Do bigger ethanol plants
mean fewer farmer benefits?
By David Morris
Editor’s note: Morris is an economist with
the Institute for Local Self Reliance. The
views expressed are the author’s own and
do not necessarily reflect those of USDA.
he structure of the
ethanol industry influences
the degree to
which its growth benefits
farmers and rural areas.
An industry dominated by small- and
medium-sized farmer-owned plants
creates more wealth for farmers and
their communities than does one characterized
by a smaller number of large
facilities owned by national and international
investment groups.
Between 1979 and 2005, the ethanol
industry has experienced four major
structural upheavals. In the beginning,
it consisted of a vast number of tiny
production units. The doubling of oil
prices in 1979–1980 inspired farmers
to build such plants. The availability of
a federal 100-percent loan guarantee
for plants with production capacities
less than 1 million gallons a year
allowed them to finance such plants.
This “stills-on-a-hill” era peaked in
1984, with 163 very small ethanol
plants in operation (some sources estimate
as many as 176). The industry
then violently contracted, a result of
crude oil prices falling to $8 a barrel
and a successful, concerted negative
publicity effort by major oil companies.
In a single year, 1985, almost half of
all ethanol plants (but only a small fraction
of production capacity) went out
of business. By 1990, only 56 plants
remained. More than half produced
less than 5 million gallons a year.
In the late 1980s and early 1990s,
the ethanol industry was dominated by
100-140-million-gallon-a-year wet
mills. These were built primarily to
serve the expanding high fructose corn
sweetener market. Archer Daniel
Midland (ADM) dominated the HCFS
market. As a result, ADM dominated
the ethanol market, accounting for
about 75 percent of the ethanol industry’s
output in 1990. Indeed, in the
early 1990s, the words ethanol and
ADM became virtually synonymous.
Rise of farmer-owned plants
The 1990s witnessed the next structural
shift in the industry: the rise of
farmer-owned plants. By the late
1990s, the vast majority of new ethanol
plants were farmer-owned. By 2002,
these were producing, collectively,
more ethanol than ADM. Some 25,000
farmers nationwide had become shareholders
in ethanol facilities.
The average size of new plants grew
from 15 million gallons a year in the
mid-1990s to 30 million gallons a year
by 2002. States such as Wyoming and
Minnesota redesigned their cooperative
laws to enable more outside
investment while retaining farmer control.
Many farmers chose the limited
liability corporate (LLC) form as a way
to access the capital required.
In 2004, a new era dawned on the
ethanol industry when the nation’s
first 100-million-gallon dry mill
opened in South Dakota. Within a
year, at least 15 more 100-million-gallon
dry mills were under construction
or planned. A doubling of oil prices,
an extension of ethanol’s generous federal
financial incentives and the passage
by Congress of a mandated doubling
of the ethanol market by 2012
all combined to make ethanol an
attractive investment. It is likely that
in the next 3 years, 75 percent of new
ethanol production will come from
large, non-farmer-owned plants.
Some farmers view absentee-owned
plants as an inevitable — and even a
welcome — development. South
Dakotan Dan Endres, who had owned
shares in two farmer-owned ethanol
plants and became a principal owner of
a company building several 100-million-gallon plants, comments:
“VeraSun’s experience indicates that
the farm-ownership model may need
to adapt as the ethanol industry gravitates
to large plants. Such operations
are increasingly financed by six to
eight principal investors, without the
need to deal with hundreds of small-scale
farm-investors.”
In mid-2005, several leading firms
in plant construction, engineering and
marketing formed a new entity, US
Bioenergy, a holding company that will
purchase and provide services to a
number of ethanol plants. The minimum
investment for shares in the
holding company is $5 million.
Investors anticipate making a significant
profit in 2 to 3 years when the
company goes public.
Industry evolution poses challenges
The evolution of the ethanol industry
into one dominated by large plants
where investors profit not from the
sale of ethanol, but from receiving the
appreciated value of the plants when
they are sold, challenges policy makers
who are trying to address agricultural,
as well as energy, objectives.
Expanded ethanol production, of
course, benefits farmers and rural areas
in the same as will any new crop-processing
facility. Supporters argue that a
more concentrated structure is necessary
to raise the billions of dollars
required to significantly expand
ethanol production. Larger plants can
produce and transport ethanol more
cheaply. And larger increments in
capacity allow the industry to expand
more quickly.
These are valid points. But there is
another side to the rise of large absentee-owned plants that concerns many.
