Balancing Act
Risk-hedging strategy big part of Iowa ethanol co-op’s success
By Dan Campbell, editor
e-mail: dan.campbell@usda.gov
he success of an ethanol
plant rests upon a fourlegged
stool, with the
legs representing the
ethanol, corn, dried distillers
grain (DDG) and natural
gas markets. You can’t
sit on that stool unless all four legs are
planted firmly on the ground, advises
Dave Nelson, board chairman of the
MGP Ethanol cooperative in the
north-central Iowa community of
Lakota.
The price of corn and natural gas
are the two major inputs that determine
operating cost, and the value of
ethanol and DDG are the
major outputs that determine revenue.
It’s a balancing act, and it takes a
savvy risk manager who knows how to
hedge to do it right, says Nelson, who
with two brothers has a 5,000-acre
corn/soybean/hog farm.
In late spring, the cost of ethanol
had everyone in the industry smiling.
When interviewed in early June,
Nelson said MGP was getting $1.30 a
gallon for its ethanol vs. $1.10 a year
ago. It markets its fuel through a Texasbased
broker, an arrangement which he
says has been working fairly well.
Co-op leaders are well aware that
the success or failure of ethanol plants
also hinges on how well they can market
byproducts. MGP has even adopted
Ethanol and more as the co-op’s
motto. But with ethanol doing so
well, we are really concentrating on
that market right now, Nelson says.
Estimating costs
The MGP plant devours a lot of
corn-- 17 million bushels annually. So,
the goal is to buy as much corn as possible
when prices are low, and to cutback
to hand-to-mouth purchasing
when the prices are soaring, Nelson
says. Ethanol prices also ebb and flow,
and the co-op strives to lock in advance
sales as far as possible when it believes
the market is peaking.
Transportation costs also play a big
part in determining the cost of corn
procurement. MGP Ethanol buys all
of its corn within a 30-mile radius of
the plant. But only 20 percent of the
co-op’s 1,000 members farm within
that radius. Nelson is a case in point.
His farm is located 60 miles from the
MGP plant.
Like the other 80 percent of the
members-- who farm in Iowa, Illinois
and Minnesota-- Nelson works with
others growers closer to the plant, who
ship corn to MGP Ethanol on
Nelson’s behalf.
Most of the popular hybrid corn
varieties grown in the area also have
high yields of the fermentable starch
desired for dry-mill ethanol plants. So
no special corn varieties have had to be
planted just for ethanol production,
Nelson says.
MGP Ethanol recently completed
its second year in operation and is running
at better than 100 percent of
capacity. It is producing at an annual
rate of 48 million gallons from a plant
that was rated at 45 million gallons.
Equity drive a struggle
The co-op was spawned by Ag
Ventures Alliance, a rural business
incubator that identifies value-added
manufacturing
opportunities for
farmers. Once the
business plan was in
hand, it required 53
producer meetings in three states during
2000-2001 to raise most of the $22
million in equity needed for the $58
million plant. Members, who must be
producers, were required to buy a minimum
of 5,000 shares at a cost of $7,500.
The average investment was $12,000.
It wasn’t easy, is Nelson’s succinct
assessment of the equity-drive process.
Eventually, farmers put up $17 million,
and the fledgling co-op was able to raise
the additional $5 million with a bond.
Members can sell their stock to other
producers through the Allerus brokerage
in Fargo, N.D.
MGP received a matching grant last
year for $150,000 under USDA Rural
Development’s Value Added Producer
Grant Program to study the potential
for biodiesel production or expansion of
the ethanol plant.
The co-op shopped around to find
the right company to build its plant.
We did a spreadsheet and listed all the
benefits and negatives of each candidate,
Nelson says. Eventually, it went
with ICM of Colwich, Kan., to design
the plant and Fagan Co. of Granite
Falls, Minn., to build it. We’re fairly
happy with how it went, although there
are always some things you would like
to change, Nelson says.
The co-op hired a CEO, who in
turn was given the latitude to hire his
own management staff. We were
focused on finding someone who could
not only operate the plant, but who
could manage people. That man is Dan
Hernandez, who now oversees a staff of
36 employees.
Iowa production to surge
Seven other dry-mill ethanol plants
are currently operating in Iowa, with
eight more under construction or in the
planning stage. Nelson says he is glad
the industry is expanding. It needs to
get bigger. And the way demand is
increasing for energy, it will continue to
get bigger.
