Few things have taken off like the ethanol industry. The number of ethanol production plants has almost doubled from 50 to 97 since 1999, and 33 more are under construction. This has helped to push the price of corn well over $3/bu., and earned hefty profits for ethanol plant investors, many of them farmers.
All this is reason for celebration in farm country. But the party may not last. The problem: The law of supply and demand is beginning to act as a brake on ethanol prices and profits, says Kevin Lindemer, managing director for Global Insight, a Lexington, MA, economic forecasting and research firm.
Ethanol profits have dropped from about $2/gal. in summer 2006 to about 30¢/gal. in late fall, he says. Prices have fallen from $3.55/gal. to less than $1.90 in the same period.
Rising corn prices have raised production costs, while two factors are exerting downward pressure on prices, Lindemer says:
One is the price of gasoline. Ethanol prices rise and fall with the price of gasoline, and the price of gasoline has dropped as much as 70¢/gal. in recent months. The other factor is a steady increase in ethanol supplies.
Tight ethanol supplies help support prices, and supplies tightened when ethanol began to replace the gasoline additive MTBE. That helped to push prices and profits up, Lindemer says. But that tightening was temporary. As new ethanol plants have come online, the supply crunch brought on by the MTBE withdrawal has begun to ease.
There are many potential risks in any boom. Some booms collapse because of over production. But a glut doesn't appear to be a problem for ethanol because it's part of a renewable resources movement with a very bright future. By 2025, ethanol and other biofuels could produce 25% of U.S. electricity and motor vehicle fuel, according to a new study from the Rand Corporation, a respected think tank.
“There's a very large potential market for ethanol as an alternative to gasoline,” says Bob Wisner, an agricultural economist and grain specialist at Iowa State University. “The chances of flooding that market look rather low. The bigger risk is that corn prices will rise to the point where ethanol processing is no longer profitable.” (That happened in 1996 when corn prices exceeded $5/bu. and some ethanol plants temporarily closed.)
If profits evaporate, says Lindemer, “Then you would have to temporarily shut down the least efficient ethanol plants until the industry becomes profitable again.”
The mechanism for restoring industry profits is the law of supply and demand. “As you shut down ethanol plants, you put more corn on the market, which helps lower the price of corn,” Lindemer says. “At the same time you would put less ethanol on the market, which helps raise the price of ethanol.”
Right now, ethanol is still profitable. Corn prices would have to rise to $4.60-5.20/bu. for ethanol production to become unprofitable, Lindemer says. But there are still upward pressures on corn prices because of demand from feedlots, the export market and continued rapid growth of ethanol production capacity.
“If you look nationwide at all the announced plants and proposed plants, they would have the potential to use almost all the 2006 corn crop if they're all built,” says Wisner. “That's an indication that they won't all get built. The market forces would change the economics to the point where some of those plants will be dropped.”