Everything You Wanted To Know About Ethanol Production But Were Afraid To Ask (ADM, HKI, VSE)

Includes: ADM, HWY, VSUNQ
by: Evelyn Rubin

In Hawkeye Holdings' (HKI) S-1 filing from yesterday, a detailed description of the ethanol production process is given. Great background for investors and potential investors in Archer Daniels Midland (NYSE:ADM) and VeraSun (VSE), which set the terms of its IPO last week. From Hawkeye's filing:

Our plants produce ethanol by processing corn with technology developed by ICM. A bushel of corn yields approximately 2.8 gallons of ethanol. Our dry-mill process of using corn to produce ethanol and co-products is illustrated in the following chart and described below. [click on chart to enlarge]

Step One: Grain Receiving, Storing and Milling

We receive corn by rail and by truck, at which point we inspect, weigh and unload the corn in a receiving building and then transfer it to storage bins. On the grain receiving system, a dust collection system limits particulate emissions. Truck scales and a rail car scale weigh delivered corn. Corn unloading and storage systems include independent unloading legs and concrete and steel storage bins. From its storage location, corn is conveyed to scalpers to remove debris before it is transferred to hammermills or grinders where it is ground into a flour, or "meal."

Step Two: Conversion and Liquefaction, Fermentation and Evaporation Systems

The meal is conveyed into slurry tanks for enzymatic processing. The meal is mixed with water and enzymes and heated to break the ground grain into a fine slurry. The slurry is routed through pressure vessels and steam flashed in a flash vessel. This liquefied meal, now called "mash," reaches a temperature of approximately 200°F, which reduces bacterial build-up. The sterilized mash is then pumped to a liquefaction tank where additional enzymes are added. This cooked mash continues through liquefaction tanks and is pumped into one of the fermenters, where propagated yeast is added, to begin a batch fermentation process.

The fermentation process converts the cooked mash into carbon dioxide and beer, which contains ethanol as well as all the solids from the original feedstock. We employ the batch fermentation process in which the mash is kept in one fermentation tank for approximately two days. Circulation through external plate and frame heat exchangers, designed for high solids content and easy cleaning, keeps the mash at the proper temperature.

Step Three: Distillation and Molecular Sieve

After batch fermentation is complete, beer is pumped to the beer well and then to the distillation column to vaporize and separate the alcohol from the mash. The distillation results in a 96%, or 190-proof, alcohol. This alcohol is then transported through a rectifier column, a side stripper and a molecular sieve system where it is dehydrated to produce 200-proof anhydrous ethanol. The 200-proof alcohol and up to 5% denaturant constitute ethanol ready for sale.

Step Four: Liquid—Solid Separation System

The residue corn mash from the distillation stripper, called stillage, is pumped into one of several decanter type centrifuges for dewatering. The water, or thin stillage, is then pumped from the centrifuges back to mashing as backset or to an evaporator where it is dried into a thick syrup. The solids that exit the centrifuges, known as "wet cake," are conveyed to the wet cake storage pad or the gas-fired rotary dryer for removal of residual water. Syrup is added to the wet cake as it enters the dryer, where moisture is removed. The end result of the process is the production of dried distillers grains with solubles, or DDGS.

Step Five: Product Storage

Final storage tanks hold the denatured ethanol product prior to being transferred to loading facilities for truck and rail car transportation. Each of our plants has one 190-proof storage tank and one 200-proof storage tank. Our Iowa Falls plant has two 750,000 gallon final storage tanks with another two 750,000 gallon final storage tanks to be be added in the fourth quarter of 2006. Our Fairbank plant has two 1,500,000 gallon final storage tanks. These final storage tanks will accommodate ten days of storage per plant.

