Valuation and Optimal Operation in the Ethanol Industry: Analytical Solutions and Empirical Evidence

Abstract

In the last twenty years a large number of competitive ethanol firms have established operations in the US. Ethanol, produced from corn, is blended with pure gasoline to produce fuel. Producers hold an option to turn off unprofitable plants. Blenders choose to substitute ethanol for gasoline at or beyond the minimum ratio set by the government. We propose and test an equilibrium model for blenders and producers that accounts for the real optionality embedded in the industry. The model, driven by the dynamics of corn and gasoline prices, leads to analytical expressions for the price and physical output of ethanol, and for the value of an ethanol producer. Using data between 2000 and 2017 we provide some empirical support for the model in its ability to reproduce certain aspects of the non linear behavior of ethanol prices in terms of gasoline and corn, time varying industry output, and share price dynamics for the largest public ethanol producer in the US.