Industry characteristics

Ethanol started and maintained as an oligopolistic industry with very few large firms controlling most of supply for a long time. In 1990, the largest ethanol producer, Archer Daniels Midland (ADM), accounted for 55 per cent of total supply while the rest was covered by other 12 firms (Kowplow, 2006). Because ethanol industry has been a highly concentrated industry, regardless of where in the supply chain the subsidy intervenes, the players with highest market power will absorb the largest shares of the benefits from government subsidies. In contrast for Schumpeterian rationale for monopoly’s incentives to innovate, these leaders of ethanol market did not use the revenues captured from government subsidies to innovate, or invest in R&D projects to find ways to cut cost and improve efficiency.

Ethanol plants and bio-refineries are predominantly located in the Midwestern states. This industry agglomeration can help diminish huge costs to transport corn from corn fields to ethanol plants, as well as to transport byproducts such as animal feeds to livestock farms. Be being located in the Corn Belt, the industry also learned valuable know-how from experienced corn farmers in order to make the most use out of corns.

However, ethanol has evolved towards a less concentrated industry for the past decade. In 2003, ADM’s market share had declined to 43 per cent while the other top five players made up 53% of the market. The growing new entry helped decrease ADM’s market share to 29 per cent by the middle of 2005, with more than 70 firms and cooperatives producing and selling ethanol. In 2011, POET surpassed ADM to be the ethanol producer with largest market share of 11.8 %, compared with 10.2 % of ADM. Valero Renewable Fuels stood at the third place with 8.2%. 122 other producers accounted for 69.8% of the market.

Ethanol Market Share by Company 2011

The U.S. ethanol production industry at present does not have high entry barriers. Potential entrants can acquire the existing plants that are idle or bankrupted due to the recent economic crisis. This trend of declining concentration in the industry for the past few years has been due to the generous production incentives for small ethanol plants which has made it easier for new firms to enter the market and restricted the existing market participants to exercise their market power. Many oil refiners such as Valero, Flint Hills, Murphy Oil, and Sunoco have been more interested in ethanol production, joining Marathon Oil Company, which currently operates ethanol facilities with The Andersons, Inc. At the end of 2011, there were 204 ethanol bio-refineries in 29 states. Production expanded beyond the Corn Belt with new biorefineries beginning production or finalizing construction in states like Virginia and North Carolina (Groundbreakingenergy.com).

The Federal Trade Commission’s report on the ethanol market concentration in 2011 shows that there was an increase in the Herfindahl-Hirschman, an index of market concentration based upon the number of market players including producers and marketers and their respective sales, production capacity, actual production as well as ease of entry and imports. Despite a small increase in HHI in 2008, it was back to its downward trend in the following years.

Herfindahl–Hirschman Index for Ethanol Industry in the U.S.
Source: Federal Trade Commission

Another important trend of ethanol production is the increasing production capacity of ethanol plants. Plant size have increased nearly eight folds, indicating the impact of the economies of scales.

The profitability of ethanol production is volatile to price nature of ethanol and corn, its major feedstock as well as price  of its co-product (distillers grains with solubles, DDGS) and its energy source (natural gas and coal)  is the second highest component of ethanol production cost while corn accounted for the largest share of this cost. In the dry-milling process, a gallon of ethanol costs (1999$)90 cents to produce, 70 cents of which goes to corn while the remaining covers labor, supplies, overhead cost, operation cost and capital depreciation. This already accounts for the surplus of 30 cents for the selling of co-products (DGS). During the post-2005 oil price hike, non-subsidized corn ethanol would not have been as cost-competitive as petroleum. In 2005 when the average wholesale gasoline price was $0.44/liter, it took $0.46 to produce the amount of ethanol that produces the same energy content. Compared with other feedstock such as sugar, corn from the U.S.  has a higher production cost.

Production Cost Comparison

Ethanol Production Cost in the U.S. (2005-2012)

In Hettinga et al. (2009) , “Understanding the reductions in US corn ethanol production costs: An experience curve approach,” researchers from the Copernicus Institute, Utrecht University and the United States Department of Agriculture examined the technological development of ethanol production and resulting cost reductions by applying the experience curve approach on the costs of dry-milling ethanol production over the period of 1980–2005. The decline in this cost was attributed to the cost reductions of feedstock (corn) production and industrial (ethanol) processing. Over this period, there was a 62% decline in corn production costs and a 45% cost decline over each doubling in cumulative production, enabled by higher corn yields and increasing farm sizes. Industrial processing costs of ethanol declined roughly 40%. Total ethanol production costs (including capital and net corn costs) per cubic metre have declined approximately 60%, thanks to higher ethanol yields, lower energy use and the replacement of beverage alcohol-based production technologies. The study shows that the technology learning has been the driver of the cost reduction in ethanol production and is predicted to attribute to future cost reduction.

However, to be less optimistic, this cost reduction might have reached or will soon reach a threshold after which it is impossible to reduce cost. Innovations in the ethanol industry have focused much on the improvement of plant efficiency, corn and ethanol yield. Future innovations may occur in the new kinds of feedstock which can be converted into ethanol more cost-effectively and more efficiently.

However, this kind of innovation may in effect cannibalize the existing corn-ethanol production. If these innovations can be commercialized profitably and be incorporated into the existing facilities heretofore used to produce corn-based ethanol, firms will be willing to invest in the new feedstock and gradually halt their corn ethanol production.

(Huong Nguyen)

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