Hard Lessons
Tri-State Ethanol struggling to overcome difficult start
By Stephen Thompson,
Assistant Editor
etting up an ethanol
plant is no automatic
path to prosperity. Just
ask the investors in Tri-State Ethanol, a limited
liability corporation (LLC) founded by
a farmers cooperative.
For the members of Tri-State Corn
Processors Cooperative, founded in
1994 in Rosholt, S.D., an ethanol plant
seemed to be an answer to the problems
they faced as commodity producers:
low prices, exposure to the whims
of the market for an undifferentiated
product with few buyers and many
sellers, and no way to tap into the
profits others derived from adding
value to their crops.
Like Alice in Wonderland’s Red
Queen, many commodity producers face
a situation in which they continually
struggle just to keep in one place.
Keeping abreast of a constant upward
trend in productivity demands rising
expenditures for operating inputs and
equipment while also dealing with a
constant downward pressure on prices.
Producing a value-added product
seemed to offer a way out of this conundrum,
and ethanol was by far the most
attractive and popular opportunity.
Outside expertise, resources needed
Tri-State soon found that starting
up a profitable ethanol operation
required expertise and a number of
skills and resources that weren’t readily
available among its members.
Foremost was access to capital. As a
cooperative, Tri-State was prevented
from selling voting shares to non-farmers--
and, as with many farmer-owned
ethanol ventures, the members
could not raise sufficient funds among
themselves.
The next step was to form a limited
liability corporation (LLC) that could
sell shares. But even then, they had no
luck finding financing for their venture.
We tried to finance the project
ourselves, says Steve Hesch, current
manager of Tri-State Ethanol, but our
sources didn’t come through. It soon
became clear that they would have to
seek outside help.
A second dilemma was obtaining
the expertise to build the plant. With
no experience or training in that arena,
the stockholders would also have to
rely on outside help to find designers,
engineers and builders with the requisite
skills.
Those problems seemed solved
when they found a consultant who specialized
in putting together ethanol
projects. The consultant linked them
up with a team consisting of a design
firm, a construction coordinator and
a construction company, that together
promised a working plant at what
seemed to be reasonable terms. He
also found a group of investors from
Omaha, Neb., willing to invest in the
project. The consultant assembled a
financing package that included lowinterest
loans from a local bank and
developed an agreement that gave the
builders partial ownership of the project.
The cooperative itself wound up
owning about a third of the business.
The ethanol distillery was designed
to produce 14 million gallons per year.
This is small for an ethanol operation,
and in the best of circumstances would
be more difficult to run profitably than
a plant with a 40-million-gallon capacity,
considered the size at which
economies of scale are achieved. But as
it turned out, small capacity was only
part of the problem.
More research time needed
In retrospect, says Hesch, the co-op
should have done more research and
asked a lot more questions. But at the
time, the package seemed to be just
what they needed. Another factor
pushed them to hurry the project: the
need to get their ducks in a row before
they ran out of time. They had permits
and investors, but delays might cause
them to lose either one. Closing loans
takes time, he says, and the co-op
hadn’t realized just how much time it
would take.
While the loan-making process
ground on, the necessary building permits
threatened to expire, putting the
low-interest loans in jeopardy.
Construction work on the plant began
in October 2000, before the loan was
closed. A construction loan agreement
for $9 million was only signed seven
months later, on May 14, 2001; it took
another three months before funds
were released.
With the funding in place, the coop’s
troubles were not over. Problems
with construction resulted in cost and
time overruns. And when the plant
finally began operating, Tri-State had
another unwelcome surprise: its
ethanol distillery did not perform the
way it was supposed to.
If it were a car, says Hesch, the
fastest it would go would be 30 miles
per hour, and it would break down
every hundred miles. The boilers were
wrong, and the way the pipes were
designed made sanitation very difficult.
According to other sources, the
plant was built around used machinery,
and its design was wholly inadequate
to produce ethanol at its nominal
capacity.
Unable to operate the plant, Tri-
State Ethanol was unable to generate
cash flow to repay its debtors. They
told us orally that it would be a turnkey
operation, Hesch says, but we
didn’t actually get it in print. The
contract had details about exceptions
and allowances, he says, that made it
difficult to pursue action against the
builders and consultants for non-performance.
The construction company and a
subcontractor slapped mechanic’s liens
on the plant, and Tri-State Ethanol
LLC was forced to declare bankruptcy.
The ensuing legal disputes have been
complicated by the fact that the construction
company is a part-owner of
the operation. It has been estimated
that it will take an additional $1.7 to
$3.4 million to make the plant fully
functional, including materials and
labor.
Backers still hoping
for eventual success
Despite the venture’s tribulations,
Hesch is optimistic that Tri-State
Ethanol will eventually be successful.
The company has put together a
Chapter 11 bankruptcy plan, approved
unanimously by the shareholders,
under which, he says, all necessary
modifications will be made to get the
plant up and running and all debts will
eventually be satisfied.
Others are less sanguine about the
operation’s prospects, saying it will
have to overcome its small size, a lessthan-ideal location and lack of a good
supply of natural gas.
In any case, the co-op members and
others who helped finance the project
have learned some very hard, expensive
lessons. We should have had more
checks and balances, says Hesch. We
thought we had checked out everything
well, but so many things didn’t
pan out. We were left with ghosts and
shadows. Hesch believes that much of
the trouble was caused by the time
constraints stemming from financing
problems. If we’d had decent financing,
he says, things would have been
different.
