This paper uses real option analysis to evaluate investment decisions in ethanol facilities. First, we consider the option to expand the scale of a conventional ethanol plant. Second, we evaluate the option to choose a production technology given three drymilling choices â a conventional natural gas-fueled plant, a stover-fueled plant, and a stover-plus-syrup-fueled plant. We develop input-output coefficients and annual cash flow projections for a hypothetical small ethanol plant (50 million gallon capacity) using available industry and market price data. Scenario analysis is done to evaluate the effect of profitability and volatility on the option to expand. We find that the best decision during 2001-07 is often to expand, since the net present values of the investment project are positive. However, there are states in the binomial tree where it is best to wait. In relatively few such states the expansion project is simply rejected. During the early part of the period low profitability and high volatility more frequently favor strategies of waiting to invest until prices and profitability improve. During the latter part of the period (2005-07), profitability is sharply higher and most often the best strategy is to invest in the expansion. This result is consistent with the observed rapid increase in industry production capacity during 2005- 07. However, more recent market developments, sharply higher corn and natural gas prices and slightly higher ethanol prices during late 2007-early 2008, have combined to sharply reduce expected plant cash flow and profitability and cash flow volatility. The implication is that plant investment plans in 2008 would be increasingly placed on hold, which the real option model correctly predicts. The real option analysis of technology choice indicates that the stover-fueled technologies are most often chosen when compared to a natural gas-fueled conventional technology based on the prices that existed during 2001-2007.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by University of Minnesota, Department of Applied Economics in its series Staff Papers with number
37872.
Length: Date of creation: Jul 2008 Date of revision: Handle: RePEc:ags:umaesp:37872
Contact details of provider: Postal: 231ClaOff Building, 1994 Buford Avenue, St. Paul, MN 55108-6040 Phone: (612) 625-1222 Fax: (612) 625-6245 Email: Web page: http://www.apec.umn.edu More information through EDIRC
For technical questions regarding this item, or to correct its listing, contact: (AgEcon Search).
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.: