Ownership at a Crossroads

Is the U.S. ethanol industry's connection to value-added agriculture—and the predominantly rural Corn Belt communities that support and benefit from production—diminishing? Or, as non-farm interests take hold of a greater fraction of the nation's ethanol market, are investment opportunities for farmer cooperatives and independent growers simply changing with the times?
By Nicholas Zeman | April 01, 2006
Financial experts and industry observers say the U.S. ethanol industry is definitely growing beyond—but not necessarily away from—its value-added agriculture origins as more private equity funds, venture capitalists, money-center banks and international newcomers are lured to the business of making and marketing biofuels. Some say the arrival of new corporate interests and deep-pocket players is competitively juxtaposed with the farm and rural community interests that ought to benefit most from ethanol production, while others say it's simply a natural progression of a robust, maturing industry.

Recent reports from a variety of sources have indicated that Wall Street's relatively newfound interest in ethanol, for example, is reshaping the landscape of the business. On the other hand, the industry's leading trade groups believe farmer investment and involvement in ethanol production will increase as the industry's marked expansion continues. From a historical perspective, they have a good point. It has been the copious rise of majority-farmer-owned ethanol plants—primarily dry mills ranging from 15 MMgy to 100 MMgy—that have, over the last half-decade, reduced Archer Daniels Midland Co.'s (ADM) market share from 50 percent to 25 percent.

In reality, says BBI International CEO Mike Bryan, the farmer cooperative, corporate and private equity interests at work in the ethanol industry complement each other. "Farmers built this industry into what it is today," Bryan says, adding that ADM, at the request of the federal government, in effect launched large-scale ethanol production in America. He explains, however, that the industry would have never grown to its present size and level of sustainability without the financial commitment of American farmers.

In December, the Federal Trade Commission (FTC) reported that a host of new entrants into the ethanol sector has effectively lowered the industry's market share concentration. That report was generally taken as good news, but it's fairly clear that less concentration is not necessarily positively correlated with more farmer investment. In a Minnesota Public Radio (MPR) story that aired Feb. 9, David Morris, vice president of the Institute for Local Self-Reliance in Minneapolis, said about 80 percent of all new ethanol plants were farmer-owned in 2000. Now, he told MPR, just 20 percent of U.S. ethanol plants that are operational or under construction are farmer-owned. Those numbers can be deceiving, though. For example, BBI International, publisher of Ethanol Producer Magazine and regularly updated plant maps and lists, stopped tracking "farmer-owned" ethanol plants in early 2005 because of the growing difficulty it had in distinguishing bona fide farmer-owned plants from majority-farmer-owned and partially farmer-owned plants. In other words, the 20 percent of ethanol plants that Morris says are farmer-owned may simply represent those that are exclusively farmer-owned and not those that include considerable investment from farmers and rural community stakeholders.

The Renewable Fuels Association (RFA) reports that 95 U.S. ethanol plants in 19 states produced 4 billion gallons of ethanol in 2005—a 126 percent increase since 2001—and that in 2005, 43 facilities came on line, began construction or underwent expansions. Despite the tough-to-define nature of farmer-owned ethanol plants, the ethanol industry's co-op-controlled or otherwise independent rural ethanol companies have widely transitioned into, or simply started as, limited liability companies (LLC), and these producers have been both unequivocally innovative and resourceful. "Many of the farmer-owned cooperatives have worked to form marketing alliances that have allowed them to compete quite effectively with some of the larger companies," says Bob Dinneen, president and CEO of the RFA. "Those same companies—[many of them run by] farmer cooperatives—have been very innovative and progressive in terms of finding additional added value for their coproducts. … This has absolutely allowed them to compete with the larger [producers]."

But rather than competing with larger companies, small majority farmer-owned ethanol plants may increasingly be compelled to sell out to larger players or buy up competing plants. So while the FTC says the ethanol industry's market concentration is breaking up, industry experts say consolidation is positively on the way.

Don Hofstrand, vice president of AgVentures Alliance, an Iowa-based consulting firm, says there is a tendency in expanding industries for every "Tom and Jerry" to try to get in on the take, so to speak. He says the American auto industry is a perfect example. In the early days of auto manufacturing, there was a plethora of independent manufacturers trying to snag a piece of the pie. "[The largest and most powerful manufacturers started swallowing up the small companies," he says, explaining that consolidation is almost always consequential—good or bad—for small, independent companies.

It's not always the large eating the small, though. Sometimes it's more a case of the most successful, or simply most aggressive, companies acquiring those that are struggling or looking to make an exit in good times. "A lot of the consolidation will occur when, for example, one successful FOC (farmer-owned co-op) invests its profits in a new or existing plant that also has strong farmer ownership," Bryan says. "The original FOC will likely be a thing of the past, with the LLC taking priority, but that doesn't mean that an FOC can't be an investor in an LLC. So, in other words, the FOC buys either a majority or a minority interest in the LLC, just like any other private investor."

