Overcoming Ethanol's Growing Pains

By Rick Kment | June 02, 2008
Growing pains are a natural part of any lifecycle. As we age and mature, growing pains are all but certainties. There are relatively few problems in the first few stages of a lifecycle.

For example, a newborn child essentially has few problems through its infancy. Everyone pays it due attention and showers it with love. However, as the child begins to mature, challenges begin to arise, and with each new phase in life comes a new set of difficulties. In particular, most remember the growing pains that consumed us during our teenage years. This is true in our lives as well as for the still-maturing ethanol industry.

At the mid-point of 2008, the ethanol industry is experiencing some adversity. As the industry continues to mature, it is important to examine and understand these challenges. In a sense, the commercial ethanol industry has grown out of its infancy and is reaching its teenage years. It is now in a phase where it is growing quickly but experiencing some awkward difficulties figuring out how to handle its development.

Ethanol Economics
Prompted by a surge in political support and financial investors, the biofuels industry has continued its strong move toward steadily increased production. This has been especially prevalent in the rapid growth of the corn-based ethanol market during the past two years. However, since early 2008 the industry has seen a decrease in the financial support from investors to finance the construction of new plants.

A number of reasons exist for this falloff in investor interest, but ultimately, the industry is experiencing a tightening of the market. Many of the newer plants that have come on line in the past two years are still paying off debt and thus having a harder time remaining profitable. Neeley Biofuels—DTN's hypothetical ethanol plant based in South Dakota—is showing a slight loss due to sharply higher input costs. Plant operators are facing input prices that are double to triple the costs that they initially anticipated when these plants were being constructed.

In addition to input costs, transportation issues also hinder plants. Whether transporting ethanol by truck or train, high energy prices—primarily diesel fuel—have increased the cost of transporting ethanol from the production facility to end users.

Despite these challenges, profit margins rebounded slightly during the spring months of 2008, which helped increase the profitability at most plants. With a number of new plants coming on line either in 2008 or early 2009, the capacity to produce 13 billion to 15 billion gallons of ethanol per year will most likely be met in 2009 or 2010.

Ethanol Infrastructure
Similar to a young teenager without a driver's license desperately trying to meet up with friends at the mall, the ethanol industry is still struggling with fundamental transportation issues. Across the country, states are beginning to blend significant amounts of ethanol into their gasoline. In particular, southeastern states such as Florida, Louisiana, Mississippi and Georgia have begun blending or increased blending of ethanol. Although eager to supply the product, transporting ethanol to these states has proven to be more difficult than expected.

Ethanol futures price

SOURCE: DTN

Unlike gasoline, ethanol isn't shipped in established pipeline systems. The fundamental problem is that the majority of ethanol is produced in the Midwest, or Corn Belt, and must be shipped to highly populated areas, which are typically on the coasts. The pipelines, however, were meant to move gasoline in the opposite direction—from the coast to inland regions of the country. Transporting ethanol through pipelines also raises concerns regarding water getting into the ethanol.

Currently, the majority of ethanol is shipped via rail. However, railways have since become overly congested. In addition, few ethanol terminal locations are large enough to unload unit trains of 80 cars or more. Currently, additional unit train facilities are being built to alleviate this bottleneck. The majority of locations can handle approximately three to 10 railcars. This still leaves much of the country to rely on the trucking industry to ship ethanol to the closest terminal location, which has proven to be costly with the ever-rising fuel prices. As the industry continues to increase overall production and demand steadily grows, transportation will be a long-term challenge that will not only damper but add to the cost of the delivered product.

Consumer Perception, Acceptance
Every teenager will say how important it is to have the right image and the struggle to win acceptance from their peers. Again, the same is true for the ethanol industry. Consumer perception and acceptance of corn-based ethanol continues to waver. Like a nasty rumor circulating through the cafeteria, speculation and finger pointing has tarnished the reputation and credibility of the ethanol industry. This is due in large part to higher energy costs, increased food prices and environmental concerns.

Yes, corn prices and food costs have risen in part due to the increased demand for ethanol, but to say the ethanol industry is the culprit behind these factors would be a broad overstatement. Increases in corn prices have also been significantly impacted by the surge in investment interest in commodities. This interest has been spurred by the fact that commodities are perceived as "safer" investments with higher returns than many areas in the stock market. Also, the issue of increased food prices is far more complicated than simply pointing a finger at corn prices.

On a broader scale, there are several factors behind the rise in food prices. According to a report by the Center for Agricultural and Rural Development at Iowa State University, there is a close and significant correlation between energy prices and food prices. The report estimated that a 10 percent increase in energy costs would lead to a 5 percent increase in retail food prices. Other factors such as labor costs and an increased demand from the booming Asian economies also can be factored into higher food costs.

The environmental issues are hit-and-miss as well. It has been reported that ethanol indirectly creates an indirect land usage issue in which land in other countries (rainforests and wildlife-rich territories) is being used to produce inputs for the biofuels industry. From this theory, some are saying the ethanol industry is more detrimental to the environment then petroleum gasoline. However, in order to correctly make that argument a study would have to take into account the indirect environmental affects of the petroleum industry and
urban sprawl. To my knowledge, no such study has been completed to accurately contrast the two.

I believe consumers are confused, and rightfully so. It seems as though everyone wants an idealistic solution to the country's dependence on oil that has no pollution or adverse affects to any facet of society or inconvenience to the general public. Unfortunately, there is no such solution. In fact, very few alternative options, such as hydrogen-powered cars, are commercially viable. Even commercial industrialization of cellulosic ethanol is still a few years away. As the industry matures, however, advancements will be made. It is also important to note that the U.S. Energy Bill has already planned to cap the production of corn-based ethanol at 15 billion gallons per year. Consumers must realize that corn-based ethanol and biodiesel, although not the perfect and end-all solution, are currently our most viable alternatives to reprieve the overall net issue of reducing the use of petroleum fuels.

Keeping focus on long-term production and continued advancements toward commercializing cellulosic ethanol should be the focus of ethanol producers. In addition, the industry needs to continue to be proactive in providing the public with a well-rounded perspective to the country's current, hot-button issues (increased costs and environmental concerns).

So a significant part of maturing, as the ethanol industry continues to do, is learning to recognize and overcome the bigger challenges that face it at various stages of development. In its teenage years, the ethanol industry is experiencing some challenging hurdles. But, as we all did in life, the industry will eventually overcome these huddles as it continues to mature.

Rick Kment is a biofuels industry analyst with DTN. Reach him at rick.kment@dtn.com.