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Published: 5/21/2006

Ethanol plants make lots of money now, but will it last?

BY JON CHAVEZ
BLADE BUSINESS WRITER

The country's fascination with ways to curb oil imports has ethanol-producing plants springing up throughout the country.

The corn-fed refineries making fuel for cars and pickup trucks are expected to be quite profitable this year and next, but after that, they may not be money machines, experts said.

Some plants bring in a 30 percent return on investment, and others are in the lower double digits, experts said. But some have much more modest profits.

The ventures can be risky. With hefty investments of $80 million for a 50 million-gallon-a-year plant to $140 million for twice that size, recouping investment takes more than a couple of years. Success depends on location, corn prices, ethanol prices, fuel prices, and other factors, they say.

"Just like the dot-com boom was not realistic, was not reality, not rational, there are a lot of questions about ethanol," said John Christianson, head of Christianson & Associates PLLP, a Willmar, Minn., consulting firm that has advised investors and ethanol plant developers in 20 states.

Jeff Ehlert, president of Great Lakes Ethanol LLC, which is building a 50 million-gallon plant near Blissfield, Mich., said his plant's profit projections are rising now as higher gasoline prices prompt demand for more ethanol and gasoline suppliers use ethanol to replace a harmful fuel additive called MTBE.

But Mr. Ehlert fears that profits will "be bouncing all around" over the long term. "It should be real good for the next few years, but after that we don't think it will be as good," he said.

Thomas Byrne, head of Byrne & Co. Ltd., of Preston, Minn., which has helped develop more than 30 ethanol plants, said " the thing to remember is it's a commodity-based industry. Sometimes it's going to be good, sometimes it will be bad."

Of nearly 100 plants operating in the United States, most were built to turn profits when the price of ethanol delivered to a terminal market, such as Chicago, hits $1.30 to $1.35 a gallon, Mr. Byrne said.

A year ago, ethanol terminal prices were down to a $1 to a $1.20 a gallon, and some plants lost money, he said.

But with ethanol prices at the terminal hovering between $2.70 and $2.90, some plants now are swimming in profits. And Mr. Byrne said he's bullish on ethanol and bets that prices will never go down to $1.20 again. "The plants right now are very profitable if managed right and in the right location," he said.

Mr. Byrne said those high profits are based on plentiful low-priced corn, which has been the case the last several years. But the price of corn has been working its way up.

And natural gas, an ethanol plant's second-largest expense, also is getting more expensive. Over the long term, those two factors could cut profitability, he said.

Feed corn is a critical fuel source, so a plant typically can have an annual purchase expense of $70 million or more. If a corn shortage sends prices up quickly and ethanol prices drop, perhaps because of lower gasoline prices, what looked to be a sure profit can drop, Mr. Byrne said.

"The problem is, your bottom line can change by $100 million pretty quickly either way, and that's pretty significant."

But for now, profits are high.

"If you have a 50 million-gallon plant and ethanol hits $2.30, you've made $50 million. Your returns now are very, very good," Mr. Byrne said.

A typical 50 million-gallon plant stands to make additional millions. Distillers' dried grain - the byproduct from distilling the starch from corn during the ethanol process - can fetch $12 million to $13 million. Cattle farmers buy the product.

Carbon dioxide, another byproduct, is worth about $2 million to bottlers and dry-ice makers, Mr. Byrne said. A plant's payroll and maintenance total less than $2 million annually.

Alex Samardzich, chief executive of Ace Ethanol LLC, which runs a 40 million-gallon plant at Stanley, Wis., said local agricultural issues greatly affect a plant's profits. "Sometimes there's too much corn, sometimes not enough. What you'll find is with profitability, it ranges across the board," he said.

Unlike some investments with only a few unknowns, ethanol has up to five price variables that affect plant profits: corn, ethanol, oil, natural gas, and transportation.

Becayse 65 percent of a plant's cost is feed corn, Mr. Christianson said, location and access to corn is critical.

Most, but not all, existing plants were built in the Midwest or near corn supplies. New plants will be closer to gasoline suppliers and save on ethanol shipping costs.