Co-Products of Ethanol Production

Our ethanol production facilities produce distillers grains as a co-product that is generated after the grains have been fermented by yeast. In the fermentation process, nearly all of the starch in the grain is converted to ethanol and carbon dioxide, while the remaining nutrients (proteins, fats, minerals and vitamins) undergo a three-fold concentration to yield modified distillers grains, or MDG, or, after further drying, dried distillers grains, or DDG. Addition of soluble syrup creates modified distillers grains with solubles, or MDGS. Each bushel of corn yields approximately 17 pounds of distillers grains in a dry mill process. Distillers grains are an economical partial replacement for corn, soybean and dicalcium phosphate in livestock and poultry feeds. Our distillers grains are marketed under the name Hawkeye Gold. Livestock owners buy large volumes of Hawkeye Gold distillers grain to enable the shipment of entire units trains with consistent quality product.

Distillers grains are derived from corn and contain a nutrient profile that has been proven to have beneficial properties for the diets of dairy and beef cattle, poultry and swine. The high digestibility and net energy content of DDGS and MDGS, compared to other feed ingredients such as soybean meal, canola meal and brewers spent grains, as well as their high fat content, results in greater milk production by dairy cattle. For beef cattle, the improved rumen health, energy effect of the fiber and palatability has been shown in feedlot studies to result in faster and more efficient weight gains.

MDGS are similar to DDGS but with a 50% moisture content rather than a 12% moisture content for DDGS. DDGS have a prolonged shelf life and reduce transportation expense, while MDGS are cheaper to produce as they spend less time in the drying process. We sell MDGS to local farmers, while DDGS are shipped longer distances by truck or rail. Most of our distillers grains sales are in the DDGS form.

Carbon dioxide, or CO2, is also a by-product of our dry-mill ethanol production process. While CO2 produced is typically of sufficient quality to be collected and sold, we do not currently market our CO2. Currently, we scrub the CO2 during the production process and release it to the atmosphere. In the future, we may explore the possibility of marketing CO2.

Corn Procurement

Our operations require approximately 75 million bushels of corn per year in order to produce the 205 MMGPY of expected ethanol output. We source our corn supply both directly from Iowa farmers who transport the bushels directly to our production facilities and from local dealers. We publish a corn bid on our website that local farmers and cooperative dealers utilize to facilitate the corn supply transactions.

Each corn purchase at our Iowa Falls plant is negotiated on a separate contract which identifies the number of bushels, price and delivery period. The price always includes delivery to the plant, making transportation costs the seller's responsibility. Delivery terms are stated for delivery in a particular month, then the plant coordinates the specific delivery dates with the various sellers. Payment for the corn is required to be made within one day of the seller's request for payment, which is typically when the seller has completed delivery on a particular contract. Corn purchases at our Fairbank plant are negotiated on our behalf by Innovative Ag Services, with whom we contract our corn procurement requirements. Terms for corn sales to our Fairbank plant are on substantially similar terms as those we obtain for our Iowa Falls plant.

Ethanol Sales Logistics

Finished ethanol product is stored in the ethanol storage tanks at the plant sites. As empty rail cars arrive at the sites, they are loaded and generate a bill of lading. Our ethanol marketer, EEI, informs us as to which contracts the bills of lading apply. We then release the cars to the railroad, which schedules them for pickup. The EEI contract has a weekly cutoff, under which ethanol that is loaded by Sunday of each week is paid for the following Thursday, whether it has left our facility or not. Title passes to EEI at the time the ethanol is loaded into a rail car or truck.

Through a long-term lease agreement, we have access to over 500 rail cars for our exclusive use for at least the next five years. We believe that this dedicated rail supply provides us with a logistical advantage over other ethanol producers by allowing us to deliver ethanol to the highest bidders in a timely manner. In addition, we own a 63.5% interest in the D&W Railroad LLC, which owns the 52.0-mile spur from our Fairbank plant to the Iowa Northern line. Under our agreement with the co-owner, we are obligated to pay our proportionate share of maintenance and capital expenditures. Iowa Northern has contracted to perform maintenance and upkeep on the D&W track.