Evaluating the Economics of Ethanol

Abstract

The ethanol industry has experienced explosive growth in the past several years due to concerns about oil dependence and climate change. However, sentiment has begun to shift against corn ethanol due to increasing food costs, dwindling profit margins and increased government expenditures propping up the industry. Despite the record increase in gasoline prices, ethanol has struggled with its own rising costs of production and market turmoil. This Masters Project assesses the economics of corn-based ethanol production in the United States through the development of three models. The Ethanol Supply Curve Model constructs an ethanol supply curve based on user defined commodity prices. The model compares the marginal cost of ethanol production to the wholesale price of gasoline in order to determine the ability of ethanol to compete with gasoline in the transportation fuel market. The Ethanol Profit Model solves for a facility’s profit margin under user defined commodity conditions. The Ethanol Variable Subsidy Model calculates the price-contingent subsidy required for ethanol to compete with gasoline on a price basis. A reference case is developed using commodity prices from U.S. government forecasts for 2008. Additionally, several sensitivity analyses are completed to provide insight about the potential health of the ethanol industry under different conditions. The results from the reference case indicate the ethanol industry is facing a treacherous production environment. The reference case scenario finds profit margins of $-0.1116/gallon for dry-mill ethanol producers, and $0.0498/gallon for wet-mill producers. Ethanol producers face the risk of bankruptcy, consolidation and failure to meet government production mandates if the current conditions persist. In the reference case, ethanol producers require a 33% increase in the ethanol subsidy from $0.51/gallon to $0.6796/gallon in order to break-even with gasoline prices. The Ethanol Supply Curve Model also shows that the market currently values ethanol on a gasoline-energy equivalent basis rather than a volumetric basis. Model instructions and computer code are included in the report.