The ethanol shakeout

Many commodity corn farmers, buffeted by decades of steadily falling prices for their goods and borne aloft only by government
subsidy, have been transfixed by the promise of ethanol, the corn-based fuel.

It's not hard to see why. For years, they've sold their product to Archer Daniels Midland, the world's biggest buyer of commodity corn, and watched the agribusiness titan turn that cut-rate corn into highly profitable ethanol. The company generates about half a billion dollars in profit each year; according to FTN Midwest Securities analyst Christine McCracken, nearly a quarter of that hoard comes from ethanol production.

As any seasoned Bitter Greens Journal readers knows, ADM's highly profitable ethanol business wouldn't make a dime if the U.S. government didn't prop it up through various tax credits and other subsidies (see this post, this post, and this one).

That means ADM benefits from a double-dose of largesse. Corn-production subsidies keep the price of corn down, cutting ADM's cost (not only for ethanol production but also for its other cash cow, high-fructose corn syrup). Ethanol subsidies boost the price it gets in the marketplace.

As Dwayne Andreas, the legendary fixer who heads up ADM, declared not long ago:

The free market is a myth. Everybody knows that. Just a very few people say it. If you're in a position like I am and do business all over the world, and if I'm not smart enough to know there's no free market, I ought to be fired.

The reason they don't call it socialism is that socialism is a bad word. [See Manning, Richard, Against the Grain, p. 144.]

So it's no surprise that farmers sick of being fleeced out of their corn for a pittance by the likes of Andreas would want to create their own ethanol plants to process their own corn, and they're doing so, pooling their own money to invest millions in new facilities.

I wish they wouldn't.

Rather than get involved with yet another highly inefficient project that wouldn't exist with government support--after all, they're already involved in large-scale monoculture corn production--these farmers might be better off scaling down, saving on input costs by going organic, diversifying their crop base, and focusing on local markets. Let ADM grow its own damned corn.

But the promise of fast profit glitters bright in the depressed cornbelt. As I've said before, if too many ethanol facilities come on line to fast, flooding the market with product, the price will drop. Small farmer-owned cooperatives will be much more vulnerable to a prolonged price slump than the likes of ADM, which has the resources--$1.4 billion of cash in the bank as of June 30, 2004--to sit out a downturn.

And the downturn is on. ADM saw its shares plunge 11 percent last Wednesday when above-mentioned analyst McCracken of FTN Midwest Securities cut her profit forecast on the agri-giant. She declared:

The primary issue driving our downward revision is that the expansion in the ethanol industry exceeds demand...Year-to-date ethanol prices have fallen 36 percent and prices are down 28 percent year-over-year.[Emphasis added]

If the fall in ethanol prices inspires investors to slash ADM's value more than 10 percent in one day, how will it affect small producers that don't generate half a billion dollars in profit each year and don't have $1.4 billion in the bank?

Corn-belt newspapers are full of hand-wringing, but no one's declaring a crisis just yet.

I'm haunted by something I read in the Wall Street Journal not long ago:

David Nelson, a farmer who's chairman of the two-year-old Midwest Grain Processors ethanol plant in Lakota, Iowa, is well aware of the overexpansion threat. "It's starting to get crowded around here," says Mr. Nelson, 52, sipping a Corona in the smoky bar of Cattleman's Steak & Provisions near his Belmond, Iowa, farm. "In the back of our minds, we know there is to be a day of reckoning."

But his solution isn't to cut back. It's to grow big enough to survive a shakeout. Midwest Grain Processors sold about $17 million more stock in January to double the size of its plant. That means this plant alone will be able to make 100 million gallons a year. And its farmer owners are already thinking about where to build a second plant. (Emphasis added.)

But there's only one player that's definitely "big enough to survive a shakeout," and it's not some farmer-owned cooperative.