Federal Reserve: Ethanol Opportunities May Fade

Kansas City report waffles on ethanol's impact for rural economies.

Published on: Jan 31, 2007

The euphoria over ethanol in rural America is overwhelming right now, in the wake of President' Bush's State of the Union address, which calls for a Renewable Fuel Standard of 35 billion gallons of ethanol and biodiesel by 2017.

Farmers are poised to capitalize, with a record number of corn acres planned to be sown this spring, to fuel the 107 ethanol plants currently in operation across the U.S., eight expansions and at least 49 more plants planned – with more announced every day.

Corn prices are cause for optimism at the farm gate. December, 2007 futures are at $3.98 in Chicago – a price that should make even the most pessimistic farmer happy.

Not so fast, cautions the Federal Reserve Bank of Kansas City. Nancy Novack and Jason Henderson, who develop the Fed's "Main Street Economist" publication
(online at www.kansascityfed.org/ruralcenter/mainstreet/MainStMain.htm.)  
argue that long-term, opportunities for farmers due to ethanol could be variable.

"Ethanol production may offer some bright opportunities for rural America. In reality, though, ethanol profits in the future will be highly variable, given the volatility of prices for corn, ethanol and other energy products," the authors write in the latest edition of the report.

"In 2006, roughly 20% of the U.S. corn crop went to ethanol production. During the fall harvest, the surge in crop prices seemed to validate ethanol's potential," the report says. "But higher prices can also bring unwanted side effects."

Among them:

  • Producers may wish to shift from other crops to corn, swelling future supplies and dampening prices.
    Feed costs for livestock are increased. From Aug. to Dec., 2006, feed costs jumped 24%. Cattle producers can feed distillers' grains, a by-product of the ethanol production process, but swine and poultry producers cannot.
  • Shift of location and structure of the livestock industry. Because wet distillers grains are prone to spoil and subject to large transportation costs, cattle feedlots and ethanol plants have a natural synergy. Therefore, we could see more feedlots emerge in the traditional Corn Belt – away from Kansas, Oklahoma and Texas.
  • In the 1990s and early 2000s, local ownership of ethanol plants was the norm, as investors sought to increase local corn prices and inject money in the local economy. Now, plants are increasing in size (from 30-50 million gallons per year – common in local ownership, to 100 million gallons per year or larger) and outside investors typically build these plants.

Risks associated with ethanol production include the increasing price for the feedstock, which is often corn, in comparison to oil prices. According to the "Main Street Economist," ethanol profits are sustainable when crude oil is at $80 per barrel, even when corn prices exceed $3.50 per bushel. However, if oil were to drop to $40 per barrel, $3.50 corn would cause ethanol producers to lose money. Oil prices now hover around $60 per barrel. Even with corn at $3.50 per bushel, ethanol producers can net about 50 cents per bushel.

Profit, however, takes into account a federal tax exemption of 51 cents per gallon of ethanol blended into gasoline (10% ethanol nets a refiner 5.1 cents per gallon of gasoline). "If lawmakers cut or discontinue the tax exemption, profits for ethanol will fall since the tax exemption is now capitalized into ethanol prices," the report states.

Also, new technologies, such as converting biomass into ethanol, could drastically impact the future of corn-based ethanol plants. While not yet reality, the first biomass-based plant is under construction and the technology is improving all the time, according to the report.