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Why Ethanol Hedges Are Profitable—For Now

12:00PM Aug 01, 2014
POET ethanol plant

Investing in ethanol plants has been touted as a way for corn producers to boost returns in years with low prices. For 2014, the strategy is working well.

Total net returns for ethanol are about $2/bu, measured as a "level of ethanol production investment where every bushel of corn produced is matched by a bushel of corn processed into ethanol," writes Don Hofstrand, ag economist with the Agricultural Marketing Resource Center at Iowa State University. The "ethanol hedge" has kept total returns for corn producers with ethanol plant shares close to levels last seen in 2012, when corn prices were twice as high.

Figure 1 Corn and Ethanol Net Return 2005 to 2014 DonHofstrand

In most years with low corn prices, ethanol plant returns are strong. As a result, corn producers with ethanol plant investments benefit from an ethanol hedge. The correlation isn’t always evident, though, as seen in the years 2009 to 2010. Source: Don Hofstrand, Iowa State University.

Yet strong ethanol profits and healthy dividend checks don’t always follow low corn prices. For example, the period 2009/10 saw negative corn returns accompanied by low ethanol returns.

"Farmers who made an investment in ethanol production did not fare much better than corn producers without an ethanol investment," Hofstrand explains.

The price of ethanol drives whether the ethanol hedge is viable, Hofstrand says. Other major influences include the price of crude oil and ethanol supply and demand worldwide. The ethanol hedge worked well from 2013 to the present and from 2006 to 2008, periods of strong ethanol prices.

For the study, Hofstrand used a hypothetical—but typical—ethanol plant of 100 million gallons updated for current corn prices, ethanol prices, distillers dried grains and natural gas prices. He also assumed the plant began production in 2007, when the ethanol boom started.

Not a cure-all. The ethanol hedge is not a perfect solution for most corn growers. Few producers have their entire corn production covered by an offsetting investment in ethanol production.

Although ethanol hedges might sound new, grain farmers have diversified their operations for years by raising livestock, Hofstrand says. Still, risks remain for both.

"It appears that the ethanol hedge will work in the near future with ethanol profitability staying strong and corn production return staying depressed," Hofstrand notes. "However, the intermediate and long term contains considerable uncertainty." Among them is whether the 10% ethanol blend wall can be worked through.

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