People, Processes and Playing the Market

FROM THE JANUARY ISSUE: Ethanol plants have a few options when it comes to protecting their margins. The main ones fall into three categories: technology, commodities and personnel/insurance.
By Lisa Gibson | December 18, 2017

Charles Wyman, president, CEO and cofounder of Vertimass LLC, says his company’s technology helps manage risk for ethanol plants by offering producers more product options when ethanol prices slump. The system converts ethanol to hydrocarbons—at a rate of 0.6 gallons per gallon of ethanol—for blending with jet fuel, diesel fuel or gasoline. It also creates the chemicals benzene, toluene and xylene. “Ethanol producers can continue to make ethanol if that is most profitable or swing to these various hydrocarbons if they provide greater margins,” Wyman says.

Vertimass’ technology is one of many that producers might explore to manage risk. Plants are trying to lower costs, increase efficiency and produce more ethanol and coproducts. “We do have a wide variety of plants in various stages of due diligence of technologies and the adoption thereof,” says Jamey Cline, business development director with Christianson PLLP. “As with any industry, as we continue to reach maturation, they’re trying to either work on lowering their costs or increasing revenue by diversification on the production side.” In general, plants are more apt to invest in technologies to cut costs than to diversify, he adds. “We’ve definitely seen more adoption of technologies on the cost side, whether it’s adding a little bit of yield or decreasing costs.”

Technology represents a viable strategy for financial risk management, but so do commodities hedging and personnel/insurance strategies. Done right, each achieves margin padding in its own way and can set a plant up for success in the near or long term.

The ‘Big Thing’ in Technology
Vertimass is developing its hydrocarbon technology with the help of a $2 million award from the U.S. DOE, Wyman says. The technology was invented by the Oak Ridge National laboratory, and, through a competitive solicitation process, Vertimass was awarded exclusive rights to further develop and scale it up, he says. The company is working on a pilot demonstration system with engineering firm TechnipFMC, already showing improved hydrocarbon yields and advancements in catalyst development.

The idea is to license the technology to ethanol producers and provide flexibility in their markets, Wyman says. While the hydrocarbon yield is less than the ethanol quantity used to produce it, Btu value is preserved in the hydrocarbon product, he adds. “What this does is just compact the energy of ethanol into a smaller volume.”

The system would cost about $15 million in capital investment for a 60 MMgy ethanol plant, but could pay itself off in a couple of years, although there are variables in that timeframe, Wyman says. Its low capital cost relative to technologies that provide risk management by producing cellulosic ethanol makes it attractive, he says.

While the cost might be lower for an add-on fuel and chemical technology, the cellulosic ethanol processes are further along in development, Cline says. “There is interest in other fuels, as well as value-added chemicals in the industry right now, but those technologies are fairly nascent and there’s a high degree of technology risk at the present time with many of those technologies. We would love to see them continue to develop and continue to move forward.” Those options represent a solution in the longer term, while technologies that produce ethanol from corn fiber, for instance, are viable shorter term, he adds.

The “big thing” now is using cellulase or corn fiber for diversification, Cline says. The approval process for them has become slightly easier, but the technologies do still bring government risks, along with their technology risks. A few technologies, including Quad County Corn Processors and Edeniq, have U.S. EPA approval to generate D3 renewable identification numbers (RIN), while several others are close behind, Cline says.

Beyond cellulosic ethanol, companies have developed processes to increase efficiency on the backend, such as White Fox Technologies’ membrane technology, and others that are working toward higher-protein DDGS for potential export.

In addition, Cline says he’s seen increased sophistication in software to help track and manage commodity pricing risk. “There’s definitely proliferation of products out there.”

Commodities Hedging
But even with evolving tracking and managing technology, commodities hedging is done by just more than half of existing ethanol plants as a financial risk management strategy, says Chip Whalen, vice president of education and research for Commodity & Ingredient Hedging LLC. “What we’ve seen, historically, is a lot of plants like to stay on the spot market,” Whalen says. “In other words, they don’t want to commit to managing risk on commodity prices forward in time, and I think there are a lot of reasons for that.”

