts. — Sano Shimoda

Significant challenges are ahead for the industry in terms of scientific and technological hurdles that must be overcome. However, my simplistic view on the future of biofuels is that economic solutions will be found to solve these very difficult challenges, such as the conversion processes of biomass into ethanol.

The real hurdle to developing a sustainable biofuels industry is the need to structurally change industry and business strategies to be able to profitably deal with potential volatile price risks and unintended consequences.

The approach companies have had to ethanol development has in many respects been too simplistic. In a commodity-based business two areas of strategy are paramount: strategies for aggressively driving down costs and strategies for mitigating potential risks to create long-term sustainability. Both are lacking in the approach to ethanol. In fact, what we are doing now is trading one risk — the risk of crude oil supply disruption from unstable Middle East or other foreign oil sources — for another risk — the impact of weather risks on regional corn/ag residue/plant or crop-based biomass feedstock supplies for the ethanol industry.

Whether or not you are a believer in global warming as a cause of erratic, non-typical weather patterns, the risks to crop/biomass/ag residue production from “natural variability” in weather patterns has been understated as a potentially significant risk to the U.S. biofuels strategy. Proactive strategies to minimize this risk will require dramatic structural changes in U.S. government policy and agribusiness strategy.

In the world of corn-based ethanol, what if there was a drought in a regional section of the Midwest (for example, Northwest Iowa or Southwest Minnesota have a high concentration of ethanol plants), that resulted in localized corn supply shortages for individual ethanol plants, let alone sky-high corn prices? When you look at ethanol plant concentrations and resultant overlapping corn draws for current plants in many parts of the Midwest (and the existing transportation/supply infrastructure), many ethanol plants would be forced to shut down, jeopardizing supplies and leading to potential ethanol shortages, a surge in prices, and would ultimately reduce the availability of fuel nationwide.

In the case of cellulosic ethanol, there is a similar risk of regional, weather-induced supply disruption, but there are other formidable challenges to reaching economic viability. These include high production costs, high harvest/transportation/supply logistics costs, and weather impacted supply constraints on cellulosic feedstocks.

Even if scientific advances can create competitive biomass conversion economics, the harvest/storage/transportation costs are extraordinary high, given volume/mass considerations, and the simple fact that harvesting most crops will occur only once a year.

Consider that just as corn prices were bid up from late 2006 through early 2008 by the surge in incremental ethanol demand, tightening global supply/demand balances, and the impact of the oil price surge (which has a indirect influence on corn prices), the price of ag residues could be bid up to prices substantially above current estimates used for cellulosic plant economics.

Consider that corn stover as a potential biofuel feedstock is not a valueless entity — it has significant fertilizer and land erosion value. Growers would demand significantly larger price premiums than are currently forecasted to recapture this lost value.

Another factor to consider is the evolution of agronomic practices around next generation seed developments. Seed companies are commercializing advanced stress traits such as drought tolerance, which will change the economics of crop production in both current and marginal growing areas. Significant competition for this marginal land, driven by changing per acre profit dynamics, could create significant unintended consequences in terms of volatile, market-driven biomass/ag residue/energy crop acquisition costs for cellulosic ethanol plants.

Long Live Corn Ethanol?

In my view, corn-based ethanol could have a much longer life than most people think. Following what I would expect will be near-term industry consolidation, individual companies may redesign their business models to create long-term, market-driven sustainability.

There is the potential for single-plant based ethanol companies to survive and prosper based on innovative R&D cost strategies, as well as unique business models and strategies to mitigate market price volatility and risks.

Just as occurred with the dot-com boom and bust, a few well-positioned companies with well thought out strategies and unique business models — think Amazon, eBay, and Google — demonstrated the power to create very successful companies. The challenge for ethanol companies and the industry is to develop new, evolutionary industry/business models to create long-term, sustainable profitable growth, and for some to take advantage of an expected period of dramatic industry consolidation.

