Market Report

December 12, 2008

Higher Yields Coupled With A Decrease In Demand Will Keep Corn Prices Lower And Improve Operating Performance Of Ethanol Producers For 2009
New seed and planting innovations will boost corn yield per acre, driving corn prices lower, in our opinion. Companies such as Monsanto and DuPont have new, innovative seeds and technologies in their research and development pipelines. On the horizon are seed technologies which will resist drought, disease and insect destruction. The hybrids that the agricultural segments of these corporations are working on will save farmers in excess of $10 billion dollars world-wide and increase yields on average 2% annually, by our estimates. We have seen a wave of biotechnology released from the R&D pipelines in 2007 and 2008, and expect further innovations for the 2009 season Corn exports for 2009 are expected to decline, adding to supply in our view. The USDA projects corn exports at 2 billion bushels for the 2009 crop year, nearly 18% below the 2008 crop year. Corn will face heavier competition with wheat and coarse grain production in the upcoming year, according to early USDA forecasts. The European Union (EU) is expected to produce more wheat in crop year 2009 versus crop year 2008, which translates to less EU corn imports and a higher supply of corn in the world market. Hedge funds and commodity sell-offs have recently put downward pressure on the price of corn and other commodities, and we expect this trend to continue through 2H:09. Speculation is one reason for the mid-summer price spike of corn. The price of corn reached an all time record of $7.99 per bushel in July, but has since retreated over 60% in less than four months. Hedge fund managers must share responsibility, as they invest in commodities to offset other losses. Currently, with the strong downward movement of commodity prices, we expect hedge fund managers and other speculators to sit on the sidelines for the foreseeable future, which will continue to keep many commodities, including corn, at current or lower levels for the next 9 months, in our opinion. The Fed’s recent Wall Street bailout package could strengthen the US dollar, maintaining downward pricing pressure on the price of corn, in our opinion. The rise of the greenback is taking place largely because the rest of the world is looking at slower economic growth or, in some cases, even recession. The US economy is expected to rebound quicker than Europe, which also is reflected in the strengthening dollar. Exports of US goods including corn, which have been strong, will run into head winds if the dollar keeps rising. We contend that lower corn prices will help improve operating margins for wellmanaged ethanol producers, all other things being equal, and that growth in demand for ethanol will lead to improved profitability for these producers. The initiative for alternative fuels has poised the ethanol market to where it is today, 8 billion barrels forecasted for 2008. We expect ethanol to be the largest demand catalyst for corn through 2009, and anticipate that this higher demand will be offset by lower demand for corn in non-US markets and through improvements in yield. We anticipate improved margins for ethanol producers’ in 4Q:08 and through 2Q:09.

Introduction
The price and supply of corn is dynamic and influenced by a variety of factors, including hedge funds, global economies, the strength of the US dollar, exports and competition with other grains. The decline in the price of corn and other commodities since July has been astounding; oil is down nearly 70%, hovering in the mid $40’s, while corn and ethanol are down over 60% to $3.09 and 53% to $1.40, respectively. The pullbacks have been exacerbated by a widening global economic slowdown that has lowered the demand for commodities such as corn. ECM’s mission in this Market Report is to examine the variables that affect corn supply and demand and to explore corn’s relationship with these variables. In particular, we want to assess the catalysts that will help maintain lower corn prices and the impact of lower corn prices to an ethanol producer’s bottom line, and come to a conclusion regarding the future direction of corn prices and yields.

Now with the price of corn hovering around $3.25 per bushel, farmers’ margins are squeezed given the rising cost of fertilizer, diesel and rents. As of November 23, roughly 11% of the corn crop has yet to be harvested, versus 1% at this time in 2007. Farmers’ wishful thinking of $7 per bushel corn is one reason for a delayed harvest, but late maturation and wet conditions in October are also responsible for the harvest set back. However, the corn must be harvested soon to prepare the soil for the 2009 planting season. We expect that farmers will store some of their grain and wait for favorable pricing, but we do not expect farmers to leave their corn in the field or store their corn too long, as the cost of storage and risk of damage will erode profits. A stronger US dollar and lower exports are the result of the Fed’s Wall Street bailout plan. The action has begun to prop up the dollar, which will help lower corn prices, as countries that have imported US corn will realize favorable economics by importing corn or alternative grains from other nations. However, if the $700 billion package reignites inflation and selling in the dollar, corn may quickly regain its price loss. We think it is likely that the US dollar will continue to strengthen relative to other currencies through 2009. We contend that the US will recover from the global recession quicker than Europe and other nations, also giving the dollar a boost. Foreign competition with other grains will fuel corn supply build up. The USDA projects US corn exports at 2 billion bushels for crop year 2009, or nearly 18% below exports of the 2008 crop year, which ended August 31. Wheat and coarse grain production outside the US are expected to be record large in crop year 2009. Feedstock consumption of wheat outside the US is projected at 3.8 billion bushels, nearly an 18% increase year over year. Foreign wheat production is forecasted at 20.1 billion bushels, roughly 9% larger than the 2008 crops. According to Darrel Good, University of Illinois marketing specialist, most of the increase is expected in the European