They significantly restrict the possibility
of widespread farmer ownership
and control. That begins to sever the
link between ethanol production as an
energy strategy and ethanol production
as an agricultural strategy.
Bigger plants do indeed lower unit
production costs. But while the savings
are considerable when the size of the
facility increases from 10 to 30 million
gallons a year, the additional reductions
from increasing the size of the
facility from 30 to 100 million gallons
are modest. Capital savings may be on
the order of 2-3 cents per gallon; labor
savings are about the same. Reduced
transportation costs from using unit
trains might be about a nickel a gallon.
Large plants do not, of course,
guarantee lower costs. There are diseconomies
of scale. A large plant can
strain local suppliers. Reporter Peter
Rohde of Inside Fuels and Vehicles
reports that a new 100-million-gallon
ethanol plant in South Dakota raised
the basis price of local corn by 30 cents
per bushel. This increased feedstock
cost wiped out any savings generated
from reduced capital, labor and transport
costs.
But let’s say that making ethanol in
a 100-million-gallon facility does
reduce the cost by 10 cents a gallon
less than that of a 40-million-gallon
facility. We know from experience that
this savings will not show up at the
pump. The consumer will not benefit.
The question is, will the farmer or the
rural area benefit? Or, to pose the
question more pertinently, will they
benefit as much as if there were three
smaller facilities rather than one large
facility?
Advantages of smaller plants
As noted above, farmers and rural
areas benefit when more manufacturing and processing facilities move in or
when the demand for a specific crop
increases. Farmers who do not own a
share in an ethanol plant benefit from
the increased selling price of their
crop. Studies indicate that increased
local ethanol production raises the
price of corn by about 10 cents per
bushel. Farmer-owners of ethanol
plants, on the other hand, have
received as a dividend, over the years,
30-40 cents per bushel.
For farmer-owners, the ethanol
plant becomes a hedge. When corn
prices decline, the production
costs of ethanol
decline. Thus, at least a
portion of the income lost
to the farmer on the sale of
the raw material is made up
from the increased profits in
the sale of the processed
material.
A 100-million-gallon,
absentee-owned ethanol
plant will return to the
farmers in the area around
the plant about $13 million
less than three farmer-owned
plants each producing
33 million gallons per
year.
According to Iowa State
University (ISU), the 5–year
average after-tax return for a
typical ethanol dry mill is 23
percent. In comparison, ISU
estimates that 70 percent of
Iowa’s counties averaged
returns on farmland of 2.5
percent or less (in 2002). In
fact, one community banker
in Minnesota told a National Corn
Growers Association task force he considers
financing stock purchases by
farmers in processing plants a far less
risky and potentially much more profitable
investment than lending money to
farmers to buy land.
With regard to the impact on the
non-farm community, large plants,
especially when they are part of a chain
owned by one corporation, spend a
smaller portion of their money locally
on purchasing and management, on
accounting and legal services and on
advertising.
Possible alternatives
What should be done? To date, public
policy, at least at the federal level,
has rarely taken into account the size or
ownership structure of ethanol plants. I
am aware of two exceptions. A program
that gave free surplus grain to ethanol
producers who were expanding or
beginning production, rewarded small
producers more than larger producers.
And since the early 1990s, there has
been an additional 10-cent-per-gallon
small producers credit that has been
limited to facilities with capacities of
less than 30 million gallons per year.
The 2005 energy bill, however,
increased the definition of “small” to 60
million gallons, a ceiling that qualifies
about 90 percent of all ethanol facilities.
The federal biofuels incentive, of
course, has no ceiling. Moreover, it targets
the consumer and the intermediary
supplier, not the ethanol producer.
So what should be done? One concrete
step would be for the government
to convert the federal excise tax
exemption into a direct producer payment.
This was done at the state level
by Minnesota in the late 1980s. That
payment could be limited to plants
under a certain size and a higher
incentive would be given to farmer-owned
facilities.
To date, the issues of scale and ownership
— at least at the federal level —
have not been addressed. One reason
may be that, until recently, farmer-owned,
modestly scaled biofuels
refineries seemed to have become the
norm. That is no longer true.
The remarkably rapid growth of
large scale, non-farmer and distantly
owned plants should lead policy makers
to engage the question and make a
conscious decision. The question
before them is how to design a strategy
that not only maximizes the use of biofuels
but also maximizes the benefit of
that expanded use to the cultivator and
the community in which the cultivation
and harvesting occurs.
