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