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Updated Corn Ethanol Economics

Executive Summary: The current cost to produce a gallon of ethanol is approximately $3/gal. The current price of ethanol is $2.86/gal, which explains why ethanol producers are shutting down. If corn and natural gas prices remain high, I think ethanol has to rise to something like $3.40-$3.60/gal to make it worthwhile to ethanol producers. So, if I was a commmodities investor, I would probably go long ethanol right now. The only risk factors I can see – given that there is a mandated (and rising) demand for ethanol – is if corn or natural gas prices collapse.

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This is an update to a post I originally made back in February 2008: Corn Ethanol Economics. While this is approximate, I think I captured most of the major economic considerations. In fact, one of the comments I received following the first essay was: “I work in an ethanol plant. Those numbers are pretty accurate, but the price we get for ethanol has been going up lately. Our margins have been poor lately, but are improving. But you did capture the important economic factors that have hurt us lately.”

Since then, natural gas, corn, and ethanol prices have all risen. So what do the economics look like today? The following is my previous analysis, with updated numbers.

I found multiple references for all of the numbers I am going to use, but I will only reference a single source. According to Ethanol Reshapes the Corn Market, one 56-pound bushel of corn will yield up to 2.7 gallons of ethanol and 17.4 pounds of distiller’s dried grains with solubles (DDGS).

The price of corn for July delivery as of this writing is $7.24/bushel, so each gallon of ethanol contains $7.24/2.7, or $2.68 of corn per gallon of ethanol. However, the DDGS can be sold, so a credit is applied for that. The current price of DDGS as of this writing is $175/ton, which is $0.0875/lb. Given that a bushel of corn yields 17.4 pounds of DDGS, there is then a $1.52 credit, which spread over 2.7 gallons is equal to $0.56 gallon. This reduces our cost per gallon to $2.68 minus $0.56, or $2.12 for just the corn input. (Note that there is sometimes a credit for carbon dioxide sales, but it is very small relative to the other costs and credits).

I still have to consider utilities (natural gas is a major cost), labor, enzyme and yeast costs, and depreciation. I have a spreadsheet from an actual ethanol plant, but there isn’t much in the public domain that I could find on this. The closest thing to a source on these is the spreadsheet in the presentation Fossil Fuels and Ethanol Plant Economics (for a standard dry mill process). If you look at Page 16 of the presentation, you can see that all of the miscellaneous costs together total approximately as much as the corn inputs. If you take the spreadsheet on Page 24 and change the natural gas price to the current price of $13.20/MMBTU, you get an overall energy cost of $0.51/gal of ethanol. (You can play around with the original spreadsheet that is in the PDF here). The sum of enzymes, yeast, and other chemicals comes out to be $0.14/gal, and labor, maintenance, and various miscellaneous expenses add another $0.23/gal.

On depreciation, I have several sources for capital costs that are pretty consistent. In the EIA’s Energy Outlook 2006, capital costs per daily barrel of corn ethanol ranged from $20,000 to $30,000, depending on the size of the plant. This breaks down to between $1.30 and $1.95 per gallon of installed capacity. This is also consistent with A Guide for Evaluating the Requirements of Ethanol Plants, which states “Current capital cost per annual gallon of installed capacity for an ethanol plant ranges from $1.25 to $2.00.” So let’s be conservative and say that we want to build a big plant, so the capital costs are on the low end at $1.30/gallon. Depreciate that over 15 years and this portion amounts to about $0.08 per gallon (but is captured above already).

However, for biomass to liquids facilities – which would include the biomass gasification to ethanol that some are calling cellulosic ethanol – the capital costs in the EIA’s Energy Outlook 2006 are listed at around 5 times that of a conventional corn ethanol plant. Thus, the capital depreciation portion is going to be around $0.40 per gallon of ethanol. (On the other hand, the feed costs should be much lower).

Summary

Times are tough for ethanol producers. This is what the economics roughly look like at $7.24 per bushel of corn and $13.20/MMBTU of natural gas. To produce 1 gallon of ethanol requires:

  • $2.68 of corn
  • $0.51 of energy
  • $0.14 of enzymes, yeast, etc.
  • $0.23 of labor, maintenance, and various miscellaneous expenses

There is a DDGS credit per gallon of ethanol of $0.56. Thus, the total cost to produce a gallon of ethanol today is $2.68 + $0.51 + $0.14 + $0.23 – $0.56, or exactly $3/gallon of ethanol. For reference, the July contract for ethanol in the Midwest closed yesterday at $2.86. And $3/gallon is merely cost of production. It doesn’t take into account any return on investment.

Also note that due to the lower energy content, this production cost is equivalent to a $4.48 per gallon production cost for gasoline ($3/0.67) – and that this production cost is a moving target: As long as the ethanol mandates are driving up the price of corn and increasing the demand for and cost of natural gas, corn ethanol producers must chase their tails in a vicious circle.

