RECENT headlines about biofuel policies paint a very negative picture of the biofuel industry, but over the last year, ethanol producers actually have enjoyed one of their best periods of profitability ever, according to Scott Irwin with the University of Illinois department of agricultural and consumer economics.
This has been driven by a drop in corn prices that substantially exceeded the price declines for ethanol and dried distillers grains plus solubles (DDGS). As a result, Irwin said the ethanol production industry is on much sounder financial footing than it was after being ravaged by drought-related losses in 2012.
Irwin conducted an analysis by utilizing the same model of an Iowa ethanol plant that has been used over the last several years to track the profitability of ethanol production. The model is meant to be representative of an "average" ethanol plant constructed after 2006.
He pointed out that there is certainly substantial variation in capacity and production efficiency across the industry and said this is something to keep in mind when viewing profit estimates.
To track plant profitability over time, weekly ethanol and DDGS prices at Iowa ethanol plants were collected starting in late January 2007. Crude corn oil prices for the Midwest were available from the Oil Price Information Service, and natural gas costs were estimated based on monthly data from the Energy Information Administration and updated using natural gas futures prices.
According to Irwin, pretax estimates of ethanol production profits per bushel of corn processed were net of all variable and fixed costs and averaged 23 cents/bu. for the entire period.
The analysis revealed four subperiods in terms of net profits: (1) high profits from 2007 through mid-2008, (2) breakeven from mid-2008 through the end of 2011, (3) losses for 2012 through early 2013 and (4) high profits again from the spring of 2013 through the present (Figure).
The most recent period is the longest run of uninterrupted profits since the series began in early 2007, Irwin noted. During this one-year run, profits averaged 93 cents/bu. of corn processed and reached a new high of $2.55/bu. in early December 2013.
"The picture presented here is certainly not one of an industry that has suffered because of recent policy proposals," Irwin explained.
What has been behind ethanol producers' historically high profits during the last year? Irwin said the three main determinants of ethanol profitability are ethanol prices, DDGS prices and corn prices.
Irwin presented the prices as a percentage of the value on March 15, 2013, in order to directly compare the price movements. He found that while all three prices declined during the last year, corn prices declined much more than ethanol and DDGS prices.
For example, on March 7, 2014, the last date for each series, the prices for ethanol, DDGS and corn were 88%, 85% and 62%, respectively, of their levels on March 15, 2013. Since ethanol and DDGS are outputs and corn is an input, this is a prescription for strong ethanol processing margins.
Irwin said the recent run of profits is unlikely to continue for an extended period of time. For one, DDGS prices have reached unprecedented levels relative to corn and soybean meal prices.
Second, there is a documented "co-integrating" relationship between ethanol and corn, which simply means that the relationship between ethanol and corn prices tends to revert to levels implied by an equilibrium long-run level of ethanol production profitability. If the ethanol price is too high relative to corn prices, then either the ethanol price must fall or the corn price must rise, Irwin noted.
"For any particular episode, it is difficult to know which price will bear the brunt of the adjustment, but history shows that such an adjustment is the norm," Irwin said.
For example, if corn prices are now driving ethanol prices due to the E10 blend wall, then it would be expected that ethanol prices would do the bulk of the adjusting.
Finally, Irwin said it is helpful to aggregate the profit margins over an annual horizon in order to see broader trends in estimated ethanol plant profitability. Profits are presented in terms of both total dollar returns to equity holders and percent return to equity.
Profits were highest in 2007 at $25 million, with 2013 profits of $23 million being only slightly smaller. When the drought drove up corn prices, the lowest profits occurred in 2012, with a loss of $7.3 million. Averages for the seven years were $7.4 million and 5.8%, respectively. The total cumulative return to equity holders for the period was $51.5 million.