It is far from clear what changes, if any, Minnesota will make in its ethanol programs in reaction to actual and anticipated budget deficits. But if it does stop payments that were implicitly promised to 13 plants built in response to state incentives, it will cause longer-term fallout.
Stopping annual payments of up to $3 million per plant will tell future investors not to count too strongly on promises of state assistance. Whether that is good or bad depends on one’s political philosophy. It does, however, illustrate the general economic principle that incentives have consequences.
The programs was started in 1996 and was aimed in part at increasing the proportion of ethanol produced by farmer-owned cooperatives. While the country as a whole has many such co-ops in the ethanol business, they tend to be small. The bulk of national production came from publicly owned corporations, the largest of which is Archer Daniels Midland, aptly described as “pricefixer to the world” by a University of Illinois agricultural economist.
The Legislature intended to change the structure of production by offering a 20-cent-per-gallon operating subsidy for a 10-year period, but capping the total payments per plant so that large, corporate-owned plants would not benefit from Minnesota taxpayers.
When the legislation was enacted, its backers clearly intended for the program to be ongoing. It is fair to say that there was an implicit promise that if farmers formed cooperatives to produce ethanol and built plants, they would get up to $3 million per year for 10 years. Business plans and cash flow projections were drawn up based on that implicit promise.
These businesses generally are so-called “new-generation cooperatives” that have a membership made up of a limited number of farmer producer-members who put up substantial amounts of their own cash to provide initial equity for the business. Minnesota ethanol co-oops have from 150 to more than 750 members who invested $5,000 to $20,000 or more of their own funds.
Clearly, any business of this size that expects to get $2 million to $3 million per year for 10 years and then sees those funds cut off will be hurt financially. A drop in profits for any firm, from high to low or from low to negative, generally shows up as a decline in the value of owner equity.
We all know the Wall Street earnings drill. Company X announces that its profits are up and the price of its stock rises. Firm Y discloses that profits are down and its stock price falls. The same is true for new-generation cooperatives. If profits fall, the value of each member’s share in the business falls. If the business becomes bankrupt, that value may fall to zero.
So existing co-op members have a legitimate complaint when they argue that the state induced them to put a lot of their own money on the line by implicitly promising 10 years of 20-cent payments.
Unfortunately for them, the promise was only implicit; there was no contractual guarantee.
It is a general principle of U.S. government that one Congress or Legislature cannot bind subsequent ones.
The upshot is that if the current Legislature accedes to Gov. Pawlenty’s initiative to halt payments, a few thousand ethanol co-op members will take a hit to their net worth. The severity of the hit will depend on how long their particular plant has been in operation and how many years it has already gotten funds.
Minnesota Power can, of course, sell surplus power into the grid, albeit at lower prices than it would get from industrial customers such a taconite plants. But it will have to eat any unamortized investment in the transmission and distribution infrastructure that serves the mining business. Some would say that the risk of a drop in statements payments to ethanol producers is no different from this unexpected decline in electricity customers.
We as a state can stiff the ethanol cooperative. It won’t be the first time a government or business has reneged on an implicit promise. Many would argue that implicit promises to provide school aid or health care to the poor through Medicaid are at least as important as implicit promises to investors in for-profit businesses.
But ending these payments will send a message that it is dangerous to invest one’s funds in a business that depends on any good faith commitment from the Legislature. It will make it more difficult for similar programs in the future to call forth the desired response because there will be old-timers out there who will caution, “Look at what they did to those ethanol co-ops back in ’03.”
Opinions on the just course of action here will vary sharply, but we all should remember that actions and incentives do have consequences.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.