Economic Development Lessons from Ethanol: Markets Work, but Not for All Investors
Part 1 of 4
From the beginning of the renewable fuels industry, Minnesotans have watched different classes of investors dash around the state building and operating ethanol plants. For some, it's been great; for others, a financial disaster. For still others, and for taxpayers, results are mixed but they offer lessons about investing in economic development projects.
The different scenarios for investors became apparent on March 18 when VeraSun Energy Corp. of Sioux Falls, S.D., announced a federal bankruptcy court in Delaware had approved the sale of most VeraSun ethanol assets. Included in the sale were two plants in Minnesota.
Valero Renewable Fuels, a subsidiary of Valero Energy Corp. of San Antonio, Tex, made the largest purchase in a $477 million deal for seven plants, including one at Welcome, MN. This means the nation's largest petroleum refiner is now becoming a big player in ethanol, a related sector of its core industry.
Creditors took over 10 other VeraSun plants. The largest of these groups was a lender group of 16 financial institutions formed by AgStar Financial Services, the large Farm Credit bank group at Mankato. It took over six plants in a $324 million deal that includes a plant at Janesville, Minn.
AgStar, like its umbrella AgriBank FCB bank in St. Paul, are federally chartered but huge farmer-owned cooperative banking institutions. Paul DeBriyn, president and chief executive, said AgStar's intent is to resell the six plants to farmers or farm cooperatives.
"Ethanol has experienced recent volatility but remains a viable industry," DeBriyn said in a statement. "Our goal is to have these plants sold as quickly as possible. This is vital so that corn will again be purchased from local sources, jobs will be brought back to rural America, and the renewable fuels industry as a whole will be reinvigorated."
Three other plants were sold to a lenders' group of investment bankers. What they will do with the plants was not immediately known.
All these investors, including the now disassembling VeraSun Energy, all bet that America and Minnesota's commitments to renewable energy assured profits from ethanol production. That hasn't been the case as corn prices reached record highs in the first half of last year and remain high enough to squeeze operating margins at ethanol plants.
Most of Minnesota's plants, however, are either farmer-owned cooperatives or hybrid business enterprises that include farmers along with either community investors or outside investors. Another group of "investors" are community citizens called upon to provide tax subsidies for these plants, either because market signals and ethanol subsidies weren't enough to make feasible development plans or because business has become hooked on tax subsidies and tax avoidance policies.
Step back a moment, examining ethanol production in Minnesota and how it fits with economic development. Investors have distinctly different goals, and these diverse goals aren't always complimentary.
The difference between farm investors and outside investors is the most profound. Gert van Dijk, a Dutch economist who is completing a two-year term as president of the farm cooperative umbrella organization for the European Union, says that difference is most apparent on an enterprise's bottom line regardless of profits.
Investments groups are motivated by returns of investment (ROI) and returns on equity (ROE) objectives. Most often, any collateral benefits to stakeholder groups such as suppliers (corn farmers), jobs and community economic activity, while nice, are irrelevant to the outside investors.
Meanwhile, farm investors in value-added plants such as ethanol factories do so with dual bottom line objectives, Van Dijk insists in a new book on cooperative theory ("When Markets Fail") that has been published in Dutch and is forthcoming in English. First, the enterprise must be successful in its own right to compete in markets and sustain its operations. Second, the member owned enterprise must make its members more successful, or entrepreneurial, in their own operations.
That plays out in Minnesota where farm income has increased even when the local plant that strengthens commodity prices might be struggling.
This sets up a clash between or among capital interests in enterprises such as ethanol plants. It can be a clash between classes of shareholders. And just as often, it sets up a clash of interests between "agents" - or managers - and "principals" - investor/owners - that is not easily resolved when the general economy or a business sector is under stress. This is currently the case across most of the U.S. and Minnesota economies.
AgStar banker DeBriyn pointed at the dual cooperative objectives and their benefits in describing why his lender group wants to resell plants to farmers and farm cooperatives. Ethanol has greatly increased farm income in Minnesota by providing new, nearby markets for corn.
But try explaining why that is a good thing to non-resident investment bankers who are now complaining that Target Corp. stock is undervalued, or Northwest Airlines' stock was undervalued, or the stock of the media companies that formerly owned Twin Cities newspapers. Take a good look at shareholder complaints against executive (agent) salaries and bonuses when stock portfolios have lost so much value.
When Minnesotans, and their community and business leaders, look for ways to reinvigorate our economy, planning should focus on sustainable benefits for shareholders and stakeholders alike. There are pitfalls built into issues of capital formation and public policy that affect all industries and are playing out before our eyes with our ethanol industry.
For the second installment in this ongoing series, Aparna Bhasin, a senior at Macalester College in St. Paul and an undergraduate research fellow at Minnesota 2020, examines farm investments in ethanol plants to gauge the economic impact of farm cooperatives in creating markets and adding value to farm commodities. In short, her research shows enormous payback from these farm investments.
The third installment is based on "agency theory" problems and the clash of interests in modern business organizations. Minneapolis native Michael Jensen, of Harvard University, created agency theory in 1976 with the late William Meckling of the University of Rochester. Their theory explains why outside investments in ethanol plants are risky when the plants better serve the capital interests of farm investors.
A final installment for later publication will incorporate observations from readers and explore lessons we should learn about stakeholder and shareholder interests in economic development projects. Specifically, it will look at public policies and how they can variously distort markets or favor one set of investors over others that can doom the enterprise over time.
Click here to read part two.