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Many factors at play in U.S. ethanol's 'merger mania,' specialist says

Ethanol industry profits have been under extreme pressure this year as ethanol prices were depressed and corn prices surged.

Merger mania is sweeping the ethanol industry as both small and large firms are joining together to create even larger entities, says North Dakota State University agriculture economist Cole Gustafson in a university report.

The recent wave of ethanol plant mergers is due to several factors, Gustafson says. First, industry profits have been under extreme pressure this year as ethanol prices were depressed and corn prices high. Firms facing financial stress often review their core strategic plan in an effort to improve long-term profitability.

The potential for efficiency gains is a second motivation. Although the majority of ethanol production costs are variable in the form of purchased corn, enzymes and other inputs, firms do face large, fixed costs. These fixed costs involve not only building and equipment costs, but also lab testing, environmental reporting and payroll. Firms that merge and share these fixed costs eventually end up with lower costs of production and become more competitive in the industry.

Third, merged firms have greater quantities of ethanol to sell and often find new market opportunities because of the higher volume of product they have to offer. Most ethanol produced still is blended with gasoline, but gasoline markets are highly concentrated. Therefore, larger ethanol plants have greater access when negotiating with gasoline firms.

Finally, technology is changing rapidly in the ethanol industry. Corn-to-ethanol conversion technology is increasing. Moreover, large federal research funding is providing a broad range of new technologies, such as fractionation, water conservation and gasification. Larger firms, with a greater capital base, will find it easier to invest in these technologies and also realize increased benefits if the technology can be spread over more gallons of production.

"Although there are many advantages to merging ethanol companies, one has to question if newly merged firms have the potential to become too large and thereby exerting monopoly power and causing hardship to the remaining firms in the industry," Gustafson says. "This is especially sensitive in the ethanol industry because of large federal and state supports in the form of tax credits, import quotas and research spending. Most economists conclude that the ethanol industry would struggle without these incentives."

A recent study prepared by the Federal Trade Commission investigated concentration in the ethanol industry. Even with the recent wave of industry mergers, the report concludes that industry concentration is far less now than it was in 2000. As of September 2007, the ethanol industry consisted of 103 firms. This large number of firms is an important indication that no firm has significant market power.

The study goes on to report that the largest ethanol firm's share of capacity actually fell last year from 21% to 16%. This decline actually has been a long-term trend as the largest firm in 2000 accounted for 41% of the domestic ethanol capacity.

"The reason individual firm shares have been declining is due to the large expansion of the ethanol industry in general," Gustafson says. "More firms and greater production has greatly reduced the market power of previous industry titans."

Ethanol industry profits have been under extreme pressure this year as ethanol prices were depressed and corn prices surged.

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