Co-op business model well suited for
next-generation biofuel development

By Dallas Tonsager, Under Secretary
USDA Rural Development

Editor’s note: The following commentary is based on remarks
Tonsager delivered in January at the Fourth Annual Iowa
Renewable Fuels Association Conference in Des Moines, Iowa.

hen Congress passed the Energy Independence and Security Act of 2007, it established a significant challenge to the nation to produce 36 billion gallons of biofuels by 2022 to power cars, trucks, jets, ships and tractors. However, only 15 billion of the 36 billion gallons can come from corn ethanol. We are nearing that point. The Energy Information Administration predicts that ethanol production will grow from about 11 billion gallons in 2009 to 12.95 billion gallons in 2010.

This poses a substantial challenge to the nation as we tap other renewable fuel sources. But we can achieve it if the technology and lender confidence are there.

Biofuel production is an evolutionary process. As with computer technology, the newest version is always just ahead of us. To reach our goal, second-generation biofuel technologies will need to become commercially viable, including those that turn crop residue (such as corn stover) and energy crops (such as switchgrass) into ethanol. Thirdgeneration biofuel technologies that turn feedstocks into advanced biofuels will also be needed. USDA’s Research, Education and Economics Service is researching the technology needed for this effort, while USDA Rural Development is working to forge the necessary business deals.

The conversion efficiency of ethanol production has improved markedly in the past decade. For example, just 200 bushels of corn can now be processed into about 540 gallons of ethanol. It would take no more than 40 gallons of fuel to produce that crop, so we would net about 500 gallons to distribute. That’s a huge improvement over the conversion rate of the early 2000s. It is reasonable to expect we will see similar advances in next-generation biofuels, given the current rate of advances in technology.

USDA has been promoting the economic opportunities derived from emerging local and regional food systems. In the Midwest, we should also consider the economic opportunities afforded by a regional energy system. The production and use of renewables on a regional basis make economic sense and represent a historic economic opportunity for agricultural producers and rural America.

How do we do this? By working backward from the 36 billion-gallon target, using a regional supply-chain approach. We should focus on a diverse group of dedicated feedstocks, including: 1. perennial grasses; 2. energycane (similar to sugarcane); 3. biomass sorghum; 4. oil seed crops and algae; 5. woody biomass. In using crop residues and planting special “energy crops” to produce biofuels, we must do so in a way that doesn’t deplete soil fertility or create problems for other crops (see page 19 of this issue for more on this topic).

A business model similar to how we developed the ethanol industry can be used in this effort. Capital was found for ethanol projects in the 1990s by issuing proposals that asked for public participation in a project. With the membership fees paid, business plans were developed and prospectuses were issued to sell stock in a company.

If enough people were willing to invest, we would be able to complete a project. We could spread the investor risk and the credit risk as widely as possible.

To encourage public support, cooperatives are a great business model. New-generation cooperatives, unlike traditional cooperatives, are financed through the sale of delivery rights. Delivery rights represent a member’s right to deliver a specific amount of commodities to the cooperative.

A Rural Development staff member in Iowa told me about a new-generation cooperative operating a producer-owned ethanol plant that is producing more than 30 million gallons per year. Within two months of its formation, 400 area residents had invested in the plant and become memberowners of the company. The shareholders are area farmers who are also the primary suppliers of the corn processed in the facility. The producers are contractually obligated not only to provide funds, but also to deliver their products to the cooperative.

Farmers invested in the plant because they are getting their feed and fuel from the cooperative. All of the corn that is processed is used in some capacity, whether it’s liquid, wet or dry feed for livestock, or alcohol for fuel. There is no waste.

Whichever way you look at it, the key is to spread the investments widely, with lots of opportunities to limit risks.

About one-third of the funding for next generation biofuel will likely need to come from producers and wellcapitalized investors, with two-thirds of the funds coming from lenders.

At USDA, we are keenly aware of today’s business environment and how sensitive lenders are to risk mitigation. We are dedicated to addressing these issues in order to get capital flowing again. We’ve been meeting with lenders, establishing new relationships and building on old ones.

As we continue to invest in, and develop, advanced biofuels technologies, many projects will become eligible for more conventional forms of financing.

We must continue to develop new technologies and demonstrate to lenders the importance of transitioning to advanced biofuels. There will always be uncertainties. There will always be surprises. Neither markets nor technologies are static.

But Congress clearly defined our mission in the 2008 Farm Bill, and we at USDA Rural Development are fully committed to reaching our goal. Our job is to implement legislation. Our responsibility is to support the entrepreneurs who have the initiative and the drive to go out there and compete in the marketplace to build a new energy future.

March/April Table of Contents