Fueling America Through Renewable Resources
Bio
E
nergy
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em f eha
Chris Hurt, Wally Tyner, and Otto DoeringDepartment of Agricultural EconomicsPurdue University
ID-339
Farming or uel is a relatively new conceptor U.S. agriculture. Biouels include bothethanol (corn) and biodiesel (soybean oil),but ethanol is ar in the lead. Productioncapacity across the country is expected toexceed 8.0 billion gallons by early 2008 andsubstitute or approximately 5% o U.S. gasolineconsumption. Some hope that biouel pro-duction can eventually substitute or as muchas 25% o the country’s gasoline over the next20 to 30 years. Te ultimate importance o biouels will be determined by events thatare still to unold. Te drivers are expected tobe ound in energy prices, state and ed-eral energy policy (Doering, 2006), and intechnology, particularly the improvement o the process to produce ethanol rom cellulose(plant material) (Mosier, 2006).Why is there such startling interest in uelsrom arms? Te nearly “gold rush” status isdriven by powerul protability, especially orethanol. Te ederal subsidy o $0.51 per gallono ethanol was established when crude oilwas less than $30 per barrel. At that price o crude oil, the subsidy was necessary to makeethanol protable. However, withcrude oil much higher, ethanol hasshied rom being just protableto being highly protable, and thusmajor investment in the sector hasbeen stimulated. Te value o etha-nol can be thought o as comingrom three components:1. Te energy value as a replacement orgasoline2. Te value o subsidies and policy incen-tives provided to ethanol,3. Te value o ethanol as an additive that isprimarily an oxygenate (to produce cleanerburning uel) and octane enhancer orgasoline.
Energy Value
Te energy value in a gallon o ethanol isless than in a gallon o gasoline. While exactdiference in gas mileage will probably vary somewhat, it is expected that a gallon o ethanolwill only do about 70% o the work o a gallono gasoline. Tereore, we would expect theenergy value o ethanol to be about 70% o thewholesale price o gasoline.
Subsidy-Policy Incentive Value
Federal government policy is to stimulateethanol production and thus provides a $0.51per gallon subsidy to blenders o ethanol. Tis$0.51 per gallon is about $1.35 per bushel o corn used. Tere are other ederal ethanol
Fueling America Through Renewable Crops
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Economics of Ethanol
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Figure 1.
Corn Breakeven Price for Ethanol: November 2006 Estimated Costs
subsidies primarily targeted at initial production years andsmaller plants. Te national Energy Bill passed in the summero 2005 mandated the use o at least 7.5 billion gallons o biouels by 2012, a level that will be exceeded in 2007.Some states also have a state subsidy or ethanol production,and still other states provide nancial incentives to ethanolproducers such as support or inrastructure developmentand job training assistance. Finally, more states are passingtheir own state renewable uels standards. Minnesota, orexample, mandates all gasoline sold in the state must be atleast 20% renewable.
Additive Value
Ethanol tends to trade at a premium price even above its value o energy and the subsidies. wenty-ve states haveeither restricted or outlawed the use o MBE (methyltertiary butyl ether) as a gasoline oxygenate because it ishighly toxic and has been ound in ground water. Te 2005ederal energy legislation ended the ederal requirement orspecic oxygen levels in gasoline. Oil companies are nowree to meet the clean air requirements in any way they choose. Tus, in May 2006, when the oxygen requirementsended, oil companies were no longer required by the gov-ernment to add a certain level o oxygen, and most companieseared legal liability i they continued to use MBE.For most blenders, the best way to meet the emissionsstandards in the Clean Air Act is now to use ethanol toblend with their gasoline. Te largest part o this premiumis related to the value o ethanol to replace MBE as anoxygenate. Also, ethanol has an octane o 106 compared to87 or gasoline, so it has value to enhance octane. Beyondthese technical values, some drivers will pay premiumsto use ethanol blends over straight gasoline. Tere is alsoa strong national interest in reducing the dependence onoreign oil, which helps enhance ethanol demand as well.
