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Hard lessons: Tri-State Ethanol struggling to overcome difficult start.

Setting up an ethanol plant is no automatic path to prosperity. Just ask the investors in Tri-State Ethanol, a limited liability corporation (LLC) founded by a farmers cooperative.

For the members of Tri-State Corn ProcessOrs Cooperative, founded in 1994 in Rosholt, S.D., an ethanol plant seemed to be an answer to the problems they faced as commodity producers: low prices, exposure to the whims of the market for an undifferentiated product with few buyers and many sellers, and no way to tap into the profits others derived from adding value to their crops.

Like Alice in Wonderland's Red Queen, many commodity producers face a situation in which they continually struggle just to keep in one place. Keeping abreast of a constant upward trend in productivity demands rising expenditures for operating inputs and equipment while also dealing with a constant downward pressure on prices. Producing a value-added product seemed to offer a way out of this conundrum, and ethanol was by far the most attractive and popular opportunity.

Outside expertise, resources needed

Tri-State soon found that starting up a profitable ethanol operation required expertise and a number of skills and resources that weren't readily available among its members. Foremost was access to capital. As a cooperative, Tri-State was prevented from selling voting shares to non-farmers--and, as with many farmer-owned ethanol ventures, the members could not raise sufficient funds among themselves.

The next step was to form a limited liability corporation (LLC) that could sell shares. But even then, they had no luck finding financing for their venture. "We tried to finance the project ourselves," says Steve Hesch, current manager of Tri-State Ethanol, "but our sources didn't come through." It soon became clear that they would have to seek outside help.

A second dilemma was obtaining the expertise to build the plant. With no experience or training in that arena, the stockholders would also have to rely on outside help to find designers, engineers and builders with the requisite skills.

Those problems seemed solved when they found a consultant who specialized in putting together ethanol projects. The consultant linked them up with a team consisting of a design firm, a "construction coordinator" and a construction company, that together promised a working plant at what seemed to be reasonable terms. He also found a group of investors from Omaha, Neb., willing to invest in the project. The consultant assembled a financing package that included low-interest loans from a local bank and developed an agreement that gave the builders partial ownership of the project. The cooperative itself wound up owning about a third of the business.

The ethanol distillery was designed to produce 14 million gallons per year. This is small for an ethanol operation, and in the best of circumstances would be more difficult to run profitably than a plant with a 40-million-gallon capacity, considered the size at which economies of scale are achieved. But as it turned out, small capacity was only part of the problem.

More research time needed

In retrospect, says Hesch, the co-op should have done more research and asked a lot more questions. But at the time, the package seemed to be just what they needed. Another factor pushed them to hurry the project: the need to get their ducks in a row before they ran out of time. They had permits and investors, but delays might cause them to lose either one. "Closing loans takes time," he says, and the co-op hadn't realized just how much time it would take.

While the loan-making process ground on, the necessary building permits threatened to expire, putting the low-interest loans in jeopardy. Construction work on the plant began in October 2000, before the loan was closed. A construction loan agreement for $9 million was only signed seven months later, on May 14, 2001; it took another three months before funds were released.

With the funding in place, the coop's troubles were not over. Problems with construction resulted in cost and time overruns. And when the plant finally began operating, another unwelcome surprise: its ethanol distillery did not perform the way it was supposed to.

"If it were a car," says Hesch, fastest it would go would be 30 miles per hour, and it would break down every hundred miles. The boilers were wrong, and the way the pipes were designed made sanitation very difficult." According to other sources, the plant was built around used machinery, and its design was wholly inadequate to produce ethanol at its nominal capacity.

Unable to operate the plant, Tri-State Ethanol was unable to generate cash flow to repay its debtors. "They told us orally that it would be a "turnkey" operation," Hesch says, "but we didn't actually get it in print." The contract had details about "exceptions and allowances," he says, that made it difficult to pursue action against the builders and consultants for non-performance.

The construction company and a subcontractor slapped mechanic's liens on the plant, and Tri-State Ethanol LLC was forced to declare bankruptcy. The ensuing legal disputes have been complicated by the fact that the construction company is a part-owner of the operation. It has been estimated that it will take an additional $1.7 to $3.4 million to make the plant fully functional, including materials and labor.

Backers still hoping for eventual success

Despite the venture's tribulations, Hesch is optimistic that Tri-State Ethanol will eventually be successful. The company has put together a Chapter 11 bankruptcy plan, approved unanimously by the shareholders, under which, he says, all necessary modifications will be made to get the plant up and running and all debts will eventually be satisfied.

Others are less sanguine about the operation's prospects, saying it will have to overcome its small size, a less-than-ideal location and lack of a good supply of natural gas.

In any case, the co-op members and others who helped finance the project have learned some very hard, expensive lessons. "We should have had more checks and balances," says Hesch. "We thought we had checked out everything well, but so many things didn't pan out. We were left with ghosts and shadows." Hesch believes that much of the trouble was caused by the time constraints stemming from financing problems. "If we'd had decent financing," he says, "things would have been different."
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Title Annotation:Special Section: Co-ops and Biofuels
Author:Thompson, Stephen
Publication:Rural Cooperatives
Date:Jul 1, 2004
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