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Price risks for biofuel producers in a deregulated market

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Highlights

In a liberalized transportation fuels market biofuel producers will face crude oil and feedstock price risks.

Theoretical, empirical, and simulation analyses suggest that the risk can be significant.

The volatility of profit for biofuel producers will be much larger than the volatility of feedstock, ethanol, and gasoline prices.

The skewed profit causes free cash flow and bankruptcy challenges.

The sensitivity analysis of results is conducted.

Abstract

In a deregulated fuels market, biofuels and fossil fuels are close substitutes. Without blend mandates or flexible subsidy schemes, biofuels will lose competitiveness in times of low oil prices or expensive feedstock prices. This paper provides a quantitative outlook of a potential post-mandate era for the US biofuels industry and highlights the importance of focusing on the random nature of feedstock and gasoline prices. The calibrated gasoline/ethanol model predicts that under all likely scenarios the distribution of profits for a representative ethanol unit will be in the range of −2$/g to 2$/g. We also observe that even with a sufficient subsidy to keep the average ethanol price competitive, ethanol plants may shut-down 40%–60% of the time. The skewness of ethanol producer’s profit is in the range of 2.3–2.5, in contrast to the 0.91 skewness of corn feedstock prices. We discuss the effects of improved technical efficiency, higher subsidies, willingness to pay, and price volatility on ethanol plant shutdown frequency. A set of possible risk management strategies to protect the biofuels sector in a deregulate scenario is offered.

Keywords

  • Biofuels markets;
  • Gasoline price risks;
  • Crude oil price risks;
  • Feedstock price risks;
  • Volatile cash-flow;
  • Risk management

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