Producers are going to be hard-pressed to ever match the 2006 windfall that was given to them when the MTBE phaseout drove ethanol prices sky-high. But my conclusion is – since ethanol is mandated – some marginal producers will shut down and prices will rise. If everything else remained constant, I think ethanol would have to rise to something like $3.40-$3.60/gal to make it worthwhile to ethanol producers. So, if I was a commmodities investor, I would probably go long ethanol right now.

June 24, 2008 Posted by | corn prices, economics, ethanol, ethanol prices, investing, natural gas | 9 Comments

Prediction on Corn Futures Fulfilled

Last year, with corn bouncing around $3.70/bu, I wrote an essay called The Mythical Ethanol Threat. I noted the number of new ethanol refineries under construction, and predicted that overbuilding would lead to additional ethanol mandates (which it did). I wrote – Note to self: Corn futures to double again by 2009.

Today corn for September delivery traded at $7.50/bu. Corn for later delivery flirted with $8/bu. Why has this happened? Lots of reasons: Increased demand due to the ethanol mandate, increased costs due to sharply higher fuel, fertilizer, and pesticide prices (all due to higher oil prices), and now decreased supply is the icing on the cake. As I warned in Unintended Consequences, all it would take was a natural disaster in the Corn Belt to push corn prices up very sharply. Surprise! We have our natural disaster in the form of Midwestern flooding.

Our esteemed political leaders have set up a situation with corn analogous to the situation with oil. As spare capacity dried up, the oil markets became volatile. Prices have climbed as spare capacity eroded. (See Peak Lite Revisited for a graphical explanation). If for some reason a million barrels of oil went off the market, you could easily see prices race past $200/bbl because there are no producers who can step in and fill the shortfall. This is now the situation with corn, where the biofuel mandates have assured that continued record harvests are the only hope against sky-rocketing prices. We now see what happens when the record harvest fails to materialize – there are no producers who can step in and fill the supply gap. That is a recipe for volatility, and rapid price increases at the first sign of trouble. Get used to it – as well as more rationalization from the ethanol lobby that the mandates aren’t impacting food prices.

June 13, 2008 Posted by | corn prices, oil prices | 14 Comments

Gas at $4 and Corn at $7

For the first time ever, with oil prices pushing $140/bbl on Friday, the U.S. national average price for gasoline cracked $4/gal:

Gas price record reaches $4 a gallon

NEW YORK (CNNMoney.com) — Gasoline rose to a milestone mark Sunday as the national average compiled by motorist group AAA reached $4 a gallon for the first time.

The national average for regular unleaded rose 1.7 cents to $4.005, according the daily measure on the group’s Web site. That surpassed the previous record of $3.989 set Thursday.

People are starting to get the message, as gasoline demand is softening. This week I had to rent a car. I had requested a small, fuel efficient model. Guess what? Fresh out. How about this Nissan Titan with a powerful V8 instead? Same price as the fuel efficient model. I took it, because 1). I don’t have to drive much while I have the vehicle; 2). I didn’t have much of a choice unless I wanted to go to another rental agency. Jet lag across seven time zones argued against that.

Corn also reached an all-time high of $7.01 a bushel:

U.S. corn soars above $7 as crude rockets

CHICAGO, June 6 (Reuters) – U.S. grains and oilseed futures markets caught fire on Friday, with corn notching an all-time high above $7 a bushel, caught in a frenzied broad-based commodity rally led by soaring crude oil, traders said.

Further boosting corn and soybean prices were worries about the young U.S. crops. Torrential rains pummeled the American heartland this week, increasing prospects for a yield drag on both.

“There are Noah’s Ark-like conditions in the Midwest through next week,” said Vic Lespinasse, analyst for grainanalyst.com.

Farmers were hoping for ideal growing conditions this year given the huge world demand for grains and oilseed for food and feedstocks to produce biofuels.

Corn prices are caught up in a perfect storm. Of course high oil prices have a direct impact. The diversion of corn into biofuels has a direct impact. But I have warned and warned and warned that there was a very big potential danger from diverting food into fuel: A bad harvest would cause grain prices to spiral out of control. (See Unintended Consequences). I always used the example of a Midwest drought, but it looks like Midwest flooding is accomplishing the same objective. I also suggested that it would take something like this to cause us to reevaluate our biofuels policies.

A little over a year ago, I wrote an essay called The Mythical Ethanol Threat. At the time, corn was bouncing around $3.70/bu (Ref: Historical Commodity Futures Charts for Corn). After noting the number of new ethanol refineries under construction, and after repeatedly predicting (accurately, it turned out) that overbuilding would lead to additional ethanol mandates, I wrote – Note to self: Corn futures to double again by 2009. Another $0.20, and that milestone will be reached.

