Hypothetical Ethanol Plant is an Exercise in Market Volatility

By Todd Neeley | June 05, 2007
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 real-time 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 MMBtua $1.45 increasefor 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 gallonan 8-cent per gallon increase since Februaryand 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.

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