But Mr. Byrne said the builders of those plants are gambling that corn transportation costs won't rise - a risk because other industries are competing to use rail to lower shipping costs as rising oil prices increase trucking costs.

Although feed corn has been plentiful - the last two years have had bumper crops - the added demand for ethanol production along with demand from farmers in the United States and abroad for hog and poultry feed means supplies could tighten quickly and raise prices, Mr. Byrne said.

Nationally, 35 ethanol plants are under construction and 97 are in operation, mostly in the Midwest. Plans for 150 other plants have been announced in the past year. Two plants will be opened in Michigan this fall, and four others could be running within a four-hour drive of Toledo.

Plants typically produce 5 million to 50 million gallons a year, although some newer ones are much bigger.

Ethanol, derived from corn and processed to mix with gasoline to make usable fuel, gives off fewer harmful emissions but also gets poorer fuel economy than regular gasoline. Some alternatives contain as much 85 percent ethanol, which some vehicles can handle.

The gas alternative now accounts for about 3 percent of vehicle fuel in the United States, but may jump to 10 percent within five years, a General Motors Corp. expert said last week.

The industry has drawn big enthusiasts and investors, from large equity firms and billionaires like Bill Gates, to farmers and small stock market players. The Andersons Inc., of Maumee, is among the companies that have benefited by the ethanol craze.

The Andersons, Mr. Byrne said, is a good fit for ethanol.

"They're no more in control of corn prices than the ethanol prices," he said. "But if the corn price drops significantly they can hedge. They have the knowledge of how to manage risk, and that's the key to profitability with these plants."

A recent profit variable is natural gas, which many plants use to heat tanks that distill ethanol, Mr. Byrne said. With natural gas prices spiking, some plants are spending $15 million to $25 million a year for gas, about twice their costs a year ago.

As a result, some are turning to alternativ energies to generate heat, including burning wood chips or dried distilled grains, and in Texas, dried cattle manure.

At Great Lakes Ethanol, Mr. Ehlert said his plant's projected natural gas costs have doubled in a year. And a steel shortage pushed construction costs up 30 percent from a year ago.

Mr. Byrne, the consultant, said in assessing sites, "We like to see a 30 percent return over a five to 10-year period. If it's not showing that, we don't recommend that they go for that," he said.

Pacific Ethanol Inc., which buys and sells ethanol supplies through its Kinergy Inc. subsidiary and is building a 35 million-gallon plant near Madera, Calif., said in its recent quarterly financial report that "the market price of ethanol will, for the foreseeable future, continue to experience significant fluctuations which may cause our future results of operations to fluctuate significantly."

Since 2003, Kinergy's gross profit margin averaged 2 to 4.4 percent. In the first quarter of 2006, it jumped to 6 percent but the company cautioned that "future gross profit margins may be lower than average historical levels" because of increased competition and because direct sales contracts could cause lower gross margins.

Rapid expansion of ethanol plants concerns small investors like Bryant and Ann Hokeness, a farm couple in Elkton, Minn.

Mr. Hokeness invested in an ethanol plant near Claremont, Minn., in 1996 and Mrs. Hokeness invested in one at Benton, Minn., last year.

The first year, corn prices were high and no return on investment was paid, he said. "But 9 of the last 10 years we got a dividend and some years we've had about a 25 percent return on investment."

His original shares in the

Claremont plant cost him $5 each. and are now valued at about $6.50. "You would think they'd be worth $13 or $15 with all the fuss."

The shares might be higher, he said, if local demand for ethanol were higher, but the pump price for E85 gas in southern Minnesota is only 20 to 30 cents less than gasoline, and at some stations, only 10 cents. At those prices, ethanol stock is valuable, but not valuable enough to make his shares skyrocket.

Mrs. Hokeness sank $25,000 into the Benton plant, paying $5.25 a share. The shares are now valued at $6 each. Mr. Christianson said most farmers investing in ethanol cooperatives paid about $2 for shares now worth about $5 each.

The majority of plants, he said, earn return on investment of 13 to 20 percent range, although some have produced well over 30 percent.

"Right now, ethanol is a good investment but it may not always be with all the new plants being built," Mrs. Hokeness said.

Contact Jon Chavez at: jchavez@theblade.com or 419-724-6128.



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