June 8, 2008 Posted by | corn prices, gas prices, mandates, oil prices | 22 Comments

Debunking Robert Zubrin

A reader asked me a while back to take a look at the claims of Robert Zubrin, and comment. So I took a look at his claims, and while I found things that were wrong, I was generally in agreement on his big picture stuff. I concluded with:

Overall, Zubrin is not completely in left field. He strays out there now and then, but his methanol argument is OK. I don’t consider him at all a crackpot…

But today he stepped out onto very thin ice with an editorial that spoke out in favor of our current biofuel policies:

The case for more biofuel

Let’s have a look:

Let’s start with the allegedly misbegotten incentives. The United States invests roughly $3 billion a year through a 51-cent per gallon credit to promote the production and use of renewable fuels like ethanol. The return on that investment? Taxpayers are saving approximately $6 billion that would otherwise be spent on counter-cyclical crop price supports, plus an additional $15 billion reduction in the country’s petroleum import bill.

First off, that $3 billion is based on 6 billion gallons of production. That number is now in the rear view mirror. There is no cap on the level of subsidy, so it just keeps growing as the production grows. If we could possibly get to that 36 billion gallon number, we would be spending $18.4 billion per year. Note that this is just direct federal subsidies. There are various state subsidies as well that add to the total subsidy pie.

But the worst part is that the Zubrin’s calculation is full of holes. To get the number above, Zubrin assumes 6 billion gallons of ethanol production. How much oil will that displace? The BTU value of a barrel of ethanol is just over half that of a barrel of oil. Say 1 barrel of ethanol is equal to about 0.55 barrels of oil. Then the 6 billion gallons of ethanol is worth 3.3 billion gallons of oil (78.6 million barrels). At today’s price of nearly $110/bbl, that only comes out to be $8.6 billion.

But there’s more. Per the most recent USDA publication on the issue, to produce one BTU of ethanol takes over 0.9 BTUs of fossil fuel. Mostly it’s natural gas, but there is some diesel and gasoline for farm trucks and tractors. So let’s say 0.7 BTUs of natural gas and 0.2 BTUs of diesel. That means within that $8.6 billion of “savings”, we still have about $5.3 billion of fossil fuels. (See Calculations at the end).

So Zubrin’s $15 billion savings is down to about $3 billion. On the other hand, there is a value for the DDGS which will add back to the savings, but it falls far short of the number that Zubrin is using to justify the subsidy. But we also haven’t counted up any of the negative externalities, and probably the most important point – you still have to pay for the ethanol. All we have done is add up the fossil fuel inputs. Add up the other costs (water usage, for instance) and Zubrin’s “savings” are now a deficit, but one that is going into certain Midwest states at the expense of everyone else.

Continuing to meander onto the thin ice, Zubrin writes:

Numerous well-documented studies have shown that by replacing oil with fuel made from biomass, America is reducing its net carbon dioxide emissions and thereby taking a bite out of global warming.

Numerous others have shown otherwise. The most recent studies have shown otherwise. And of course the recent Science articles show otherwise. Which to believe?

The claims that biofuel production in the United States might indirectly encourage rainforests to be cut down were published recently in the hallowed pages of the journal Science. But it turns out that “scientific avalanche” is itself being demolished. The studies published in Science offered no new data to substantiate their claim of a causal connection between U.S. ethanol and forest destruction – just a theoretical model that has since been roundly debunked by respected researchers from the U.S. Department of Energy’s Argonne National Laboratory and Biomass Program.

Let me make sure I understand this. The theoretical model for the study in Science has been “roundly debunked” by Argonne? First, Argonne is using a theoretical model as well. Second, note the strong language in the debunking: Michael Wang writes “At this time, it is not clear what land-use changes could occur globally as a result of U.S. corn ethanol production.” Whoa! What a debunking. You publish your study in Science, I reply with “Beats me”, and that’s a debunking! And by the way, was the Argonne model published in a “the hallowed pages of the journal Science” as was the study it presumes to debunk? Why no, it wasn’t.

So on the one hand I have a model from one of the top universities in the U.S. The researchers, formerly ethanol supporters, have no apparent axe to grind against ethanol. The paper is published in the premier peer-reviewed scientific journal. On the other hand I have a model that comes from a political agency in an administration that is very supportive of ethanol – written by Michael Wang, who has a history of being associated with dubious ethanol studies – and a model that was not peer-reviewed in any scientific journal. Tough call.

Meanwhile, real world data from the U.S. Department of Agriculture simultaneously belie claims that American ethanol is causing arable land to be cleared elsewhere and food prices to rise. In fact, the data show that the total acreage devoted to corn in America is not projected to go up, but that annual corn yields are expected to rise steadily – from 155.3 bushels per acre this year to 173.3 bushels per acre in 2017.

They projected that, did they? You know how they make those projections? They use a model. Did the model predict that grain stocks would be where they are today?

