Giving Them Credit: Farm Credit System is still a player in the ethanol game

For most of its history, the ethanol industry was dominated by small plants owned by farmer cooperatives and limited liability companies. These pioneering efforts were boosted by the Farm Credit System, which looked at the industry as part of its mandate to help farmers expand their markets. When the industry began to boom, Wall Street and commercial banks started putting a lot of money into the ethanol industry. But with a looming credit crisis, is it time for the FCS to again take the lead in financing growth in the industry?
By Jerry W. Kram | March 10, 2008
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In the early days of the fuel ethanol industry, many of the pioneering plants were built by farmers who formed cooperatives to get more and better markets for their grain. Starved for credit, the cooperatives staged equity drives where farmers invested their hard-earned cash to build the plants with help from the Farm Credit System. In recent years, the boom in demand for ethanol made it more attractive to private corporations who funded their plants with investments from equity funds and commercial banks. With ethanol margins being squeezed and a possible credit crunch looming, not to mention a dramatically expanded renewable fuels standard (RFS), the FCS could re-emerge as a force in the ethanol industry.

A study commissioned by the American Bankers Association and the Independent Community Bankers Association indicated that the FCS provided just 8 percent of the development capital for the industry since 2004. According to the study, commercial banks provided 56 percent of the funding and private equity sources such as individual investors and hedge funds provided 36 percent. The study was conducted by New Energy Finance Limited of Alexandria, Va.

SOURCE: new energy finance

Ken Auer, president and chief executive officer of the Farm Credit Council, says the study overlooks the role the FCS played in building and sustaining the ethanol industry through most of its history. "We looked at the stories that were being written and they were mischaracterizing what the study was saying and trying to imply that the vast bulk of financing for the renewable fuels industry had come from community and commercial banks," he says. "They were looking at a three-year period that really came after the industry had gotten up and running as opposed to who helped the industry get started."

Auer objects to the study because it was based on an internal database of ethanol industry transactions maintained by New Energy Finance. "It's not a very good study," he says. "You don't often see a study where they did a cursory review of their data without using or citing any specific data. It was like they used a proprietary set of data and didn't make it available."

Auer says the FCS continues to be a significant and growing source of capital for the ethanol industry. "As of the end of the third quarter of 2007, the outstanding loans and loan commitments to the industry was something like $4.2 billion," he says. "That represented something like a $900 million to $1 billion increase over the end of 2006. So in 2007, the system continued to play a role in providing capital to the industry. We do that directly as well as working with other financial institutions."

Auer says a FCS study shows that to meet the requirements of the RFS in the Energy Bill the ethanol industry will need an additional $105 billion in capital over the next 15 years.

He says the New Energy Finance study indicated that commercial banks and other private institutions only invested about $2 billion a year in the ethanol industry over the past four years—the period of ethanol's fastest growth. "Our view has always been that that sort of increase in capital requirements was going to require a broad base of financial institutions to participate in that marketplace," he explains. "As of right now, Congress has not seen fit to expand the flexibility of the system. It is up to Congress whether they want to pursue that or not."

SOURCE: lecg llc

2007 was a challenging year for the ethanol industry with higher feedstock costs and lower ethanol prices. Without a change in economic conditions ethanol has the appearance of being a riskier investment than in the earlier years of the decade. Rumblings in the real estate markets have shaken credit markets, which have in turn impacted investment in many industries, including ethanol. "The commercial banks have said they can and would do it all," Auer says. "That is a fine thing to say, but considering what has been happening in the credit markets lately, it's kind of a fantasy land they will continue to extend themselves in a risky business."

Changes Upon Changes
The industry has evolved in impressive directions the past four or five years. Where 25 MMgy plants were once the rule, now 110 MMgy seems to be almost a "standard" ethanol facility. Production has doubled and redoubled from 1 billion gallons to nearly 7 billion gallons per year. However, Auer argues, much of the underlying economic realities of the industry haven't changed. "It's not a matter of ethanol becoming big business," he says. "It has always been a business. These folks were in business to produce a product, be successful and earn income from that product, whether it's done through a cooperative or is privately owned or a limited liability company."

In 1991, only a small fraction of the 865 MMgy of ethanol production was owned by farmer controlled cooperatives or limited liability companies. Today, with nearly 7 billion gallons per year of production, more than 40 percent of all plants qualify as farmer owned, according to a study by LECG LLC commissioned by the Farm Credit Council, a trade organization for FCS lenders.

That study showed that the FCS was the lead lender or a participant in financing 75 of the 131 ethanol plants in production in 2007 (57 percent). "The mission of the Farm Credit System is to be there and be supportive of agriculture and rural communities," Auer says. "The system viewed ethanol as a value-added business that farmers were getting involved in. The system was supportive of the industry as it grew."

Some of the changes in the ethanol industry have made it more difficult for the FCS to become involved in ethanol projects. There are limitations in current law on who can receive loans from the FCS. Auer says there has to be significant farmer investment in an ethanol project to qualify for a FCS loan. "If an ethanol plant is owned more than 50 percent by farmers, and those farmers put their own corn through that facility, which is called throughput, then that entity would be eligible to borrow from the FCS," Auer says. The ethanol company could be either a cooperative or limited liability company, as long the required level of farmer investment and throughput was met.

The legal organization of the company—whether as a cooperative, limited liability company or other business—isn't as important as being able to prove that the plant has the required level of farmer participation. "You may have a corporate-owned plant that is actually a limited liability company that involves not only farmers but nonfarmers in a given area," Auer says. "It could be a major corporation like Archer Daniels Midland Co. So there are all sorts of different types of ownership out there. The system works with those ownership models where we can and where they are eligible to borrow from the system. In that case the system is interested in competing to provide them credit."

Bigger plants, which have been getting more expensive per gallon of capacity to build, are making it harder for ethanol developers to gather enough farmer equity to allow the projects to qualify for FCS financing. "What has become clear as the capital needs of these plants has increased, farmers have been saying they can't put up the full capital," Auer says. "They have to find additional outside investors. Where farmer ownership could once have been 55 percent, now it could be 30 percent. When that happened, the FCS could no longer directly finance those projects." There was a proposal in the House of Representatives to allow FCS to finance ethanol projects irrespective of the level of farmer ownership.

That provision was included in the House version of the Farm Bill that came out of the Agriculture Committee. However, that provision was struck from the bill on the floor of the House.

If ethanol producers want the FCS to be more active in the industry, they will have to help persuade Congress that changes need to be made, Auer says. "FCS continues to be very supportive of the industry. We continue to be very interested in working with the industry. To the extent that the current law prevents that, we need help to convince Congress we need greater flexibility to provide credit to the industry. Congress needs to be hearing from the industry if it would like the FCS to have greater flexibility."

Jerry W. Kram is an Ethanol Producer Magazine staff writer. Reach him at or (701) 738-4962.