Economic Bottom Line
Figure 1 illustrates the economics o ethanol, depicting therelationship o crude oil prices and the estimated break-even price per bushel that an ethanol plant could pay orcorn. Breakeven corn prices still allow the plant to be paidof in 15 years and or equity investors to receive 12% peryear return on their investment dollars. Construction andoperating costs similar to November 2006 are assumed. Tethree lines relate to the three component values or ethanol.(Te Appendix explains the complete set o assumptionsbehind the relationships in Figure 1.)Te bottom line in Figure 1 represents the value o theenergy in ethanol based upon 70% o the value o gasoline.As an example, with $60 per barrel crude oil an ethanol
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Economics of Ethanol
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plant could pay $2.19 per bushel or corn. Te middle linerepresents the corn breakeven price when the value o the$0.51 per gallon ederal subsidy is added, and at $60 oil thisis $3.96 per bushel. Finally, when an oxygenate premium o $0.25 per gallon is added, this raises the estimated break-even price an ethanol plant could pay to $4.82 per bushel.During some periods, the oxygenate premium has beenconsiderably higher than the 25 cents per gallon assumed here.Given these assumptions, this means that i a plant can buy corn at less than $4.82 per bushel, the owners will get ahigher return than 12% and/or a quicker payback than 15years. We should note also that the capital cost componento ethanol production cost is about 30 cents per gallon, or80 cents per bushel. Tis means that existing plants withcapital costs already recovered could potentially pay 80cents more per bushel or about $5.60.Tis summarizes some o the great opportunities in etha-nol, but also highlights some o the extreme vulnerabili-ties. One vulnerability is the oxygenate premium. As thesupply o ethanol increases to meet the amount needed toreplace MBE, the oxygenate premium could drop sharply.We have not experienced the situation in which ethanolproduction exceeds oxygenate demand, so there is consid-erable uncertainty regarding ethanol market value oncewe reach that threshold. Without the oxygenate premium,the ethanol industry will be operating on the middle linein Figure 1. You can see that lower crude oil prices couldmake ethanol prots vulnerable as well. Te corn breakevenon the middle line with $50 oil as an example is a bit over$3.00 per bushel.Te high demand to build ethanol plants is bidding upconstruction and processing costs, which also makeethanol prots vulnerable. Another major vulnerability isthat as more ethanol capacity comes on line, the increasingdemand or corn results in higher corn prices, thus narrowingethanol producers’ margins. Finally, the ederal subsidy is very large and could be subject to change, as higher cornprices have adverse impacts on livestock producers andultimately on livestock product consumers (yner andQuear, 2006).
Conclusion
Te uture direction o ethanol will be highly dependent onstate and ederal governmental policy and on energy andcorn markets. I all actors were to stay as they are today, theexponential expansion o ethanol plants would continueuntil corn prices were bid up to near their breakeven level.It is much more likely, however, that policy and energy priceswill also be dynamic, that corn prices will rise, and thatother constraints will dramatically slow the growth o theindustry aer 2007.It is clear that the ethanol industry cannot continue togrow at the current rate based on the use o the corn seedas a eedstock source without hitting major constraintsincluding extreme competition or corn to be used oreed, exports, and ood. Aer 2007 the industry will haveto grow at a much slower rate, probably keeping pace withcorn production increases. Te hope is that cellulose-basedethanol can then emerge by 2010 to 2012. However, as longas corn based ethanol is protable, investors will probably preer the more certain technology to the still uncertaincellulose technology.
References
Doering, O. “Ethanol and Energy Policy.” (ID-340).Purdue University Cooperative Extension Service (2006)<http://www.ces.purdue.edu/bioenergy >.Mosier, N. “Cellulosic Ethanol—Biouel Beyond Corn.”(ID-335). Purdue University Cooperative ExtensionService (2006) <http://www.ces.purdue.edu/bioenergy >.ifany, D.; Eidman, V. “Factors Associated with Success o Fuel Ethanol Producers.” Staf paper series, P03-7,Department o Applied Economics, University o Minnesota (2003).yner, W. E.; Quear, J. “Comparison o A Fixed and VariableCorn Ethanol Subsidy.”
Choices
, Volume 21, No. 3,pp 199-202 o pd. (2006) <http://www.choicesmagazine.org/2006-3/grabbag/index.htm>.
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