Those steady corn supplies are just one reason you can’t blame ethanol for food price increases.

You forgot the word “projected.” Those were “projected steady corn supplies.” You know, from the model. Yet you are treating these as actual data points.

If there is any problem with biofuels it is that America needs to produce more, not less, to put an end to the pick-pocketing of our national purse by OPEC.

Credibility is slipping due to all of these half-baked claims. If this were qualified by specifying methanol from gasification – as your earlier essays indicated – it wouldn’t be a big deal. Coming toward the end of an ill-advised defense of corn ethanol, it is garbage.

If Zubrin continues to write essays like this, he will have no credibility at all on this issue. This is unfortunate, because I think he has a contribution to make if he will stick to ideas that are actually defensible and stop defending that which isn’t. Far better to say “Corn ethanol isn’t ideal, so let’s move beyond it as quickly as possible.” Of course we know that this it not politically feasible, and this “bridge” is going to be permanent right up until even the dumbest politician recognizes the consequences. At that point, we will have driven over the cliff of bad consequences.

Assumptions and Calculations

The basis is six billion gallons of ethanol
One gallon contains 76,000 BTUs
One gallon has an embedded 76,000 (0.7) = 53,200 BTUs of natural gas
Today’s price of natural gas is $10/MMBTU (abnormally high, but so are oil prices)
Then in one gallon of ethanol, there is ($10/1e6)*53200 = $0.53 of natural gas

One gallon has an embedded 76,000 (0.2) = 15,200 BTUs of diesel
Today’s (spot, not retail) price of diesel is $3/gallon.
One gallon of diesel has 130,000 BTUs.
Then in one gallon of ethanol, there is (15,200/130,000)*$3 = $0.35 of diesel

Thus, in one gallon of ethanol we find embedded $0.88 of fossil fuels.
In six billion gallons, there is an embedded $5.3 billion.

March 12, 2008 Posted by | corn prices, ethanol, Robert Zubrin | 254 Comments

A Vicious Circle

What a vicious chain of events our politicians have set into motion. It just continues to worsen.

It started out innocently enough. Oil prices were climbing. Our energy production was shifting to an ever greater extent to countries that are hostile to the U.S.

So, Step 1 is to propose a solution:

1. Subsidize ethanol production to encourage biofuels and enhance energy security.

However, subsidies didn’t do the trick. It was still too expensive to produce ethanol. People still chose gasoline derived from hostile sources over more expensive ethanol. What we really needed was Step 2.

2. Let’s mandate ethanol usage.

At the point that the subsidy turns into a mandate, things change. Now, the fuel doesn’t have to be economically priced. It is going into the fuel supply regardless of the price. And this kicks off a massive expansion of ethanol capacity.

But soon we notice that too many people are building ethanol plants. This is causing a glut of ethanol, and putting downward pressure on the price of ethanol. On the other side, it is raising the price of corn. This lowers the margins for ethanol producers, and some producers start to go bankrupt. Projects are delayed or cancelled. The solution? Proceed to Step 3 (which was entirely predictable):

3. We need to raise the mandate for ethanol usage.

Unfortunately this leads to more of the problems that arose from the original mandate. Corn prices go even higher. Land prices continue to climb. Land is shifted to corn production, forcing commodity prices up in other areas. Very few segments of the population are experiencing true benefits.

The primary beneficiaries are commercial corn (and other commodity) farmers who purchased their land several years prior to the mandate. They are truly experiencing a windfall from these policies, and thus will fight the hardest to continue down this ill-advised road.

Secondary beneficiaries are lobbyists who defend the practice, as well as those who are willing to write papers (commissioned by the National Corn Growers Association) that downplay the consequences (or even better, point the finger in another direction).

The ethanol producer is hurt each time the overbuilding cycle occurs. They are starting to realize that the energy business is often low margin (and cyclical), and not as lucrative as they once thought. Maybe the solution is to increase the mandate again? 😉

The cattle rancher (like my Dad) and pig and poultry farmers get hurt from higher feed prices that cut into already razor-thin (or negative) margins.

The person trying to buy farmland is hurt by land prices that have exploded as a result of the mandates (unless they inherit family land).

The environment suffers as the mandated corn production means more herbicide, pesticide, and fertilizer usage, some of which ends up in our waterways.

The person who eats is hurt because higher commodity prices ripple through their food budgets, already stretched because of increasing energy costs.

So what’s the solution to this mess that has been made? I think it is simple, really. We all need to become either corn lobbyists or corn farmers. That way we all get rich and can afford to pay the financial consequences of spiralling inflation resulting from these mandates. (I suppose we will need to be subsidized for our farm purchase, since farms have gotten pretty expensive).

As for the impact on the environment? We can simply commission a study to show that there is in fact no impact on the environment. Ah, the aquifers. I forgot about those. Looks like I will need to commission another study.

Problem solved.

