Market Analysis

Introduction

According to the Renewable Fuels Association, as of December 2010, the U.S. ethanol production industry consisted of 204 plants operating in 29 states, and 9 plants under construction or expansion,

Ethanol production and production capacity have both increased this year.  Domestic ethanol production increased approximately 23 percent between 2009 and 2010, from 10 billion gallons to 12.3 billion gallons.  Production has increased over 750 percent since 2000, when domestic ethanol production was 1.6 billion gallons. Domestic ethanol production capacity, including capacity under construction, also rose from 14.5 billion annualized gallons as of October 2009 to 15.2 billion gallons per year as of October 2010.  Industry participants expect some of the expansion projects currently underway to come online by the end of 2010.

Ethanol is primarily used to blend in gasoline (usually at 10% levels) and as an octane extender for gasoline due to the fact that it is a clean air additive in the form of an Oxygenate.  A desire to reduce American dependence on foreign oil, reduce America’s trade deficit, and promote jobs and other economic benefits through the creation of a domestic ethanol industry have all combined to make ethanol a favored product and industry.  For example, Congress has implemented a “blender’s credit” to encourage domestic oil companies to blend ethanol into their fossil based fuels.  This was first implemented in the Mid-1970’s and has been renewed through the year 2010.

The current credit is $0.51 per gallon and is taken as an exemption from the Federal Gasoline Excise Tax paid by marketers of gasoline products.  This credit allows oil companies to supply a higher octane, cleaner burning gasoline to their customers while reduce their excise tax liability at the same time.  Due to more stringent clean air standards and a variety of other factors, ethanol sales are increasing.

Size and structure of Ethanol Industry

According to the Renewable Fuels Association as of September 1, 2010 the U.S. ethanol industry was made up of 200 nameplate refineries with a total capacity of 13.544 million gallons per year (MGY).

Of these, 192 refineries were operational with an annual capacity of 12.9 MGY.  An additional 12 plants were under construction or undergoing expansion.  The location of these ethanol plants is illustrated in. As can be seen in Figure 2 ethanol production is concentrated in the Midwest corn-belt states.  The top ten ethanol producing states also are the nation’s leading corn producers.  This is further illustrated in which compares operating ethanol capacity and corn production.

Ethanol Pricing

The market price and value of fuel ethanol depends on a number of variables.  These include its value from volume contribution to gasoline blends, octane enhancement, tax credits, and its value as an Oxygenate for regulatory compliance.  On the other hand, ethanol value is reduced due to its need for special handling because of its high affinity for water and because it adds to the volatile nature of fuels.

Also on the demerit side, ethanol has an energy content that is lower than gasoline on a per volume basis; however the industry’s value calculations and price formulas do not reflect this.  Supply and demand have a great impact on ethanol price as is true with all commodity pricing.

Relationship to Crude Oil and Gasoline Price

Over the last 10 years, the spot prices of fuel ethanol, crude oil, and gasoline have been on a definite upward trend.  The cost of crude has a direct effect on the price of gasoline since gasoline is produced from crude oil such that the correlation between crude oil and gasoline is almost 1.00. 

There is a historical correlation of 0.79 between the price of ethanol and crude oil, and a 0.80 correlation between the price of ethanol and gasoline.  The price of fuel ethanol is often based on the rack price of unleaded gasoline plus a significant portion of the blenders’ federal excise tax exemption.  Most of the price changes for ethanol are in response to price changes in crude oil and/or gasoline and not as a result of increased ethanol production costs.

As can be noted from the above graph, much of the price volatility for oil/gasoline is caused by external events or macro-economic shocks. Similarly, given the high correlation between the price of ethanol and the price of crude oil gasoline, the price of ethanol also tends to be very volatile.

Distillers Grains Pricing

Distillers’ grain along with CO2 is co-products of the ethanol production process.  Nexsun Ethanol is located in the heart of cattle feeding country and within an 85-mile radius of Ulysses, there are 2.5 million head of cattle fed daily.  Historically, the price of distillers’ grain rises to 30% of the percentage rise in the price of feedstock.

Nexsun plans to save approximately 1/3 of its natural gas costs, by selling WDG as much as possible.  Nonetheless, to allow for added flexibility, Nexsun will construct one dryer, which can dry approximately half of the distillers’ grain output and make the market for DDGS available whenever the WDG market is not attractive.  (Wet distillers’ grain shelf life does not allow for long-term storage.)

Cattle on Feed Numbers

The exhibit above indicates feed yards that are members of the Kansas Livestock Association. Non-member feed yards account for an insignificant number of cattle to be fed. The average price of wet distillers used in the financial projections was $37 per ton average over the 10-year projection.

Carbon Dioxide Pricing

There are no current plans for revenue for carbon dioxide sales. However, various local businesses in and around Ulysses have expressed an interest in purchasing this co-product. No revenue has been projected for carbon dioxide, but markets will be pursued before production begins.