Strategies for Lending in the Ethanol Industry
Lenders in the ethanol industry are operating in previously unchartered territory. Over the past three and a half years, ethanol producers and their lenders have seen ethanol prices paid to producers range from $1.98 per gallon (January 2007) to a historical high of $2.85 per gallon (June 2008). In March 2010, ethanol prices hit a 5 year low at $1.51 per gallon and have rebounded only slightly to $1.59 per gallon (June 2010). These price swings have been unpredictable. During this time, the ethanol producer’s primary input cost (corn) and processing cost (natural gas) have also experienced volatility – but not necessarily in tandem with ethanol prices. The result has been that ethanol producers have experienced – and continue to experience – severe margin erosion, impacting their ability to meet scheduled debt service requirements. Lenders need to quickly determine which ethanol producers warrant restructuring and which will need to seek alternative solutions.
Ethanol production is a four-variable business that combines:
- Production costs, of which the costs of corn and natural gas are the primary drivers
- Ethanol prices,
- By-product sales, and
- Production efficiencies, including corn conversion rates, natural gas usage, enzyme and chemical consumption
All four variables are highly inter-related and require constant measurement and review.
Ethanol Industry Forecasts
The graph below shows the average ethanol blender’s profit per gallon from January of 2007 to November of 2012 (actual data through June 2010, futures prices through 2012). When the blender’s profit per gallon exceeds $0.00, blenders are incentivized to blend ethanol up to the 10% of unleaded gasoline blending limit. The blender’s profit did not incent ethanol production until April of 2007 and subsequently dropped below $0.00 from October of 2008 to January of 2010 (though there were a few months in 2009 with positive blender’s profit).
The current outlook for the ethanol futures market suggests that blenders should expect to be able to generate a profit through 2012. Based on current pricing assumptions, the demand for ethanol will remain strong at the blender level as the blender’s profit is projected to remain between $0.40 and $0.60 per gallon for the foreseeable future. Even a reduction in the federal tax credit from its current level of $0.045 per E-10 gallon (or $0.45 per gallon of ethanol) to the proposed level of $0.036 per E-10 gallon (or $0.36 per gallon of ethanol) should not have a significant effect on the blender’s demand for ethanol, if the price differential between ethanol and Reformulated Blendstock for Oxygenate Blending (RBOB) gasoline remains relatively stable. However, there are two outside factors which would influence profitability in the industry:
- The EPA’s existing annual aggregate blending ceiling: If unleaded gasoline “RBOB” demand in U.S. falls again due to a “double dip” recessionary event, the annual aggregate 10% blending ceiling would be applicable to a lower unleaded gasoline consumption level, which would likely reduce the overall demand for ethanol in the marketplace.
- The EPA’s existing blend limit and annual aggregate blending ceiling: If the EPA raises the E-10 blend limit and its annual aggregate blending ceiling to above 10%, the demand for ethanol should immediately increase as blenders increase their ethanol buying level to the new blend limit for every gallon of E-10+ they produce.
An increase in demand for ethanol could generate a double benefit for some ethanol producers by:
- Raising the price of ethanol in the market, and
- Allowing producers to increase their ethanol production, if they are currently operating below their maximum production capacity level.
Focus Expertise in the Ethanol Industry
Focus Management Group has developed a significant knowledge base within this industry. This specific industry knowledge has resulted in the development of an Operating Success Matrix, devised by Focus Professionals, that combines corn and natural gas costs, ethanol prices, by-product sales and plant efficiency rates. The matrix enables the determination of which combinations of inputs, sales, and efficiency result in an ethanol producer generating sufficient cash flow to cover its operating expenses. Additionally, this matrix produces the range of scenarios that would provide dollars to cover debt service. The more combinations of factors that result in dollars available for debt service, the higher the probability a lender can expect to obtain long term repayment by a specific ethanol producer of its debt obligations. If there are few combinations of factors that result in an ethanol producer having cash available to service debt, the lender can work with the producer to change costs structures or exit the industry.
This specific industry knowledge is coupled with Focus Management Group’s well-honed expertise in weekly cash flow development and weekly key indicator reporting to provide lenders with an ability to monitor ethanol producers’ performance in real time.
A Recent FMG Ethanol Engagement
Focus Mangement Group was hired by a producer and wholesale distributor of ethanol and ethanol by-products which was in default of its debt service financial covenants with its lender. Due to the dramatic decline in gasoline prices, the Company had experienced a sharp decline in the net sales price for ethanol, which significantly reduced the Company’s profitability.
Focus Professionals under took the following actions on behalf of this Company:
- Analyzed the Company’s business operations and financial statements and identified problems, practices and issues affecting the Company’s profitability
- Prepared a comprehensive 26-week cash flow and evaluated performance via an Operational Success Matrix
- Reviewed the Company’s loan agreements, and determined potential restructuring options with a view to better aligning debt service requirements with Company’s anticipated cash flow capabilities
- Assisted the Company in negotiations with its incumbent lender with respect to restructuring of its current debt obligations
As a result of Focus’ analysis, the Company and Lender agreed to a debt restructuring plan that enabled the Company to continue its operations uninterrupted.
Focus Services for the Ethanol Industry
Focus Management Group provides a range of specialized services to lenders in the ethanol industry. These services include:
- Portfolio reviews of lenders’ existing loan files for ethanol producers, to ensure the lender is receiving appropriate data (including financial statement reports, annual production records, contracts, etc.) on a timely basis in order to adequately manage the credit
- Forecasting of future debt service capabilities, which would involve an expanded review of forecasts or the development of forecasts in conjunction with the ethanol producer
- Preparation of an Operational Success Matrix for the ethanol producer
- Working with the ethanol producer to develop weekly cash flow forecasting and reporting capabilities, weekly key indicator reporting, and variance analysis
- Review of operations and comparative operating data
- Expert testimony
For more information on the ethanol industry, listen to Managing Director Pete Dominici’s Podcast and Article on the BioFuels Journal website. If you would like learn more about Focus Management Group’s Ethanol Industry Report and Operating Success Matrix, contact our Corporate Offices at (813) 281-0062.
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