Catalysts Lowering Corn Prices
Hedge funds and corn speculation have been a catalyst for corn price increases and pullbacks. Hedge funds and other speculators jumped into corn future markets during the summer on news that bad weather and flooding would threaten crop yield, and the investment in corn more than offset losses in other investments. The exuberance fueled corn prices to a record high of $7.99 per bushel by mid-July. Inexperience is partially to blame for the burst in the commodities bubble. For the first time, many hedge fund managers were exposed to a commodities boom and were not prepared for the volatility associated with commodities, like corn. Hedge funds and other big institutional investors plowed money into commodities as prices sourced in 1H:08. According to Alaron Trading Corp., the speculation drove a wedge between the commodities trading price and the intrinsic value of the asset as reflected by actual supply and demand.

Union, which translates to a decline in EU corn imports of 354 million bushels. Mr. Good went on to say, “Although the US exports virtually no corn to the EU, the decline in import demand makes more corn from other sources available to the world market.” A weakened global economy will continue to put downward pressure on corn prices. As the standard of living increases, people change their diets. They shift away from a diet consisting largely of staple food crops (such as rice and wheat) into a diet that includes more fish, meat, dairy products, and eggs. A broader economic slowdown has the potential to temper the increase in world meat demand for the short term, and therefore the rate of increase in corn feeding. A protein-based diet requires the feeding of livestock. Livestock is fed grass, grain and protein meal. More grazing land and an increased production of feed grains will be required to meet the escalating demand for the higher-income diet, in the long-term. US exports of all grain for livestock will retreat for the short-term, if a global recession continues, in our view. In the likelihood of a global recession, the trend will change and importing nations will shift to starch based diets that are native to the respective countries versus importing grain and livestock. Competition for sweeteners and livestock feed will lower demand for corn, in our view. According to the USDA, the US is the largest consumer of sweeteners, including high fructose corn syrup (HFCS), and one of the largest importers of sugar, making the US sweetener market the largest and most diverse in the world. Recent increases in sugar demand have been offset by decreases in demand for high fructose corn syrup.
HFCS, sugar for industrial uses, and direct consum ption im ports
15000 10000 5000 0 2004/ 05 2005/ 06 HFCS 2006/ 07 2007/ 08 4228 7272 4660 7218 4723 7017 4961 6807

About 70% of HFCS is used in soft drink beverages; most of the HFCS decline is attributed to reductions in demand for these beverages. We have not seen a downward trend in the sweeteners used by food manufacturers, indicating a greater likelihood that sugar has been replacing some of the HFCS. Other grains are used more widely than corn kernels for livestock feed. Nearly half or 95.8 million bushels of barley grown in the US is used to feed livestock. Some of the nation’s wheat is planted to a limited extent as a crop for livestock; also the straw is used for livestock feed. Soybean husks and soy meal are used primarily as animal feed. And lastly, a large part of the diet for horses, cattle and chicken is comprised of oats.
Planted Area for US Corn, Sorghum, Barley, and Oats 140 Acres (millions) 120 100 80 60 40 20 0
Corn Sorghum Barley Oats

93 /9 4

96 /9 7

99 /0 0

Corn for livestock feed use in the US is relatively static as a demand driver because of the growing availability of distillers grains as an alternative feedstock. This translates to lower corn prices on softer demand.