David Kolsrud of Minnesota-based Agri-Energy LLC agrees that the cooperative model of ethanol plant ownership is slowly fading from the radar, largely because of unattractive tax structures and the potential for double taxation. "Mid-Missouri [Energy] in Malta Bend, Mo., may be, in my estimation, the last new plant that is truly farmer-owned. There is certainly a trend away from the cooperative model."

Is there room for everyone?

While market concentration in the ethanol industry is in flux, the fact remains that the product is sold into a very highly concentrated oil industry. That makes market analysis more complicated, the FTC suggests, leading to what is essentially a debate over the relevance of market share versus production capacity. That is, statistics showing a dip in ADM's ownership in the ethanol industry "may be true in percentage … [but] not true in gallons," says Harold Tilstra of Land O'Lakes Purina Feed.

In addition, ADM, the nation's largest ethanol producer, has recently submitted an air application to the state of Nebraska in order to expand production at a facility it inherited with its purchase of Minnesota Corn Processors in mid-2002. The corporation now appears poised to increase production at the rate of hundreds of millions of gallons per year.

Many experts say the industry is big enough—or will be big enough—for everyone, and that opportunities for farmer investment will not go away. In a mid-January recording posted on the RFA's Web site, Tom Branhan, general manager of two U.S. ethanol plants and an RFA board member, said, "Ethanol's importance to rural America is no secret. Every ethanol plant raises local corn prices upwards of 10 cents per bushel, generates more than $100 million in economic activity and provides dozens of good-paying jobs. New York to California realizes the importance of a strong renewable fuels industry—and family farmers will continue to lead the way."

Still, the staunchest protectors of farmer ownership in the ethanol industry—Morris, for example—are grappling over the fate of farmer-owned ethanol plants. They say marketing and management alliances, acquisitions and an influx of private equity are changing the landscape of the ethanol industry, and slimming down the role of the American farmer. "My concern is that in the future the farmer will simply become a raw material provider for the ethanol processing corporations," Morris says.

Likewise, following ethanol's pop-culture entrance—including President George W. Bush's State of the Union address and national advertising campaigns for E85-capable vehicles—Tilstra says he's concerned that ethanol will become primarily associated with America's effort to decrease its dependence on foreign oil and maintain clean air standards, and lose its reputation as a boon to farmers and rural communities. However, Kolsrud says non-farm investment has been taking place for years and is a virtual prerequisite to financing ethanol projects these days. "A lot of farm groups looking at building ethanol plants are [inviting] the investment of [both] farmers and private equity money," Kolsrud says. "I don't think the mix has changed that much."

It's common for a cooperative to have a majority ownership in an LLC-structured ethanol plant. An LLC has the ability to buy corn on the open market, and can procure corn from an invested co-op and also buy the feedstock on the open market. In fact, LLCs have emerged as the dominant legal structure in the industry principally for the purposes of plant financing and open-market corn buying. Farmer-owned cooperatives have traditionally struggled with the ability to finance large value-added projects. This is a widespread problem in American agriculture and not exclusive to the ethanol industry. "Cooperatives in all areas of agriculture are under-capitalized," says Jeff Kistner, vice president of financing for BBI International Project Development. Turning to the LLC model, U.S. ethanol plants sprouting from farmer cooperatives have been able to be more flexible, and subsequently more competitive and financially successful. In that way, American farmers have benefited, not suffered, from non-farm investment. Still, some government officials want to make sure rural communities are gaining from one of the few great opportunities to come their way in the last quarter-century.

Thomas Dorr, undersecretary for the USDA, speaking at the National Ethanol Conference: Policy & Marketing in Las Vegas in late February, said that flexibility and well-designed legislation should be implemented so that rural America should not be left in the wake of non-farm investment in the ethanol industry. "State legislatures need to design tax and regulatory structures that allow these investors to pool funds that become equity stock for those who want to build these plants," Dorr said. "If you write the legislation, if you develop the strategy that everyone who wants to invest can … we will have done a tremendous job in generating wealth and making rural America much stronger than it has been."

Bryan says the role of the farmer remains essential, and indeed, farm and non-farm investment must be integrated as the ethanol industry evolves. "Farmers will always play an important part in this industry—they have to—because without their underlying support, the industry will soon become too tenuous for the big money folks to get involved in," Bryan says. "Farmers are the base. They have the political clout. They grow the feedstock, and they have the desire and the guts to build a future, no matter how tough it gets. The money people have is just that—money—and that means the industry will continue to depend on agriculture. The money-people are not risk-takers. Farmers risk it all every spring."

Nicholas Zeman is an Ethanol Producer Magazine staff writer. Reach him at nzeman@bbibiofuels.com or (701) 746-8385.