One thing that must be watched, he
says, is to not build plants so close to
each other that they begin to cannibalize
each others’ fuel stock. But so far,
that does not seem to be happening.
The industry is also spreading to
more states, which Nelson says will
help to increase political support for
ethanol beyond the Midwest.
He sees a trend toward new plants
being pursued as producer-owned, limited
liability corporations rather than
pure co-ops. This is primarily due to
the need to secure more outside investment
capital from non-producer members.
It can also be much quicker and
easier to raise capital from non-producers,
he notes. But critics of such an
approach say that producers may then
wake up one day to find that they have
lost control of their plants.
The major problems for farmer coops
in the ethanol industry is securing
quality management, says David Morris
of the Institute for Local Self Reliance, a
Minneapolis-based educational organization
that provides technical assistance
and information on environmentally
sound economic development strategies.
Since co-ops are owned by farmers, and
farmers comprise all, or at least the
majority, of the board of directors, they
control the operations. But they often
lack expertise in management, industry
experience and entrepreneurial innovation--
those are the key problems,
Morris says.
On the other hand, the key asset for a
co-op plant is its relationship to the
farmers, he continues. In the late 1990s,
when corn prices were sky-high, corn
farmers who owned ethanol plants were
willing to take below-market prices to
help the company, knowing that part, or
perhaps even all of that, would be
returned to them in higher dividends,
Morris says.
Another key problem is not the coops
themselves, but the lack of federal
(and sometimes state) policies that give
local and farmer owners a higher priority,
Morris adds. The federal incentive
and grant programs do not distinguish
between an absentee-owned plant and a
farmer-owned plant.
Good timing
The timing of this strong ethanol
market has been perfect for co-ops
formed in the past four to five years,
Nelson says. And it’s been good for
consumers too, he adds, noting that
gasoline prices would be significantly
higher were it not for ethanol.
Predictions that Midwest farmers
will continue to see corn yield increases
of 1.5 bushels per acre each year for
the foreseeable future bode well for the
supply being sufficient for both livestock
feed and ethanol production, he
notes.
Nelson says his best advice to other
farmers looking to go into ethanol is
this: Just make sure you have the time
and energy for it. It takes a tremendous
amount of time. We met every week for
two years in developing the co-op. So
you need to make sure you are paid for
your time. You can do it in a shorter
time frame if you hire someone else to
do it all for you, but then it’s not really
your plant.
Proximity to grain supply, livestock feeders
key factors in ethanol plant site selection
Grain feedstock represents from 50 to 70 percent of
the cost of producing ethanol, so having access to a
reliable grain supply that can be procured at a reasonable
price is the biggest single factor in deciding
where to locate a plant, says David Coltrain, coordinator
for the Kansas Cooperative Development Center at
Kansas State University.
Proximity to large livestock feeding operations is
another big advantage for ethanol operations in marketing
dried distillers grains (DDGs). Not only does
proximity to feeders cut transportation costs, but the
DDGs can be sold in a semi-wet status, which means
less natural gas is burned in drying it.
Natural gas is a major expense for ethanol operations.
“It can easily cut a plant’s natural gas consumption
nearly in half, for approximately a 5-percent reduction in
total operating cost for a typical plant,” says Coltrain.
Kansas has six ethanol plants in operation, and
one more under construction. Proximity to the state’s
large cattle feeding yards is a major asset for ethanol
plants in the Sunflower state, Coltrain notes.
Availability of state subsidies can also help,
Coltrain says. The federal subsidy is currently 52 cents
per gallon, and many states offer additional subsidies,
normally in the range of 5-10 cents per gallon for a limited
amount of ethanol produced.
Another key factor is building a plant that is
large enough to be competitive. At least 40 million gallons
produced annually is widely considered to offer
the best economy of scale.
Management and marketing expertise are the
other big keys to success. Coltrain notes that some
ethanol co-ops are less successful due to poor management.
The talent pool seems to be steadily improving,
he says, noting that some of the plant-building
firms have established good training programs for
plant operators.
Coltrain cites two recent research developments as
showing great potential for the ethanol industry. The
first development is close to reality while the second is
“still down the road.” University of Illinois researchers
have developed a new method to remove the corn
germ in dry-mill ethanol plants, which may reduce the
cost of manufacturing ethanol by 10 cents per gallon
by capturing the valuable corn oil as a co-product. University
of Minnesota researchers have also produced
hydrogen from ethanol in a reactor small enough to
heat homes and power cars, offering new long-range
market potential.
— By Dan Campbell
