01 Sep 2008
Farming for Fuel
The Economics of Ethanolby Julia HannaTopics:
What happens when a group of Missouri corn farmers gets into the energy business? With consumers paying more than double for gasoline than they did a year ago, turning crops into fuel, not food, seems like a good way to go — but not so fast. In “Mid-Missouri Energy,” HBS professor Forest Reinhardt, with senior researchers James Weber and Mary Louise Shelman, examines the complex political and economic underpinnings of the ethanol industry and the dilemma facing the farmers of Mid-Missouri Energy (MME). The farmers must make major decisions about production levels and the potential sale of the ethanol plant in an increasingly competitive, complex environment.
“For the first time in history, the food and energy markets are converging,” says Reinhardt. “It’s hard to imagine two areas of greater importance, or with greater government intervention.”
The beginnings of MME lie with case protagonist Ryland Utlaut (the group’s president) and ten other farmers, who put together seed money of $25,000 in 2002 to launch the project. A feasibility study shows that an ethanol plant capable of producing 40 million gallons a year can be built for an initial cost of between $55 and $60 million. In 2003, the group fans out to test the idea with some 2,500 farmers in the area; after this outreach, MME has 729 members willing to make the minimum investment of $20,000 and 10,000 bushels of corn annually. For the farmers, MME offers a potential hedge against the volatility of commodity prices and the hope of a more stable future for their children.
“This is also a fascinating entrepreneurial story,” Reinhardt notes. “These farmers have reduced their exposure to corn prices, but at the expense of exposure to the oil market.” With oil prices currently at record levels, that doesn’t seem like such a bad tradeoff to make. But Reinhardt points out that we’ve seen this story before. “In the 1970s, we said that prices would never go down again, and they did,” he remarks. “Will demand from India and China change the equation? Maybe. Ordinarily when the price of something goes up, people figure out ways to make more of it and use less of it. So the assumption that we’re not going to have supply and demand responses to this is an audacious one.”
MME completed construction of its plant in February 2005 and quickly ramped up production to 48 million gallons of ethanol annually. By the end of FY 2007, it had posted $23 million in profits but also had begun to experience the harsh realities of rising corn prices, falling ethanol prices, and land scarcity. With all of these factors as a backdrop, students analyze several options the MME members must consider. They can pursue a plan (initiated in 2005) to double the plant’s size. Utlaut, however, is worried: Not all of the farmers are interested in doubling their corn commitments to the plant, and some have even invested in a competing interest. Another alternative is to sell the plant, although Utlaut believes that the best offer would be the book value, roughly $50 million. The third option is to maintain current levels of operation until the situation becomes clearer.
Reinhardt has taught the case in his Energy course in the second-year MBA elective curriculum, as well as the Agribusiness course in the MBA and Executive Education programs. “One objective of the case is a greater understanding of the way materials and energy flow in the modern American agricultural system. As our economy becomes more information-driven, it’s good to remind ourselves that we still need to eat cornflakes, or chickens that ate cornflakes, and that we still need to get around,” he notes. “When commodity prices are kept low, we have a tendency to think these things are unimportant and uninteresting, but that’s never been true.” Greater transparency may be brought about through the introduction of carbon trading markets, Reinhardt suggests — an area he is exploring in a future case coauthored with finance professor André Perold.
— Julia Hanna