Catalysts Increasing Corn Supply
Biotech will increase corn yields
New seed and planting development will add to an increase in the supply of corn in crop years 2009 and 2010. Companies such as Monsanto Co. (NYSE: MON) and EI DuPont de Nemours & Co (DuPont) (NYSE: DD) develop agricultural seeds that are modified to enhance yield. In the pipeline of both organizations are advancements in biotechnology that will address the following:

Source: USDA

Ref ined Sugar

20 02

20 05

19 87

19 90

08 /0 9E

/8 8

/9 1

/0 3

/0 6

1) Drought tolerant corn. Drought causes world wide losses in excess of $8 billion. Reducing the need for irrigation will save growers time and money and increase yield. The product is in stage III of development at Monsanto; we expect a launch in about 2 years. 2) Corn that will combat rootworms, corn borers and other leaf or ear feeding insects. Globally, these insects combined are responsible for losses over $4 billion. A prelaunch is scheduled for 2009 and full commercialization is intended for 2010. 3) The most common disease found in corn fields worldwide is stalk rot, which is creating estimated yield losses of more than 263 million bushels in North and South America alone. DuPont expects the launch of the new disease-resistant seed for the 2009 growing season. 4) According to Dupont, US growers apply an average of 138 pounds of nitrogen per acre of corn, which translates to a cost of nearly $90 per acre. DuPont envisions a hybrid that will require less nitrogen, lowering the grower’s input costs. The reduced nitrogen corn is still in the first stage of development at DuPont; we do not expect commercialization before 2015. 5) More than 1.6 billion bushels of corn annually are used to produce ethanol, corn sweeteners and a variety of food and industrial starch products. Some hybrids in the development pipeline have the potential to produce more starch, decreasing the aggregate amount of corn needed for these productions. These products have recently been commercialized. 6) An exciting hybrid in the pipeline is a corn that will increase the value of ethanol co-products. DuPont reported that its hybrid will increase the levels of fermentable starch, improve corn oil

characteristics and enhance protein content in feed co-products. We expect commercialization of this hybrid in 3-5 years, as it is in stage II of development. New technologies and planting methods will also increase crop yields. New technology will improve performance predictability, reduce yield variability and accelerate the pace of yield enhancement. Gene sequencing and shuffling, laser and marker assisted seed selection and seed development technology all have the capability to boost yields. Farmers are using technologies like GPS, onboard computerized yield monitors and satellite imagery to ensure the most efficient use of fertilizers and chemicals. Also, today’s tractors and combines use state-of-the-art propulsion systems that more efficiently use diesel fuel. In the past 10 years, annual per acre yield production has grown more than in the previous 50 years. Biotechnology is responsible for an increase in yields from 1.5% per year for 1944-1994 to 2% per year since 1996, which translates to a 15 billion bushel corn crop by 2020. For 2008, the USDA estimates a yield of 154 bushels per acre grown on 86.9 million acres, compared to the 2007 harvest year of 151.1 bushels per acre grown on 93.6 million acres. We look for the average US corn yield to grow 2% for crop year 2009 to 157.1 bushels of corn per acre. We attribute the growth in yield partially to breakthrough technology.

Impact of corn price on the US ethanol industry
Factors determining profitability
The two most significant variables that drive the profitability of ethanol production are the cost of a bushel of corn and the selling price of a gallon of ethanol. As long as the change in the cost of a bushel of corn and the change in

the price of a gallon of ethanol retain a 3 to 1 relationship, profitability remains the same, all other costs being equal. Since 2006, increased demand for corn, including demand for ethanol production, resulted in temporary increases in price of corn; however, we think that corn prices will continue to adjust to near historic averages in the long run, given current and expected corn production levels. Increasing yield potential, along with the growth and segmentation of both new and old corn markets, will keep the corn market balanced. Ethanol’s presence in the corn market is necessary to stabilize corn price. According to the Ethanol Promotion and Information Council, corn markets have not seen significant growth in the past 10 years, with the exception of ethanol, and it is likely that without the increasing market for ethanol, corn prices would have decreased to near historic lows and acres would have transitioned into other crops such as soybeans and wheat. Corn used for ethanol will not significantly affect the price of corn, provided that ethanol production and corn yields increase at adequate rates.

The rapid increase in the price of oil slowed demand and reduced consumption, which in turn contributed to the decrease in the price of oil. As the economic conditions continued to deteriorate, both the demand for and price of gasoline and ethanol fell.

