A recent report commissioned by the Missouri Corn Growers Association, state of Missouri and USDA set out to answer a question asked by many who grow corn: How many ethanol plants can Missouri support?

Five is the answer, but that's a simplification. The study on Missouri's ethanol potential was more in-depth than a mere suggestion of how many facilities the state could support. Instead, SJH & Co., the Boston consulting firm that conducted the research, put a critical eye on the industry's history, its future and what parameters ethanol needs to be profitable.

Specifically, the report suggests Missouri's top capacity for ethanol production should be limited to five facilities (including existing facilities at Craig and near Macon) that would each produce 30 to 50 million gallons annually. Thus, total capacity build-out for the state would be between150 to 250 million gallons annually. The lower end of the range is assuming current market trends. The higher end allows for a federally mandated renewable fuel legislation that is wending through Congress in a couple of different forms.

From the range in those figures, you might guess that much of the report is concerned with a simple, but critical hinge--supply and demand.

While the concept of supply and demand seems simple enough, it gets more complicated when farmer-owned businesses have to track a traditional commodity like corn coming into the facility, and a less familiar commodity, ethanol, which moves through an entirely different market structure as it leaves the facility.

Local focus
On the ethanol side, local demand is critical. If federal renewable fuel legislation happens to pass, national demand for ethanol could grow, over a 10-year period, to 10 billion gallons per year from the current level of about 2 billion gallons. That's an increase that would boost ethanol producers--if it were to happen. But Jeff Kapell, a principal associate with SJH and Co., says Missouri farmers need to make decisions based upon access to local demand for a portion of their production. Research for the study shows demand for ethanol in Missouri is about 60 million gallons. Analysis from SJH shows that could grow to 80 million in the mid- to long-term future (or more if petroleum-based fuel oxygenators are banned in urban markets).

"It is important to lower marketing risks by balancing distribution of production between local and national markets. In the ethanol industry, an rule of thumb is for 30 to 50 percent of a facility's production to be used in a local market," said Kapell.

An obvious advantage for local sales is lower transportation costs. According to the study, rail freight to the West Coast costs about 14 cents per gallon while truck delivery to local markets averages about 6 cents per gallon.

And local markets can be more reliable.

"There is considerable risk selling on the open market, especially in a downturn," Kapell said, explaining that many smaller producers of ethanol don't lock into price or 'take-or-pay' contracts because current demand is high.

"But sooner or later," he said. "There will be a market correction."

Still, there is a need to tap regional and national markets. When solely pursuing local markets, ethanol producers can become more direct competitors, pushing down local prices and reducing profit margins.

Where the corn grows
There's an advantage for corn-fed ethanol plants to be where corn grows. That's common sense, but the study points out that facility location can influence local basis enough to reduce profitability for ethanol. The study identifies five sites as ideal. Those sites include the existing plants at Craig and Macon. Efforts to site plants in the east-central, west-central and southeast parts of the state are already underway.

Kapell said that the possibility of price disruption in corn figures more prominently in Missouri compared to corn-rich states like Iowa and Illinois. He added that the areas identified as likely locations would be limited to one facility in the 30- to 50- million gallon range. More facilities within one area would increase basis, pushing up the facilities' corn-bid prices and cutting profitability. Locating plants in areas less dense with corn is possible, said Kapell, but the facility would need to find a competitive advantage to justify the location and offset feedstock costs.

John Eggleston runs a grain farm operation with his wife and brother in Scotland County and is president of Northeast Missouri Grain Processors, Inc., the ethanol facility at Macon. Eggleston says that the study served the state well because it helps highlight the need for well-thought-out site selection for ethanol facilities.

"My biggest fear is that we would get too close together," said Eggleston. "The biggest expense for a plant is procuring feed stock [corn]."

According to the study, the cost to acquire corn represents close to two-thirds of all costs of production.

Eggleston added that the study will be important for the strength of the ethanol industry in Missouri if its blueprint for site location is followed.

"I'd love to see the additional plants be built in Missouri," he said. "We just have to be careful on how we do it."

Build to scale
The study, recommends doubling the size of existing facilities at Craig and Macon and to consider 30-million-gallon facilities as low-end of viability for new ethanol plants. To build a new, 30-million-gallon facility carries a $1.58 capital cost per gallon of capacity, according to estimates from SJH. For capital costs per gallon of capacity to build a 15-million-gallon plant, figure $1.77.

According to the report, economies of scale also figure into the daily operation of an ethanol facility. It doesn't take many more people to operate a larger facility. Nor does it take much additional overhead.

While efficiencies of scale look good on paper, Eggleston and others involved in startup efforts at Macon faced another reality.

"Initial capital is hard to get," he said. "We knew that the economies of scale for a 30-million-gallon plant were attractive. But make no mistake, the money it takes to build that plant is very hard to get."

In the end, the plant at Macon was scaled back to 15 million gallons. But its success in the meantime has made way for expansion. Work is underway to launch a capital campaign to expand to a 36-million-gallon capacity.

Market props
Farmers may be wary of investing in a project, like ethanol, that depends largely on a market driven by governmental fiat. But demand is demand. Current federal excise tax exemptions, a driving force in the ethanol market, will last until 2007. After that sunset date, there is bound to be debate on the topic. Right now, blenders of gasoline get a 5.3-cent exemption (on 18.3 cents of tax liability) for every gallon of fuel blended with 10 percent ethanol.

Legislation pushing renewable fuels could boost demand further. Regardless of future demand, the SJH study points out that sometime in the future increased ethanol production will likely cause a market correction. According to Kapell, the ability of ethanol facilities to balance local and national markets will be important in navigating future market conditions.

"Being too dependent on a local ethanol market could be a mistake if that market gets big enough to draw in larger producers," he said. And as for selling ethanol with contracts that do not share market risks, "In the short term because of demand there has not been much risk. But for the long term, that contract with the resaler is something that needs to be figured out," said Kapell.