Leave a Reply

Management Stories

4r Nutrient stewardship
StewardshipNominations For The 4R Advocate Program Due October 31
October 24, 2016
Nominations for the 4R Advocate program are due to The Fertilizer Institute by October 31, 2016. The program recognizes agricultural Read More
ManagementThe Latest Dow-DuPont Rumor, Product of the Year Voting Update, and CropLife 100 Preview
October 20, 2016
CropLife Editor Eric Sfiligoj shares a new rumor about the Dow-DuPont merger and updates on two CropLife-driven programs, the CropLife Read More
ManagementHarvest and Crop Price Updates; EPA and Crop Protection Reviews
October 13, 2016
Glyphosate and atrazine get public comment support from ARA as each is reviewed by EPA, and the latest on the Read More
ManagementVision Conference Preview, Monsanto Earnings, and Product of the Year Voting
October 7, 2016
Editors Paul Schrimpf and Eric Sfiligoj talk about the upcoming PrecisionAg Vision meeting in Arizona, Monsanto’s latest revenue numbers, and Read More
Trending Articles
AGCO RG700 cab
OpinionRoadblocks To Precision Ag Innovation
October 5, 2016
On August 29, I got to preside over the PrecisionAg Innovation Series event, “Game-Changing Advances in Precision Farming Technology,” developed Read More
J.C. Ramsdell containment system
EquipmentClear Opportunity In The Tank Market
October 4, 2016
Crop prices may be down, but steel prices are too — and that’s good news for retailers looking to add some Read More
WinField booth Farm Progress
Special ReportsTalking Weed Management Strategies At Farm Progress 2016
October 2, 2016
The annual Farm Progress Show — this year staged in Boone, IA — is always a great place to catch Read More
Corn Field
Eric SfiligojFacing Ag Industry Challenges
September 26, 2016
At the 2016 annual Mid America CropLife Association (MACA) meeting in September, a pair of crop protection company representatives discussed Read More
Bayer Monsanto
Crop InputsBayer-Monsanto Mega-Merger: 6 Things You Need To Know
September 14, 2016
Mega mergers have become almost routine in the agricultural industry. Right on the heels of Monday’s news that fertilizer giants Potash Read More
Potash Corp Agrium
Crop InputsAgrium, Potash Corp To Merge To Create $36 Billion Company
September 12, 2016
Canada’s Agrium Inc. and Potash Corp of Saskatchewan Inc. have agreed to combine in a deal that would create a Read More
Latest News
4r Nutrient stewardship
StewardshipNominations For The 4R Advocate Program Due October 31
October 24, 2016
Nominations for the 4R Advocate program are due to The Fertilizer Institute by October 31, 2016. The program recognizes agricultural Read More
Corn close up
Eric SfiligojProtecting Agriculture’s Ability To Feed The World
October 24, 2016
The rate of change coming to agriculture is growing, and will continue to do so for the foreseeable future. This Read More
Student Young Worker CHS
CropLife 100CHS Supports #FirstJob Compact
October 24, 2016
CHS joins the White House and many of the country’s largest employers in signing a new initiative centered on helping Read More
Kennebec Grain terminal
CropLife 100Wheat Growers Kennebec Facility Loads First Rail Cars
October 21, 2016
In a season of firsts for Wheat Growers’ Kennebec Grain Terminal, the first 115-car unit train was loaded with soybeans Read More
ManagementThe Latest Dow-DuPont Rumor, Product of the Year Voting…
October 20, 2016
CropLife Editor Eric Sfiligoj shares a new rumor about the Dow-DuPont merger and updates on two CropLife-driven programs, the CropLife Read More
Soybean Closeup
FungicidesFMC Begins Registration Process For New Fungicide Activ…
October 19, 2016
FMC Agricultural Solutions has begun the joint U.S. EPA and Canadian Pest Management Regulatory Agency registration process for bixafen, a new Read More
Soil Young Corn
Industry NewsAgribusiness Search Firm Appoints New Managing Partner
October 18, 2016
Morris Bixby Group, a leading agribusiness search firm providing the highest quality professional recruiting and career advancement services since 2000, Read More
Wheat Field North Dakota
FertilizerUnited Suppliers Acquires Kansas Fertilizer Business
October 17, 2016
United Suppliers, Inc. has purchased the assets of Evans Enterprises, LLC, an ammonium chloride fertilizer business based in Olathe, KS. Read More
Corn Field
Industry NewsFMC Launches New Operations In Argentina, Exits Joint V…
October 17, 2016
FMC Corp. has exited its joint venture with Ruralco Soluciones S.A. FMC has launched new commercial operations, FMC Quimica S.A., Read More
Dow AgroSciences
InsecticidesRenewed Registration Issued For Products Containing Sul…
October 17, 2016
On October 14, 2016, the U.S. EPA re-established the registration of products containing sulfoxaflor (Isoclast Active), including Transform WG, Closer Read More
Eric SfiligojThe Whys Of Agriculture
October 17, 2016
During 2016, there have been myriad challenges facing the whole agricultural industry. Such wide ranging issues as water protection, sustainable Read More
Young Corn Field
FertilizerImproved Phosphorus Management Essential To Feeding Wor…
October 14, 2016
With a global population expected to reach 9 billion people by 2050, improved management of key essential nutrients such as Read More
ManagementHarvest and Crop Price Updates; EPA and Crop Protection…
October 13, 2016
Glyphosate and atrazine get public comment support from ARA as each is reviewed by EPA, and the latest on the Read More
Matt Hopkins15 Twitter Accounts Every Ag Professional Must Follow
October 13, 2016
What do singer Katy Perry and the President of the United States have in common? They are two of the Read More
Corn Field
Industry NewsArysta LifeScience Adds Two Key Account Managers
October 13, 2016
Arysta LifeScience North America recently announced the addition of two key account managers: Doug Hoberty and Rob Wier. Hoberty and Read More
EquipmentDeere Announces Development Deal with Scherer Design
October 12, 2016
Deere & Co. announces a joint development agreement with Scherer Design Engineering, Inc. to develop and commercialize kernel processing solutions Read More
Crop InputsMarrone Bio Innovations Celebrates 10 Years Of Innovati…
October 12, 2016
Richard Rominger, former Deputy Secretary of the USDA and former agricultural secretary of California, emceed a 10th anniversary luncheon celebration on Read More
Photo credit: The United Soybean Board/The Soybean Checkoff.
Industry NewsVive Crop Protection Closes Financing To Support Corpor…
October 11, 2016
Vive Crop Protection has announced the closing of growth financing to support 2017 commercial expansion. The financing was led by Read More