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Do lender-imposed sweeps affect ethanol technology investment?

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Author Info

  • Jason Fewell
  • Cole Gustafson

Abstract

Purpose – New federal legislation proposes to reduce greenhouse gas (GHG) emissions associated with biofuel production. To comply, existing corn ethanol plants will have to invest in new more carbon efficient production technology such as dry fractionation. However, this will be challenging for the industry given the present financial environment of surplus production, recent profit declines, numerous bankruptcies, and lender-imposed covenants. The purpose of this paper is to examine a dry mill ethanol firm's ability to invest in dry fractionation technology in the face of declining profitability and stringent lender cash flow repayment constraints. Firm level risk aversion also is considered when determining a firm's willingness to invest in dry fractionation technology. Design /methodology/approach – A Monte Carlo simulation model is constructed to estimate firm profits, cash flows, and changes in equity following new investment in fractionation to determine an optimal investment strategy. Findings – The addition of a lender-imposed sweep, whereby a percentage of free cash flow is used to pay off extra debt in high profit years, reduces the firm's ability to build equity and increases bankruptcy risk under investment. However, the sweep increases long-run equity because total financing costs are reduced with accelerated debt repayment. Practical implications – Results show that while ethanol firm profits are uncertain, imposition of a lender sweep combined with increased profit from dry fractionation technology helps the firm increase long-run financial resiliency. Originality/value – Examination of ethanol plant financial structures and investment capabilities has received scant research attention to date.

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Bibliographic Info

Article provided by Emerald Group Publishing in its journal Agricultural Finance Review.

Volume (Year): 70 (2010)
Issue (Month): 2 (August)
Pages: 169-183

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Handle: RePEc:eme:afrpps:v:70:y:2010:i:2:p:169-183

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Related research

Keywords: Fuels; Legislation; Monte Carlo simulation; Production methods; United States of America; Waste management;

References

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  1. Searchinger, Timothy & Heimlich, Ralph & Houghton, R. A. & Dong, Fengxia & Elobeid, Amani & Fabiosa, Jacinto F. & Tokgoz, Simla & Hayes, Dermot J. & Yu, Hun-Hsiang, 2008. "Use of U.S. Croplands for Biofuels Increases Greenhouse Gases Through Emissions from Land-Use Change," Staff General Research Papers 12881, Iowa State University, Department of Economics.
  2. Hochman Gal & Sexton Steven E & Zilberman David D, 2008. "The Economics of Biofuel Policy and Biotechnology," Journal of Agricultural & Food Industrial Organization, De Gruyter, vol. 6(2), pages 1-24, December.
  3. Gustafson, Cole R., 2008. "Financing Growth of Cellulosic Ethanol," Staff Papers 44870, North Dakota State University, Department of Agribusiness and Applied Economics.
  4. Ozgur Arslan & Chrisostomos Florackis & Aydin Ozkan, 2006. "The Role of Cash Holdings in Reducing Investment-Cash Flow Sensitivity: Evidence from a Financial Crisis Period in an Emerging Market," Discussion Papers 06/08, Department of Economics, University of York.
  5. Perrin, Richard K. & Fretes, Nickolas F. & Sesmero, Juan Pablo, 2009. "Efficiency in Midwest US corn ethanol plants: A plant survey," Energy Policy, Elsevier, vol. 37(4), pages 1309-1316, April.
  6. Baker, Mindy L. & Babcock, Bruce A., 2008. "Value maximization from corn fractionation: feed, greenhouse gas reductions, and cointegration of ethanol and livestock," Transition to a Bio Economy Conferences, Integration of Agricultural and Energy Systems Conference, February 12-13, 2008, Atlanta, Georgia 48714, Farm Foundation.
  7. Kenkel, Philip L. & Holcomb, Rodney B., 2006. "Challenges to Producer Ownership of Ethanol and Biodiesel Production Facilities," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 38(02), August.
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