One, he says, is that corn prices are in a carry, meaning they increase over time when projected out. But ethanol is the opposite—its price decreases as projections get further out. “There’s almost been a disincentive for ethanol companies to hedge,” Whalen says. “But over the last few years, they’re more open to doing so because they realize that there is a lot of risk out there. It’s a growing trend. The liquidity of the market is improving as more plants embrace it. I’d venture to guess that more than half of the plants out there are actively looking at this and taking positions.”

Ethanol plants have a few choices in commodities hedging. They can lock in an ethanol or corn price with a futures contract, or they can purchase options to protect their margin but allow for price flexibility if the margin improves. The ideal position is to be able to protect the margin against decreases, but allow flexibility to improve over time, at a minimal cost, Whalen says. But realizing that minimal cost after the initial option purchase can take time and requires market changes. That’s why market fluctuation is positive in an option scenario. “We need that volatility in the markets over time to be able to make adjustments to a position, to take advantage of those swings on the market to get to that point,” Whalen says.

So, in a hedging strategy, a producer would consult forward margin projections, determine what might be driving those margins, determine whether those margins are worth protecting and then devise a strategy—hedging—to do it. “What we see is plants will set targets or triggers to initiate protection or coverage,” Whalen says. Then, continue to manage and monitor that margin.

Each plant will have its own tolerance to risk and biases in the market, he says, so the strategies aren’t standard across the board. “It’s standard in the sense that we can look at strategies in isolation and talk about attributes of the market.” Beyond that, commodities hedging strategies are subjective to each ethanol company.

While it might be hard to quantify in a spreadsheet, proper personnel, compliance and insurance decisions can make a big difference in the bottom line, too, says Mike Santo, risk management consultant with Parthenon Agency LLC, a risk management service provider in the ag cooperative and ethanol industries. The company helps ethanol plants choose proper insurance coverage, navigate compliance mazes and interpret workers compensation claims. Compliance, in particular, is a major concern for ethanol plants Santo works with, he says.

With so many government agencies watching over them, plants can easily trip up. “They all try to stay in compliance, but sometimes the lack of knowledge is a concern. They might not know all of what they have to comply with.” Noncompliance, as most plants are aware, can result in fines and shutdowns. “You’re spending money to get this done, and it’s hard to quantify the bottom line because if you do it right, you don’t have any bottom line costs, but if you do it wrong, you have a bunch of bottom line costs.”

Hiring the proper personnel and employing appropriate insurance for plants also helps lessen the risk of liability or other insurance claims, in the event of an accident, for instance. An injury causes lost time, medical expenses, and potentially retraining a new employee, retraining the injured employee for another position within the plant, or even disability payments, Santo says. Therefore, actively practicing proper safety procedures and having a trained and specified safety manager is a must, he adds.

Many plants have employees pulling double duty, handling safety responsibilities in addition to their primary jobs. But safety warrants a designated employee who handles it as his or her primary job, providing constant feedback onsite, out on the production floor, Santo says. “Most big plants have caught on to that. It’s come a long way over the last 10 years. Safety always was a secondary thought. But nothing beats having boots on the ground and being with the employees all the time.”

The extra investment for pay and benefits for that employee outweighs the financial and safety risks that arise when nobody is dedicated specifically to the job, Santo says. “Sometimes it’s hard for a general manager or a CEO to quantify the cost/benefit of ‘How much do we invest in safety for our employees? How much risk do we take?’ There’s always a dollar amount involved.”

But much like managing risk through hedging or investment in new technologies, personnel-related strategies are evolving and improving, too. “Personnel risk management has come a long way in ethanol in the past 10 years, but there’s always room for improvement.”

Author: Lisa Gibson
Managing Editor, Ethanol Producer Magazine