Continued Importance of Ethanol
Ethanol is added to 70% of the total US gasoline inventory at levels up to 85% (E85). We expect 100% of the US gasoline inventory to be blended with ethanol under PresidentElect Obama. We estimate that an additional 5 billion gallons of ethanol would be required to bring E10 to areas in the US that are not using E10. The number of vehicles that can operate on ethanol mixtures as high as 85% ethanol (E85) are on the rise; we expect that all new cars made in the US will be able to run on blends of E85 by 2013. According to the Energy Information Administration, the US production of 585,000 barrels of ethanol a day is reducing the US oil imports by roughly 500,000 barrels per day. In the short term, with a global recession looming, the price of oil has dropped considerably from its all time high of over $147 a barrel to roughly $45, or nearly 70%, in 5 short months. We cannot discount the nearly 750 million automobiles on the road world-wide that require fuel. We expect that the worldwide growth in new automobiles and demand for gasoline and ethanol will ease in reaction to a global recession. However, when economies do recover, the demand for automobiles, gasoline and ethanol will also strengthen. Emerging nations, such as China and India, will be the last to recover and restore demand, in our opinion. We are confident that the demand and price of oil will surpass record 2008 levels when the global economy recovers, high levels of manufacturing commence, emerging nations continue to develop, and an increased number of automobiles are on the road in more counties. We expect, within a year, the price of ethanol to rebound as supply of oil is limited and ethanol fills in the supply gap.

There is a distinct correlation between the cost of corn, the price of ethanol and the price of oil. As the price per barrel of oil peaked at $147, the price of ethanol spiked at $2.96, and the price of corn jumped to $7.99. If we examine the oil and ethanol relationship, we can conclude that higher oil prices helped fuel the demand for corn-based ethanol, which is the only commercially viable alternative fuel for cars and trucks in the US today. Ethanol is blended with gasoline in the US to lower the price of fuel and improve environmental quality.

Conclusion
US Ethanol Production 15 10 5 0 2008E 2009E 2010E 2011E 2012E 2000 2001 2002 2003 2004 2005 2006 2007

A decline in corn prices will reduce the cost of goods sold and result in improved gross margins. Although we anticipate two or three quarters of earning’s pressure as the selling price of ethanol is lower than the price in 3Q:08, we do expect lower corn prices to help mitigate the impact of a decline in revenue. We expect the price of corn to remain substantially lower than mid-summer prices, hovering in the range of $2.30-$3.50 based on our estimates through 2010. Lower prices will be the result of increased supply and lower demand. Higher corn supply and lower price will be attributed to: A stronger US dollar, reducing US exports. Corn’s increased competition with other grains for livestock feed. Emerging countries possible dietary shift, substituting local starches for meats. Global recession lowering the demand for gasoline and ethanol. New seed technology and farming innovations that will increase yield. Hedge fund and commodity speculator investment easing.

We do expect pressure on ethanol producers’ bottom-line for the short-term. The squeeze will be attributed to the selling price of ethanol, in our opinion. We think that the cost of goods (primarily corn) for ethanol producers will be favorable longer than the selling price of ethanol is unfavorable, from an ethanol producer’s perspective. We expect quarterly earnings for ethanol producers to reflect the lower corn costs, beginning with 4Q:08. We think that in 1Q:09, ethanol producers might feel top-line pressure as the demand for oil and price of ethanol continue to retreat, but a likely upswing in oil and ethanol prices during 2Q:09 will improve margins as the economy begins to mend and summer travel commences, increasing gasoline consumption.

Disclaimer This document and any attachments are for communication purposes only and are not intended to be a balanced view of investing in ethanol biorefineries. This information and any attachments neither constitute an offer to sell nor a solicitation of an offer to buy any security or other financial instrument including any limited partnership or LLC interest. The information may be inadvertently incorrect and is subject to change without notice. Care was taken in the production of this document and any attachments to obtain accurate information from reliable sources. However, Ethanol Capital Management LLC does not attest to the accuracy of any piece of information contained in this document or any attachments. In addition, some of the material in this document or in the attachments may contain opinions of the writer or of Ethanol Capital Management LLC and projections of future events made by the writer or by Ethanol Capital Management LLC. The opinions, projections and conclusions of the writer or of Ethanol Capital Management LLC may not be accurate

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