Baker & O'Brien, Inc.

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Defining Ethanol’s “Cost-of-Production” - What’s Included?

Arbitration, United States

July 1, 2014

 

The United States Government’s Renewable Fuel Standard (RFS) mandates the use of increasing volumes of ethanol in the nation’s gasoline supply.  When the RFS was initially enacted in 2005, many gasoline suppliers were concerned about their ability to obtain sufficient ethanol volumes to meet their RFS obligations.  As a result, some suppliers entered into long-term contracts with producers to secure such supplies.

A large independent gasoline retailer executed a long-term contract with an ethanol production facility to purchase all of the plant’s annual output.  The contract called for the ethanol price to be determined by a formula based on the ethanol facility’s actual “cost-of-production,” plus a margin to recoup the plant’s investment.  Initially, the formula price resulted in the retailer paying less than the open market price for ethanol.  However, as the ethanol market matured and new production volumes came onstream, the formula price began to exceed the market price.  The retailer ceased to lift the contracted volumes, claiming that the formula price did not accurately reflect the producer’s true cost-of-production, as intended, and filed for arbitration.   

Baker & O’Brien was engaged as an expert witness in the arbitration to examine the original bases for the formula price and to ascertain whether any adjustments were warranted.  Early in our investigation, we determined that, among other issues, one of the key factors in the dispute was that the calculation of the formula price  did not take into account revenues received from the ethanol facility’s sale of distillers’ dry grains with solubles (DDGS)—an ethanol plant by-product that is used as an animal feed supplement.  Ignoring the DDGS revenues resulted in an ethanol formula price that was inconsistent with the generally accepted industry definition of “cost-of-production.”   

Baker & O’Brien testified in the arbitration, and the results of our investigations were entered into the record that the arbitrators used in reaching their decision.