March 10, 2008 Posted by | corn prices, environment, ethanol subsidies, food prices, mandates, subsidies | 342 Comments

Ethanol in the News

And the news is bad. First up, an issue that is shaping up to be a major battleground between states. Nate Hagens brought this issue up on yesterday’s API call, but it was part of the lost transcript:

Ethanol Boom Saps Water

Mike Adamson remembers when water wasn’t such a problem. As a kid growing up on his family’s cattle feedlot along the Colorado-Kansas border, “you could dig a post hole and see water runnin’ in the bottom,” he recalls. Today, Adamson is 48 and in charge of the family business, Adamson Brothers and Sons Feedlot, a holding ranch for cattle as they go to market. And the water, he says, is disappearing. “The lakes are gone. The wetlands are gone.” In fact, Adamson adds, entire stretches of the nearby Republican River are gone.

Growing corn demands lots of water, and, in eastern Colorado, this means intensive irrigation from an already stressed water table, the great Ogallala Aquifer. One sign of trouble: in just the past two decades, farmers tapping into the local aquifers have helped to shorten the North Fork of the Republican River, which starts in Yuma County, by 10 miles. The ethanol boom will only hasten the drop further, say scientist and engineers studying the aquifers.

The region’s water shortage has pitted water-hungry farmers against one another. And lurking in the cornrows: lawsuits and interstate water squabbles could shut down eastern Colorado’s estimated $500 million annual ethanol bonanza with the swing of a judge’s gavel. Collectively, “[ethanol] is clearly not sustainable,” says Jerald Schnoor, a professor of engineering at the University of Iowa and co-chairman of an October 2007 National Research Council study for Congress that was critical of ethanol. “Production will have serious impacts in water-stressed regions.” And in eastern Colorado, there’s lots of water stress.

And the money quote:

“Trying to solve problems by using the same old techniques doesn’t solve the problem,” Adamson says. “We’re going to make the area a desert. It’s going to be uninhabitable.” And that would be a high price to pay.

Check out the article. It’s a good one, and concerns an issue that is only going to grow more urgent.

Next up, last year’s crop report (published in December, but I just saw it yesterday):

CAN THE U.S. PLANT MORE CORN, MORE SOYBEANS, AND MORE WHEAT?

U.S. crop producers made dramatic shifts in acreage in 2007. The shifts were motivated by rising corn-based ethanol production and high corn prices, rising wheat prices, and a surplus of soybeans.

The acreage shift was led by a 17 million acre increase in feed grains, including 15.3 million more acres of corn. Winter wheat acreage increased by about 3.1 million and harvested acreage of hay was up by nearly one million acres. These increases were accommodated by an 11.9 million acre decline in soybean plantings, 1.3 million fewer acres of spring wheat, 4.4 million fewer acres of cotton, and about 900,000 fewer acres devoted to other oilseeds; edible beans, peas, and lentils; and sugar beets. In addition to the acreage shifts, total planted acreage (harvested acreage of oats and hay) increased by four million acres. The large increase in total acreage likely includes some pasture acreage converted to row crops and perhaps an increase in re-planted acreage stemming from the spring freeze that damaged the winter wheat crop.

The next bit connected the dots:

Prices of corn, soybeans, and wheat remain at very high levels. World and U.S. inventories of wheat and soybeans are expected to decline sharply during the current marketing year.

Another bit suggests to me that supplies will tighten further, and I should be buying corn futures:

The USDA projects the consumption of U.S. corn during the current marketing year at 12.69 billion bushels.

Why is that a problem? Because the mandate in the new energy bill is such that it will require an additional 1.5 billion bushels in 2008 and 800 million bushels on top of that in 2009 – just to meet the higher ethanol mandates. By 2012, we will have mandated an additional demand on corn supplies of 3.8 billion bushels a year as the ethanol mandate moves from 5 billion to 15 billion gallons per year. (Throw a Midwestern drought in the mix, and we will see chaos).

This is as I predicted when ethanol producers were overbuilding capacity. This wasn’t the first time I said it, but here was a comment from over a year ago:

…never underestimate the power of the corn/ethanol lobby. If producers start to lose money, the mandate will go up. The other thing I would point out is that the demand for corn will continue to increase over present values. Demand from ethanol producers will continue to grow, and this is driving high prices now. Unless farmers can bring a lot of new production online, then corn prices will remain high even if ethanol prices start to drop.

That’s exactly the way it has played out so far, so you can expect the overbuilding cycle to continue – which means continuous high pressure on corn prices. Ethanol producers are getting the message loud and clear that the government will protect them as much as possible from the inherent cyclicality (often caused by overcapacity which crashes prices). If you overbuild, the government will increase the mandates to protect you. They have set up a vicious cycle, and a very undesirable (at least for me) experiment with our food supplies.

I wonder if my neighbors will object to me growing corn in my front yard when I move back to the U.S.

