identifying and evaluating risk management strategies for alternative energy crops joe l. outlaw...

Identifying and Evaluating Risk Identifying and Evaluating Risk Management Strategies for Management Strategies for Alternative Energy Crops Alternative Energy Crops

Joe L. OutlawProfessor & Extension Economist

Co-Director, AFPC

James W. RichardsonRegents Professor &

Co-Director, AFPC

David P. AndersonProfessor & Extension Economist

2011 Extension Risk Management Education National ConferenceSt. Louis, MO

April 13, 2011

Presentation OutlinePresentation Outline

• RFS 2• Alternative Energy Crops• Major Areas of Risk• Managing Risks• Conclusions

Energy CropsEnergy Crops

Renewable Fuel Standard – Renewable Fuel Standard – RFS 2RFS 2

• Energy Independence and Security Act of 2007

• 36 billion gallons of biofuel by 2022 15 B gal conventional (“Corn Ethanol”)

• 21 B gal of 2nd generation biofuel• 16 B gal of cellulosic (primarily

cellulosic ethanol)• 4 B gal of advanced biofuel; 1 B gal

of biomass based diesel

•Sources:  Nebraska Ethanol Board, Lincoln, NE.  Nebraska Energy Office, Lincoln, NE.

Historical and Projected Historical and Projected Ethanol Dry Mill Net ReturnsEthanol Dry Mill Net Returns

Source: FAPRI January 2011 Baseline

Alternative Energy CropsAlternative Energy Crops

• Not focusing on current feedstocks with established markets– Ex. Corn, sunflowers, soybeans

• Partial list of other dedicated energy crops

Sweet sorghum  Biomass sorghum

Energy cane Switchgrass

Napier grass Miscanthus

Miscane Sorcane

Palm Safflower

Castor Camelina

Jatropha Algae**

Food vs. Fuel Land Food vs. Fuel Land IssueIssue

• Respondents to a Biofuels Digest survey in Florida – 12 percent said it was immoral “to use crops that are generally used

for animal feed to make energy or fuel”. – 15 percent said it was immoral “to use a (human) food crop at any

time to make energy or fuel” – 24 percent said it was immoral “to convert land that is used for

growing (human) food crops to the production of energy or fuel.” – Less than <1% thought use of ag waste for biofuel was immoral, but

5% said immoral to use forest residues if it is collected in the forest– 45% voted immoral to convert land used for conservation, national

parks, or forests– Only 6% said it was immoral to convert land that can grow crops to

biofuel feedstock production

Source: Biofuels Digest April 6, 2011

Futures Contract Closing PricesFutures Contract Closing Prices

As of 4/05/11

Commodity Contract Close

Corn Dec-2011 6.46

Soybeans Sep-2011 13.83

Wheat Jul-2011 8.22

Cotton Dec-2011 1.3776

Rice Sep-2011 15.165

Sources: USDA-ERS and USDA-NASS, Census of Agriculture, Various Issues.

U.S. Land Most Likely to be U.S. Land Most Likely to be Used for Dedicated Energy Used for Dedicated Energy

CropsCrops

Francis Epplin, “Biomass: Producer Choices, Production Costs and Potential”, presented at the Transition to a Bioeconomy: The Role of Extension in Energy Conference, June 30-July 1, 2009, Little Rock, Arkansas.

Major Areas of RiskMajor Areas of Risk

• Everyone will categorize/define differently• Production - risks within the business• Market/Price - risks outside the business • Counterparty - risks with entities outside the business• Government/Policy - risks resulting from government involvement or a change in government involvement

Francis Epplin, “Biomass: Producer Choices, Production Costs and Potential”, presented at the Transition to a Bioeconomy: The Role of Extension in Energy Conference, June 30-July 1, 2009, Little Rock, Arkansas.

ProductionProduction

• Seed availability and suited for their soils

• Weather– Drought– Flood– Rain, but not timely

• Not when needed or at harvest

• Fire– Tracts (large and small) of dry matter

• Won’t be near a fire hydrant

– Also in storage facility

Risk for Switchgrass Yields Risk for Switchgrass Yields on a Typical Tennessee on a Typical Tennessee

Farm Farm

4 5 6 7 8 9 10 11 12 13

Tons/Acre

Feedstock Availability Feedstock Availability RiskRisk

200 700 1200 1700 2200 2700 3200

MT Camelina Yield Risk Lb./Ac

MarketMarket• Input Prices• Output Prices

– Plant not operational– Depending on an economically viable conversion system– Whatever the business model is – that it’s profitable– Competitive position with fossil fuels– Uncertain as to how many acres will be contracted each year– Limited alternative uses for feedstock – can you feed it?

• How Do You Overcome the Lack of Established Markets?– Cross Hedging– Contracts

• Contract has to cover:– Costs of establishment– Opportunity costs

Source: Agricultural Prices, National Agricultural Statistics Service, USDA.

ContractsContracts

•Contract establishes a safety net– Establishment costs– Price– Volume– Term– What happens if terms violated– Exits– Needs to be flexible

• Ex. Fuel clause that adjusts the contract value upwards if fuel costs increase

CounterpartyCounterparty

• The risk to each party of a contract that the counterparty will not live up to its contractual obligations.

• Fancy way to say default risk

• Ex. VeraSun, Pilgrims

Government/Policy RiskGovernment/Policy Risk

• Volumetric Ethanol Excise Tax Credit (VEETC)

• RFS II• Import Tariff• Biomass Crop Assistance Program

Managing RisksManaging Risks

• Production– No government subsidized crop insurance for

most dedicated energy crops – yet– Self insure

• Market– Contracting, hedging(if possible), etc

• Counterparty– Choose business partners wisely– Some state’s initiating funds

• Government/Policy– Don’t include incentives in business plan

ConclusionsConclusions

•Going to have to incentivize producers to grow dedicated energy crops•Will be a lot of different types of risk than producers are used to dealing with

• Ex. NO MARKET for my crop instead of situations of unacceptable price

•Relative prices between fossil fuels and ethanol/biodiesel and competing crops and dedicated energy crops will drive industry