Risk Management Issues & Challenges In Ethanol Production
11/04/2009 01:46PM
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After a few years of extreme growth and large profit margins, the U.S. fuel ethanol industry has transitioned into a more mature stage. Growth opportunities are still present, but with the industry’s current size and potential impacts on the corn market through added demand from expansions, it has become a commodity processor. The era of double and triple digit returns on ethanol investment for significant periods of time appears to be behind us. As a result, cost and careful attention to risk management strategies have become essential for survival, profitability and growth of individual firms.
Ethanol refineries typically convert two commodities, corn and either natural gas or coal, into two value-added commodities, ethanol and distillers grains (DGS). Unlike industries whose products can be differentiated from those of other producers, ethanol processors use the same type of corn and natural gas as everyone else in the industry and produce the same type of ethanol, and for the most part, the same kind of DGS as everyone else. Accordingly, individual plants have little or no opportunity to influence the prices they pay for inputs or receive for their products, except through risk-management strategies. In this environment, risk-management considerations dictate that individual companies become managers of their processing margins rather than focusing on prices of individual components of those margins. That’s a sharp change from the 2004 to early 2007 period, when strong ethanol prices and low corn prices brought large returns.
In this article, we will provide an overview of the components of ethanol processing margins, a history of the margins, a partial view of the co-product (distillers grains) history, similarity to risk-management needs of the soybean processing industry and tools available for managing margins. Financial management is a closely linked element in this process; however, space does not permit us to touch on that aspect of risk management in the current article. We anticipate having more articles relating to risk management in future newsletters.
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Source: AgMRC