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Using a spark-spread valuation to investigate the impact of corn-gasoline correlation on ethanol plant valuation

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  • Kirby, Natasha
  • Davison, Matt

Abstract

Corn ethanol plants have been criticized for a number of reasons in recent years. This paper provides another ground for criticizing these plants. Historical corn and gasoline prices are uncorrelated, but widespread adoption of corn ethanol production might reasonably lead to future correlation between these prices. We present a real options -- like valuation of an ethanol plant as a spark spread between the corn price and the gasoline price. This analysis shows that the value of an ethanol plant monotonically decreases with increasing correlation and the optimal production schedule greatly depends on the correlation. Even relatively small new correlations can result in a significant proportional value decrease; a 50% correlation between corn and gasoline causes ethanol plants to lose 10% of their value. The limiting case of full correlation would lead to a 30% value loss.

Suggested Citation

  • Kirby, Natasha & Davison, Matt, 2010. "Using a spark-spread valuation to investigate the impact of corn-gasoline correlation on ethanol plant valuation," Energy Economics, Elsevier, vol. 32(6), pages 1221-1227, November.
    • Handle: RePEc:eee:eneeco:v:32:y:2010:i:6:p:1221-1227
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    References listed on IDEAS

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    1. Tad Patzek & S.-M. Anti & R. Campos & K. ha & J. Lee & B. Li & J. Padnick & S.-A. Yee, 2005. "Ethanol From Corn: Clean Renewable Fuel for the Future, or Drain on Our Resources and Pockets?," Environment, Development and Sustainability: A Multidisciplinary Approach to the Theory and Practice of Sustainable Development, Springer, vol. 7(3), pages 319-336, September.
    2. Shapouri, Hosein & Duffield, James A. & Wang, Michael Q., 2002. "The Energy Balance of Corn Ethanol: An Update," Agricultural Economic Reports 34075, United States Department of Agriculture, Economic Research Service.
    3. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-186, March.
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    Cited by:

    1. Maxwell, Christian & Davison, Matt, 2014. "Using real option analysis to quantify ethanol policy impact on the firm's entry into and optimal operation of corn ethanol facilities," Energy Economics, Elsevier, vol. 42(C), pages 140-151.
    2. Ghoddusi, Hamed, 2017. "Blending under uncertainty: Real options analysis of ethanol plants and biofuels mandates," Energy Economics, Elsevier, vol. 61(C), pages 110-120.
    3. Felipe Isaza Cuervo & Sergio Botero Boterob, 2014. "Aplicación de las opciones reales en la toma de decisiones en los mercados de electricidad," Estudios Gerenciales, Universidad Icesi, November.
    4. Nunes, Luis Eduardo & Lima, Marcus Vinicius Andrade de & Davison, Matthew & Leite, André Luis da Silva, 2021. "Switch and defer option in renewable energy projects: Evidences from Brazil," Energy, Elsevier, vol. 231(C).
    5. Schmit, T.M. & J., Luo & Conrad, J.M., 2011. "Estimating the influence of U.S. ethanol policy on plant investment decisions: A real options analysis with two stochastic variables," Energy Economics, Elsevier, vol. 33(6), pages 1194-1205.
    6. Davison, Matt & Merener, Nicolas, 2023. "Equilibrium and real options in the ethanol industry: Modeling and empirical evidence," Journal of Commodity Markets, Elsevier, vol. 31(C).

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