Fuel for Thought: Protecting an Ethanol Production Business

By Scott Helmer | July 08, 2008
Fueled by concerns about climate change and U.S. dependence on foreign oil sources, ethanol production is a fast-growing industry that may account for 15 percent of liquid transportation fuels within 10 years. Poised to meet growing demand, the number of ethanol production companies is expanding at a slowing but still rapid pace.

While ethanol production provides an alternative fuel source that may help protect the health of the planet and the U.S. economy, some ethanol producers are in need of protection from risks inherent in the operation of an ethanol production business. Fuel production plants are subject to losses that can damage operational infrastructure, shutting down production for long periods of time.

Ethanol producers are also at risk due to factors completely beyond their control, such as market fluctuations that affect the price of raw materials necessary to produce ethanol, including corn prices. The volatility in fuel prices can also have a significant impact on ethanol producers' profitability. Fuel production costs depend on raw material expenses, but the market price for finished fuel can also vary considerably. The bottom line: While the ethanol production business holds great promise, individual ethanol producers face a variety of risks that can keep them up at night.

Managing Risks, Getting Sleep
So how do ethanol producers take advantage of the great opportunities the industry offers and prudently manage the very real risks unique to the industry? How do they deal with the possibility of significant business losses that can result in lengthy, expensive downtime and the uncertainties caused by fluctuating material and fuel costs? The answer may be a well-designed property insurance policy.

However, it's important to bear in mind that not just any insurance policy will do. Because ethanol producers face risks that are unique to their industry, they should not settle for a cookie-cutter policy offered to every type of business from apple orchards to zinc mining operations. Ethanol producers need a policy tailored to address their particular concerns.

The following are items relevant in evaluating policy offerings.

Ethanol producers seeking the peace of mind that comes with adequate insurance coverage need to look beyond regular property insurance policies. Property insurance coverage typically includes business income provisions that provide some measure of protection against income loss. However, if the protection ends there, it's not enough for an ethanol producer.

That's because to determine business income protection limits, insurers typically look at annual income. However, that can vary a great deal for an ethanol producer. Producers who purchase coverage after a year in which income was reduced due to price fluctuations may pay less for their coverage. However, if they suffer a loss during a year in which income is high, they'll find their coverage isn't sufficient to cover their losses.

On the other hand, producers don't want to pay too much for coverage they don't need. That's why it's essential to obtain coverage from an insurer with expertise in the industry: a risk management partner who understands the risks posed by market fluctuations. An insurance broker who is also an industry expert can offer coverage that is adequate to cover losses in a profitable year without forcing producers to buy more coverage than they need.

The best approach is a policy that allows producers to estimate their annual incomes and then obtain a refund for overestimates. This type of tailoring is possible with an insurance broker who understands the ethanol production industry.

Addressing Time, Money Factors
Another factor that makes average business protection policies inadequate for ethanol producers is the limitations on time and money a typical policy carries. For example, most policies provide coverage for income loss only and limit it to 30 or 60 days.

Ethanol producers may need much longer to recover from a loss. They have expenses to meet such as payroll for highly skilled workers and ongoing operational expenses that are unique to the industry.

A serious incident at an ethanol production facility can knock the business out of commission for months. Ideally, an ethanol producer's insurance coverage would provide benefits to cover not only the loss of income that would occur while the facility was undergoing reconstruction but would also cover payroll expenses so that the producer could retain the skilled workers needed to get operations going again after repairs are made.

Consider that after a loss and during repairs, a smaller ethanol concern may be losing valuable tax credits the business had counted on as a result of projected production volume. A typical business insurance policy wouldn't factor the loss of income from taxes when determining coverage. An industry expert would discuss such a provision while crafting coverage specifically for an ethanol producer.

Contractual Obligations, Utility Interruptions
Another factor that may impact ethanol producers' ability to recover from a loss is their contractual obligations. In the ethanol fuel production industry, it's common for producers to sign contracts agreeing to produce a certain amount of fuel for a third party. The contracts often carry stiff penalties for failure to produce and deliver the agreed upon amount.

What happens to those contracts when a plant is out of commission? A typical insurance policy might cover the loss of income, but would it also cover the funds lost due to a failure to deliver on a contract or pay an amount adequate for the ethanol producer to outsource the work in order to meet the contractual obligation? With the right risk management partnership, ethanol producers can address these specific risks.

An added concern for ethanol producers is coverage against utility interruptions. Seamless utility service is vital for ethanol productionmore so than for many other types of business. However, many policies severely limit the amount of coverage for losses incurred due to utility interruptions. That might be OK for some types of businesses, but it could have a profound negative effect on an ethanol production plant. A broker who knows the industry would recognize the risk and make sure adequate coverage is available.

Another factor that can be critically important in determining whether coverage is adequate is how the insurer values stock. In the event of a loss, some insurers determine the value of lost stock based on how much it cost to produce it. Others determine value strictly by the market, which, as we've observed, is subject to significant price swings.

How ethanol producers' policies define stock value can make all the difference between recovering actual losses and being exposed to major unanticipated expenses. Again, the insurance broker's industry expertise comes into play since an experienced broker would help a client understand this risk and address it.

Recovering, Moving Forward
The ethanol production business offers a multitude of exciting possibilities for success, which is why it is growing at such a rapid rate. It plays a key role in policies designed to address environmental and geopolitical concerns. The industry can also provide much needed jobs that employ highly skilled individuals.

As with any potentially rewarding venture, the ethanol production business is also subject to a number of risks. Some of those risks, which are often specific to the industry, can derail a successful enterprise, leaving it exposed to catastrophic losses that make recovery unlikely.

However, with the right risk management partner, ethanol producers can protect their valuable businesses from losses that a broker who is not an industry expert might not anticipate. For ethanol producers, it pays to take a look at the business coverage limits with all the special factors affecting their industry in mind. Only by taking into account their unique circumstances can ethanol producers ensure they have the protection they need to fuel their business for years to come despite whatever challenges may rise.

Scott Helmer is president and CEO of Helmer Risk Management. Reach him at scotth@helmerrisk.com or (877) 435-6371 ext. 226.