FTC: Ethanol Industry is ‘Unconcentrated'
February 5, 2008
BY Bryan Sims
In 2007, despite lower ethanol prices and project financing challenges, the ethanol production industry experienced historic growth. With the flood of new plants coming on line, the U.S. ethanol industry kept its status of "unconcentrated," according to a report conducted by the Federal Trade Commission in late November. The report, as prescribed by the Energy Policy Act of 2005, has reached similar conclusions in all three years that it has been issued.
The intent of the report was to simply gauge the ethanol industry's competitiveness using the Herfindahl-Hirschman Index, a calculation method the FTC uses to measure individual market shares to "determine whether there is sufficient competition among industry participants to avoid price-setting and other anti-competitive behavior," the report stated.
Calculations were based on figures compiled by the U.S. Energy Information Administration and the Renewable Fuels Association from July 2006 to July 2007. As outlined by the FTC and the U.S. Department of Justice, HHI values below 1,000 are deemed unconcentrated and competitive, while a score between 1,000 and 1,800 is considered moderately concentrated. An index score above 1,800 is considered a pure monopoly. Based on actual production volumes (instead of production capacity), the FTC gives the U.S. ethanol industry a score of 465, down from 736 in 2006.
"This [study] provides the underpinnings for continued growth of the industry," says Todd Alexander, principal at Chadbourne & Parke LLP. "The pace at which the industry is growing has certainly slowed down based on what I've seen, and the ability to raise private equity for these projects has definitely diminished. Last year at this time, the spreads in the market were masking some of the flaws in projects' business plans."
The FTC noted that the decline in concentration was attributed to the recent increase in new ethanol production and proposed ethanol projects starting construction. In September 2007, 103 companies were producing ethanol in the United States, a 13-company increase from 2006 and a 28-company increase from 2005, according to the report. The largest ethanol producer's share of capacity has continued to fall each year as new firms enter the market. The report also indicated that the largest producer accounted for approximately 16 percent of domestic ethanol capacity, down from 21 percent in 2006 and 26 percent in 2005.
Source: renewable fuels association/national association for retail marketing
If this period of rapid growth creates an oversupply, followed by lack of profit and trends toward consolidation, the report could serve as a viable benchmark for the industry in the long-term as the market matures. "This report is important for people to take a step back and realize that [the ethanol industry] is not in fact controlled by one or two companies," says Cory Garcia, senior research analyst at Raymond James & Associates. "The industry is really fragmented, which is good for the entire market because it shows that the industry isn't monopolized by one or two larger players."
Looking ahead into 2008, analysts say consolidation activity should occur and become a significant element in the FTC's 2008 report. Evidence of this trend became obvious when two of the largest ethanol producers—VeraSun Energy Corp. and U.S. BioEnergy Inc.—announced a monumental merger agreement one day after the 2007 FTC report was released. "To our knowledge, we haven't seen too much consolidation outside of the U.S. BioEnergy/
VeraSun deal," Garcia says. "So, there are no real mechanisms for the market to get further concentrated. I would guess that the concentration percentage would be going lower like it has."
According to Alexander, on the other hand, the ethanol industry's inherent and turbulent commodity cycle could increase concentration before the 2008 report. "I do expect the industry to become more concentrated," he says. "The industry is a commodity business. In general, commodity businesses move toward a situation where there are several large players who can capitalize on the economics of scale to lower their marginal cost of production, and I expect that the ethanol industry will be no different."
The intent of the report was to simply gauge the ethanol industry's competitiveness using the Herfindahl-Hirschman Index, a calculation method the FTC uses to measure individual market shares to "determine whether there is sufficient competition among industry participants to avoid price-setting and other anti-competitive behavior," the report stated.
Calculations were based on figures compiled by the U.S. Energy Information Administration and the Renewable Fuels Association from July 2006 to July 2007. As outlined by the FTC and the U.S. Department of Justice, HHI values below 1,000 are deemed unconcentrated and competitive, while a score between 1,000 and 1,800 is considered moderately concentrated. An index score above 1,800 is considered a pure monopoly. Based on actual production volumes (instead of production capacity), the FTC gives the U.S. ethanol industry a score of 465, down from 736 in 2006.
"This [study] provides the underpinnings for continued growth of the industry," says Todd Alexander, principal at Chadbourne & Parke LLP. "The pace at which the industry is growing has certainly slowed down based on what I've seen, and the ability to raise private equity for these projects has definitely diminished. Last year at this time, the spreads in the market were masking some of the flaws in projects' business plans."
The FTC noted that the decline in concentration was attributed to the recent increase in new ethanol production and proposed ethanol projects starting construction. In September 2007, 103 companies were producing ethanol in the United States, a 13-company increase from 2006 and a 28-company increase from 2005, according to the report. The largest ethanol producer's share of capacity has continued to fall each year as new firms enter the market. The report also indicated that the largest producer accounted for approximately 16 percent of domestic ethanol capacity, down from 21 percent in 2006 and 26 percent in 2005.
Source: renewable fuels association/national association for retail marketing
If this period of rapid growth creates an oversupply, followed by lack of profit and trends toward consolidation, the report could serve as a viable benchmark for the industry in the long-term as the market matures. "This report is important for people to take a step back and realize that [the ethanol industry] is not in fact controlled by one or two companies," says Cory Garcia, senior research analyst at Raymond James & Associates. "The industry is really fragmented, which is good for the entire market because it shows that the industry isn't monopolized by one or two larger players."
Looking ahead into 2008, analysts say consolidation activity should occur and become a significant element in the FTC's 2008 report. Evidence of this trend became obvious when two of the largest ethanol producers—VeraSun Energy Corp. and U.S. BioEnergy Inc.—announced a monumental merger agreement one day after the 2007 FTC report was released. "To our knowledge, we haven't seen too much consolidation outside of the U.S. BioEnergy/
VeraSun deal," Garcia says. "So, there are no real mechanisms for the market to get further concentrated. I would guess that the concentration percentage would be going lower like it has."
According to Alexander, on the other hand, the ethanol industry's inherent and turbulent commodity cycle could increase concentration before the 2008 report. "I do expect the industry to become more concentrated," he says. "The industry is a commodity business. In general, commodity businesses move toward a situation where there are several large players who can capitalize on the economics of scale to lower their marginal cost of production, and I expect that the ethanol industry will be no different."
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