February 22, 2008 Posted by | corn prices, ethanol, food prices | 287 Comments

Impending Food Crisis?

I know this is my second pessimistic post this week, but along with an energy crunch, I have been concerned about a food crunch. The whole ethanol love affair has had me worried for a long time about the impact on food supplies. My concern has been that as we diverted corn to ethanol, corn prices would go up (affecting food prices) but that also other crops would be affected. Some cropland would be shifted to corn, to take advantage of the artificial market created by the ethanol mandates, and this could cause acreage of other crops to fall short.

And if you look at USDA Long Term Crop Projections, you will see that in fact, as corn prices climbed due to ethanol mandates, the amount of acres devoted to wheat and soybeans decreased – which has exacerbated an already difficult wheat situation. (Though they are expecting wheat acreage to rebound this year due to very high prices).

My good friend, Nate Hagens (a very level-headed guy), at The Oil Drum notes today:

Hard red wheat is limit up again (i think thats 9 days out of 11) and is at $19.80 a bushel. When it broke $6 a bushel last summer that was an all time high. I have to believe there are going to shortages. I know I can’t buy in bulk at local bulk food store right now – orders are backlogged. Ticker symbol MWH8. I don’t know enough about the differences between soft and hard wheat other than the hard has more protein and is used in breads, bagels etc. Wow. $20 a bushel….

Now there is an article from today’s FT suggesting that we are on the cusp of a food crisis:

The next crisis will be over food

A few days ago, I happened to hear Goldman Sachs discuss the state of the global financial system with European clients.

And what struck me most forcefully from this analysis – aside from the usual, horrific litany of bank woes – was just how much trouble is quietly brewing in corners of the commodities world.

Never mind that oil prices are high; that problem is already well known and gallons of ink have been spilt debating that, along with the pressures in metals and mineral spheres.

Instead, what is really catching the attention of Goldman Sachs now is the outlook for agricultural prices. Or as Jeff Currie, head of commodities research at the US bank, says with disarming cheer: “We think we could go into crisis mode in many commodities sectors in the next 12 to 18 months . . . and I would argue that agriculture is key here.”

Following that, a troubling historical note:

Now, to some readers of the Financial Times, that observation might seem odd. After all, inhabitants of the western world typically spend far more time worrying about the price of petrol for their car, rather than the price of wheat or corn. And when western investors do think about “commodity shock”, their reference point typically tends to be the 1970s oil crisis.

However, as Mr Currie observes, this is a dangerously blinkered view. Back in the 1970s, famine touched a much bigger proportion of the world’s population than the energy crisis, he says. And even today, rising food prices pack a powerful political punch in the developing (or partly-developed) world, to a degree that is sometimes underappreciated by the pampered west.

And the writing is on the wall in Africa:

Now, for any investor who is long on commodities right now (and I would guess that club includes Goldman Sachs), such trends might seem to smack of good news. For anybody who is dirt poor in the developing world, however, the picture is disastrous.

A WFP official, for example, recently showed me the red plastic cup that is used to dole out daily rations to starving Africans – and then explained, in graphically moving terms, that this vessel is typically now only being filled by two-thirds each day, because food prices are rising faster than the WFP budget.

Now I will be the first to acknowledge that higher energy prices across the board are a contributing factor here, but we have made matters worse with worldwide mandates that result in converting food into fuel.

February 15, 2008 Posted by | corn prices, food prices, wheat prices | 32 Comments

Impending Food Crisis?

I know this is my second pessimistic post this week, but along with an energy crunch, I have been concerned about a food crunch. The whole ethanol love affair has had me worried for a long time about the impact on food supplies. My concern has been that as we diverted corn to ethanol, corn prices would go up (affecting food prices) but that also other crops would be affected. Some cropland would be shifted to corn, to take advantage of the artificial market created by the ethanol mandates, and this could cause acreage of other crops to fall short.

And if you look at USDA Long Term Crop Projections, you will see that in fact, as corn prices climbed due to ethanol mandates, the amount of acres devoted to wheat and soybeans decreased – which has exacerbated an already difficult wheat situation. (Though they are expecting wheat acreage to rebound this year due to very high prices).

My good friend, Nate Hagens (a very level-headed guy), at The Oil Drum notes today:

Hard red wheat is limit up again (i think thats 9 days out of 11) and is at $19.80 a bushel. When it broke $6 a bushel last summer that was an all time high. I have to believe there are going to shortages. I know I can’t buy in bulk at local bulk food store right now – orders are backlogged. Ticker symbol MWH8. I don’t know enough about the differences between soft and hard wheat other than the hard has more protein and is used in breads, bagels etc. Wow. $20 a bushel….

Now there is an article from today’s FT suggesting that we are on the cusp of a food crisis:

The next crisis will be over food

A few days ago, I happened to hear Goldman Sachs discuss the state of the global financial system with European clients.

