Looking back on 2007, I am reminded of the old sports saying, "Don't let the highs get too high; don't let the lows get too low." In the past year, the ethanol industry has experienced a true rollercoaster of highs and lows being hailed as a savior one month and a travesty the next. Would it be a stretch to think the ethanol industry might have been the victim of this old adage?

For much of early 2007, politicians—Republican and Democrats alike—stood in support of corn-based ethanol. It was viewed as a boon for the American farmer and a remedy for the quickly rising gasoline prices that pained consumers at the pump. Sparked by President George W. Bush's State of the Union address on Jan. 23, 2007, the general public was eager to learn more about this exciting new industry, and investors were eager to get in on the action. At that time, the ethanol industry seemed to be a win-win for everyone involved.

By the end of last summer, however, the social and political environment had become much more hostile as environmentalists, humanitarians and some politicians voiced concerns regarding the validity of ethanol as a solution to the country's energy woes. Ethanol production has since been blamed for higher food costs and water shortages. In the most severe case, an outside expert speaking to a United Nations committee referred to the use of food crops to produce biofuels as "a crime against humanity," although the comment was later dismissed by the U.N. Food and Agriculture Organization.

Let's face it, corn-based ethanol might have been over-hyped by the media, investors and politicians in early 2007 and then given an unfair amount of blame by year's end. Moving into 2008, what type of environment should the ethanol industry expect to help keep things on a more even keel?

Production Slows Slightly
Overall, the ethanol industry is expected to see continued production growth. Although production is not expected to increase at the same rate as it did in 2007, there are still many plants under construction scheduled to be operational near the end of 2008. In addition, the announcements of new plants, which should be expected to continually decrease as the year progresses, have significantly slowed.

As the expansion of the ethanol industry continues to slow, the structure of the industry will continue to change. Most notably, lower profit margins have led to consolidation in the form of mergers and acquisitions. At press time, the merger between VeraSun and U.S. BioEnergy was the largest to date. Many believe mergers of this size are merely the beginning of a larger consolidation movement. As the ethanol industry transitions out of its initial growth stages, larger companies are focusing on the economics of scale and searching for ways to build and maintain market share, profitability and an increased sustainability for years to come. In the past six months, it has not been uncommon to hear rumors of other large ethanol companies reportedly looking to acquire smaller ethanol producers.

However, 2008 stands to see an interesting contrast in plant operation as some smaller, independent ethanol plants remain strong and resistant to consolidation. Most smaller, local plants focus on paying down debt, work on a more-equity basis and strive to develop the markets for local owners and growers. It is a stark contrast that I refer to as the difference between Main Street and Wall Street operations.

Wall Street operations will usually be publicly traded companies that look to increase market share and stock value by focusing on short-term revenues and gains. Locally-owned Main Street operations remain focused on the long-term viability of the industry and are not as concerned with the ebbs and flows of their initial stocks. In fact, many of these types of operations are not publicly traded and generally try to build a market for those in their local community. Although different in philosophy, both types of ethanol-producing operations will help stabilize the industry as it continues to mature.


Average ethanol plant net profit over 2007
SOURCE: DTN

The Food-Versus-Fuel Debate
One of the ethanol industry's greatest challenges in 2007 was defending itself in the food-versus-fuel debate. Food prices have dramatically increased in the past year. This rise in food costs was felt by all consumers as the price of dairy, meat and grain items rose an average of 6 percent for the first nine months of 2007. Much of the blame, whether founded or unfounded, has been placed on the ethanol industry due to direct correlation to corn prices. Unfortunately, this has been a heavily publicized topic in the media and is a key reason why support for the ethanol industry has begun to falter in recent months.

A variety of studies support and disprove ethanol's correlation to the rise in food costs. For example, a recent study funded by the Renewable Fuels Association indicated that, based on 20 years of price data, raw corn prices have a minimal impact on the U.S. Consumer Price Index for food. The study says that consumer food costs are far more complex in the long U.S. food chain and the cost of corn is just one of a number of different factors coming into play.

In a Dec. 7 interview with CNN "Money," Jacinto Fabiosa, co-director of the Food and Policy Research Institute at Iowa State University, said, "Only about 25 percent of the price of pork at the retail level reflects costs on the farm. So if the price of corn goes up 10 percent, the farmers' overall cost might go up 5 percent, but the ultimate retail price for a pork chop may only rise 1 (percent) or 2 percent."

One element that surely should share in the blame is continuously rising oil prices. As crude oil prices continue to hover near $100 per barrel, transportation costs continue to rise. The increased transportation costs play a much larger role in the price of food as well as the amount of discretionary income a family has to help support the economy.


Ethanol future prices from March 2005 to December 2007
SOURCE: DTN

The Political Environment
Although public impressions of ethanol began to waver in late 2007, political support still remains in favor of the advancement of biofuels. At press time, President George W. Bush signed a bill that passed through the House of Representatives and Senate and calls for another massive increase in ethanol production. The 2005 energy bill called for the production of 7.5 billion gallons by 2012, a mark that the United States is poised to meet by the end of the year. The 2007 energy bill increases production to 36 billion gallons by 2022, and calls for 15 billion gallons per year of corn-based ethanol and another 21 billion gallons from "advanced biofuels" that use materials other than food crops.

Although this bill demonstrates a significant amount of support for the ethanol industry, an increased amount of debate will continue to circle around the support of the 51-cent blenders' credit and the 54-cent import tariff as pressure continues to build from other ethanol-producing countries such as Brazil. It will also be interesting to see how the many presidential hopefuls will handle ethanol-related questions during the 2008 primary elections. If the general public's ethanol impressions do not improve, many candidates could face some pointed questions regarding the country's energy initiatives and ethanol.

Research and Development
In 2008 and continued into the foreseeable future, corn-based ethanol will remain the leader in ethanol production. However, in the past year there has been a significant amount of research and development conducted toward cellulosic ethanol. With added pressure from the food-versus-fuel debate, the industry will continue to search for a more economical way to develop an alternative to corn-based ethanol. As highlighted in the 2008 energy bill, the direction of the biofuels industry will eventually move to a cellulosic-centric plan. It is not likely that these types of advancements will be made and implemented in the coming year, but a number of larger ethanol companies are continuing to research and develop methods for extracting ethanol without feed crops.
Yes, 2008 will be different in many ways from 2007. It is unlikely 2008 will begin with the same trumpets and fanfare the ethanol industry received a short year ago. Nor should it expect a continued backlash. The industry is still relatively young and will continue to mature as it moves through a number of growing pains. The lesson learned from 2007 is that the ethanol industry should not be judged based on a one-year period of highs that were too high and lows that were too low. EP

Rick Kment is a DTN biofuels analyst with more than 15 years of experience in the agribusiness industry. For more information, visit www.dtnethanolcenter.com.