The Ethanol Glass Is Still Only Half Full

by David Morris

originally published in Ethanol Today, September 2003

The ethanol industry is alive and well. By the middle of next year demand could exceed 3 billion gallons. As New York, Connecticut and other states phase out MTBE demand could surpass 4 billion gallons by 2007. These are remarkable figures. Consider that the Renewable Fuel Standard in the House Energy Bill (H.R.6) doesn’t require annual sales of 3 billion gallons of biofuels until 2009. Not until 2012 do sales have to reach 4 billion gallons, Ethanol plants are springing up like mushrooms after a spring rain. Biorefineries could soon outnumber oil refineries in the United States.

The ethanol community deserves to celebrate these important short term successes. Yet to assure long term victory the industry must address two important questions. One is the question of ownership. Ownership matters. Expanding the market for ethanol does help corn farmers, but not a lot. Farmers may see a price increase of 8-12 cents per bushel from multi-billion gallon sales of ethanol. But when farmers own the ethanol plant they can receive 25-50 cents per bushel or more per year in dividends and share appreciation. Ownership has its risks, but farmers understand risks. An investment in an ethanol plant represents a hedge against future price decreases. As the price of corn drops, profits and therefore dividends of ethanol plants should increase.

The ethanol industry has boasted three distinct structures in its brief history. In the early 1980s federal loan guarantees spurred the construction of hundreds of tiny ethanol facilities. The collapse of oil prices in the mid 1980s led to widespread bankruptcy and ushered in a new structure: domination by a single company, Archer Daniels Midland (ADM). In the late 1980s ADM was producing almost 80 percent of the nation’s ethanol. In the mid and late1990s small and medium sized ethanol facilities owned by local farmers became increasingly important. Today some 25,000 farmers may own shares in one or more ethanol plants.

The rapid multi-billion gallon expansion of the ethanol industry may encourage another structural change. One news story discusses the entry of ?bigger players?. Several 100 million gallon dry mills are under construction. An engineer at a multi billion dollar company just entering the ethanol industry declares, ?Size matters.? Will the ethanol industry begin to look like traditional agriprocessing industries, dominated by a handful of large companies? Will farmer ownership stagnate at present levels? Washington is neutral on these questions. Federal incentives do not differentiate between a 15 million gallon ethanol facility owned by 500 farmers and a 150 million gallon ethanol facility (or multiple 150 million gallon facilities) owned by a single multinational corporation.

Farmer owned ethanol facilities exist because states, beginning with Minnesota in the late 1980s, changed their state incentives. Rather than mirror the market-expansion federal incentives, they embraced incentives for in-state production of ethanol by many small and medium sized producers. Today the ethanol industry can honestly say that it is significantly benefiting rural communities and America’s farmers. Will it be able to say so 5 years from now?

The second problem the ethanol industry needs to face is the reliance on starch crops (i.e. corn). Starch crops probably cannot produce more than 10 billion gallons of ethanol per year. That seems like a lot, but it is less than 10 percent of the nation’s gasoline consumption. In part because of the lack of sufficient feedstock, ethanol is currently viewed only as a gasoline additive, not as a gasoline replacement. Which means it is viewed as a temporary, transitional fuel.

Dependence on corn results in the concentration of ethanol production in a handful of Midwestern states. That is good news for those states but means there is little constituency in the more populous and politically powerful states for ethanol. This can become especially important when the ethanol tax incentive must be renewed in 2007 and the vast majority of the country are seeing little in-state economic development to show for the $2 billion a year incentive. What should be done to address the twin issues of ownership and feedstock?

The Senate and House energy bills have a provision authorizing $500 million to the MTBE industry to pay for the cost of shifting to the production of other petrochemicals. Congress should offer an equal amount to allow states that are shifting to ethanol to produce ethanol. This incentive could be structured like state incentives today. Assuming a 10 year 20 cent per gallon incentive with a 10 million gallon cap, $500 million would result in the creation of 25 new ethanol plant producing 250 million gallons of ethanol. Most, perhaps all, would be locally owned.

With regard to feedstock diversification, significant quantities of cellulosic materials like organic wastes, agricultural residue, fast growing trees, grasses, are available in virtually every state and county. Sufficient quantities of cellulose exist that we can truly begin to view ethanol as a replacement for gasoline. We’ve been hearing about the imminent commercialization of cellulose to ethanol for a decade but today only one plant, in Canada, is producing small quantities of ethanol from cellulose.

The nation needs to accelerate its cellulose-to-ethanol commercialization program. The goal should be to have three such plants operating by 2007. A provision of the current energy bills may offer a way to accomplish this. The bills offer an 80 percent loan guarantee to the production of ethanol from cellulose.

Unfortunately the guarantee is restricted to ethanol made from urban garbage. It should be made more widely available. Interestingly, for economic reasons the first cellulose-to-ethanol plants may be installed on the front end of existing ethanol facilities, and use corn fiber as its feedstock. Grain farmers can play an important role in the cellulose-to-ethanol industry for they are the nation’s largest producers of cellulose in the form of agricultural residue like wheat straw and corn stover.

Against great odds, the ethanol industry is flourishing. But if 5 years from now farmers are no longer significantly benefiting, if facilities are not located in increasing numbers of states, if ethanol is still viewed only as an additive rather than a replacement for gasoline, we may look back on this moment not as the take-off point for ethanol but as its high water mark.