And what struck me most forcefully from this analysis – aside from the usual, horrific litany of bank woes – was just how much trouble is quietly brewing in corners of the commodities world.

Never mind that oil prices are high; that problem is already well known and gallons of ink have been spilt debating that, along with the pressures in metals and mineral spheres.

Instead, what is really catching the attention of Goldman Sachs now is the outlook for agricultural prices. Or as Jeff Currie, head of commodities research at the US bank, says with disarming cheer: “We think we could go into crisis mode in many commodities sectors in the next 12 to 18 months . . . and I would argue that agriculture is key here.”

Following that, a troubling historical note:

Now, to some readers of the Financial Times, that observation might seem odd. After all, inhabitants of the western world typically spend far more time worrying about the price of petrol for their car, rather than the price of wheat or corn. And when western investors do think about “commodity shock”, their reference point typically tends to be the 1970s oil crisis.

However, as Mr Currie observes, this is a dangerously blinkered view. Back in the 1970s, famine touched a much bigger proportion of the world’s population than the energy crisis, he says. And even today, rising food prices pack a powerful political punch in the developing (or partly-developed) world, to a degree that is sometimes underappreciated by the pampered west.

And the writing is on the wall in Africa:

Now, for any investor who is long on commodities right now (and I would guess that club includes Goldman Sachs), such trends might seem to smack of good news. For anybody who is dirt poor in the developing world, however, the picture is disastrous.

A WFP official, for example, recently showed me the red plastic cup that is used to dole out daily rations to starving Africans – and then explained, in graphically moving terms, that this vessel is typically now only being filled by two-thirds each day, because food prices are rising faster than the WFP budget.

Now I will be the first to acknowledge that higher energy prices across the board are a contributing factor here, but we have made matters worse with worldwide mandates that result in converting food into fuel.

February 15, 2008 Posted by | corn prices, food prices, wheat prices | 288 Comments

Impending Food Crisis?

I know this is my second pessimistic post this week, but along with an energy crunch, I have been concerned about a food crunch. The whole ethanol love affair has had me worried for a long time about the impact on food supplies. My concern has been that as we diverted corn to ethanol, corn prices would go up (affecting food prices) but that also other crops would be affected. Some cropland would be shifted to corn, to take advantage of the artificial market created by the ethanol mandates, and this could cause acreage of other crops to fall short.

And if you look at USDA Long Term Crop Projections, you will see that in fact, as corn prices climbed due to ethanol mandates, the amount of acres devoted to wheat and soybeans decreased – which has exacerbated an already difficult wheat situation. (Though they are expecting wheat acreage to rebound this year due to very high prices).

My good friend, Nate Hagens (a very level-headed guy), at The Oil Drum notes today:

Hard red wheat is limit up again (i think thats 9 days out of 11) and is at $19.80 a bushel. When it broke $6 a bushel last summer that was an all time high. I have to believe there are going to shortages. I know I can’t buy in bulk at local bulk food store right now – orders are backlogged. Ticker symbol MWH8. I don’t know enough about the differences between soft and hard wheat other than the hard has more protein and is used in breads, bagels etc. Wow. $20 a bushel….

Now there is an article from today’s FT suggesting that we are on the cusp of a food crisis:

The next crisis will be over food

A few days ago, I happened to hear Goldman Sachs discuss the state of the global financial system with European clients.

And what struck me most forcefully from this analysis – aside from the usual, horrific litany of bank woes – was just how much trouble is quietly brewing in corners of the commodities world.

Never mind that oil prices are high; that problem is already well known and gallons of ink have been spilt debating that, along with the pressures in metals and mineral spheres.

Instead, what is really catching the attention of Goldman Sachs now is the outlook for agricultural prices. Or as Jeff Currie, head of commodities research at the US bank, says with disarming cheer: “We think we could go into crisis mode in many commodities sectors in the next 12 to 18 months . . . and I would argue that agriculture is key here.”

Following that, a troubling historical note:

Now, to some readers of the Financial Times, that observation might seem odd. After all, inhabitants of the western world typically spend far more time worrying about the price of petrol for their car, rather than the price of wheat or corn. And when western investors do think about “commodity shock”, their reference point typically tends to be the 1970s oil crisis.

However, as Mr Currie observes, this is a dangerously blinkered view. Back in the 1970s, famine touched a much bigger proportion of the world’s population than the energy crisis, he says. And even today, rising food prices pack a powerful political punch in the developing (or partly-developed) world, to a degree that is sometimes underappreciated by the pampered west.

And the writing is on the wall in Africa:

Now, for any investor who is long on commodities right now (and I would guess that club includes Goldman Sachs), such trends might seem to smack of good news. For anybody who is dirt poor in the developing world, however, the picture is disastrous.

A WFP official, for example, recently showed me the red plastic cup that is used to dole out daily rations to starving Africans – and then explained, in graphically moving terms, that this vessel is typically now only being filled by two-thirds each day, because food prices are rising faster than the WFP budget.

Now I will be the first to acknowledge that higher energy prices across the board are a contributing factor here, but we have made matters worse with worldwide mandates that result in converting food into fuel.

February 15, 2008 Posted by | corn prices, food prices, wheat prices | 63 Comments

Corn Ethanol Economics

Someone e-mailed a few days ago and asked some questions about the present economics of corn ethanol. I did a few calculations, which I think are interesting enough to share. (Note that because this is a snapshot, the numbers will change over time. But you should be able to use the methodology here to roughly calculate the economics at any point in time.)

I found multiple references for all of the numbers I am going to use, but I will only reference a single source. According to Ethanol Reshapes the Corn Market, one 56-pound bushel of corn will yield up to 2.7 gallons of ethanol and 17.4 pounds of distiller’s dried grains with solubles (DDGS).

The current spot price of corn as of this writing is about $5/bushel, so each gallon of ethanol contains $5/2.7, or $1.85 of corn per gallon of ethanol. However, the DDGS can be sold, so a credit is applied for that. The current price of DDGS as of this writing is $170/ton, which is $0.085/lb. Given that a bushel of corn yields 17.4 pounds of DDGS, there is then a $1.48 credit, which spread over 2.7 gallons is equal to $0.55 gallon. This reduces our cost per gallon to $1.85 minus $0.55, or $1.30 for just the corn input. (Note that there is sometimes a credit for carbon dioxide sales, but it is very small relative to the other costs and credits).

I still have to consider utilities (natural gas is a major cost), labor, enzyme and yeast costs, and depreciation. I have a spreadsheet from an actual ethanol plant, but there isn’t much in the public domain that I could find on this. The closest thing to a source on these is the spreadsheet in the presentation Fossil Fuels and Ethanol Plant Economics (for a standard dry mill process). If you look at Page 16 of the presentation, you can see that all of the miscellaneous costs together total approximately as much as the corn inputs. If you take the spreadsheet on Page 24 and change the natural gas price to the current price of $8/MMBTU, you get an overall energy cost of $0.33/gal of ethanol. The sum of enzymes, yeast, and other chemicals comes out to be $0.14/gal, and labor, maintenance, and various miscellaneous expenses add another $0.23/gal.

On depreciation, I have several sources for capital costs that are pretty consistent. In the EIA’s Energy Outlook 2006, capital costs per daily barrel of corn ethanol ranged from $20,000 to $30,000, depending on the size of the plant. This breaks down to between $1.30 and $1.95 per gallon of installed capacity. This is also consistent with A Guide for Evaluating the Requirements of Ethanol Plants, which states “Current capital cost per annual gallon of installed capacity for an ethanol plant ranges from $1.25 to $2.00.” So let’s be conservative and say that we want to build a big plant, so the capital costs are on the low end at $1.30/gallon. Depreciate that over 15 years and this portion amounts to about $0.08 per gallon (but is captured above already).

However, for biomass to liquids facilities – which would include the biomass gasification to ethanol that some are calling cellulosic ethanol – the capital costs in the EIA’s Energy Outlook 2006 are listed at around 5 times that of a conventional corn ethanol plant. Thus, the capital depreciation portion is going to be around $0.40 per gallon of ethanol. (On the other hand, the feed costs should be much lower).

Summary

Times are tough for ethanol producers. This is what the economics roughly look like at $5 per bushel of corn and $8/MMBTU of natural gas. To produce 1 gallon of ethanol requires:

  • $1.85 of corn
  • $0.33 of energy
  • $0.14 of enzymes, yeast, etc.
  • $0.23 of labor, maintenance, and various miscellaneous expenses

There is a DDGS credit per gallon of ethanol of $0.55. Thus, the total cost to produce a gallon of ethanol today is $1.85 + $0.33 + $0.14 + $0.23 – $0.55, or exactly $2/gallon of ethanol. For reference, the February contract for ethanol in the Midwest as of this writing is $2.15. And $2/gallon is merely cost of production. It doesn’t take into account any return on investment.

Also note that due to the lower energy content, this production cost is equivalent to a $3 per gallon production cost for gasoline – and that this production cost is a moving target: As long as the ethanol mandates are driving up the price of corn and increasing the demand for and cost of natural gas, corn ethanol producers must chase their tails in a vicious cycle. Producers are going to be hard-pressed to ever match the 2006 windfall that was given to them when the MTBE phaseout drove ethanol prices sky-high.

Anyway, this was a useful exercise for me to understand the magnitude of the various inputs (and the DDGS offset) in corn ethanol production. I hope you found it of some value. If you see errors or have suggestions, please let me know.

February 2, 2008 Posted by | corn prices, economics, ethanol, ethanol prices, natural gas | 291 Comments