Enhancing Digester Profitability: Strategies for Farmers

Introduction:

If you're considering an anaerobic digester for your farm, you probably know some of the benefits- generating your own heat and electricity, investing in renewable energy, managing waste more efficiently, minimizing odors, and new income streams, among others. A well-run digester can be a great investment, turning digestate into fertilizer, animal bedding, and biogas that powers your farm or gets sold back to the grid.

But digesters are a big investment, and their profitability depends on the details. How much food waste should you process?  What tipping fees make sense? How do grants, tax credits, and energy prices factor in? These are just some of the questions to consider when planning an investment in an anaerobic digester.

In this article, we'll walk through a realistic case study of a Pennsylvania dairy farm with a digester. We ran different scenarios using version 1.3 of Penn State's On-Farm Digester Assessment Tool to see what factors enhance a digester's profits, how they interact, and what you can do to keep your digester financially sustainable in the long run.

The lead image for this article shows the process of digestion we use in this model, with inputs including cow manure and food waste. There can also be other organic inputs like winter cover crops, but we didn't include those in this article for the sake of simplicity. The inputs are processed in the digester to produce biogas, which can be upgraded to produce electricity and heat, and digestate, which can be separated into solids for fertilizer and liquids for animal bedding.

How We Measured the Digester's Economic Performance

Economic analysis uses estimates and calculations of a project's profits and costs over its lifetime to determine if it will be financially successful. There are many different indicators of performance that project developers can use, so we calculated five of those indicators here:

Net Present Value (NPV)

NPV calculates the project's total dollar value over time by discounting future cash flows to their present value. It tells us whether the project is expected to generate more value than it costs. Positive NPV indicates profitability, while negative NPV signals potential losses. A project's NPV should be high enough to justify the risk and hassle of the project.

Internal Rate of Return (IRR)

IRR represents the project's annual return on investment or how efficiently the project converts investment into profit. The IRR is the rate at which the project's future cash flows equal the initial investment (meaning the NPV equals zero). In other words, it is the discount rate that makes the project break even. A project's IRR should ideally be higher than the rate of return you could get from putting your money into another investment with similar risks, like stocks, bonds, or another project.

Payback Period (PBP)

PBP measures the time it takes to recover the initial investment. A shorter PBP is better because it means you will get your investment back faster. Ultimately, you will decide how long you're willing to wait for your investment to pay off, but 5 years is typically a good PBP for a project like this.

Weighted Average Cost of Capital (WACC) and Modified IRR (MIRR)

The WACC is often compared to a project's MIRR (a modified IRR, adjusted for a realistic reinvestment rate and accounting for the cost of financing) to assess profitability. WACC represents the minimum return a project needs to generate to cover its costs and provide returns to investors. By comparing the MIRR to the WACC, you can determine if the project is financially viable or not. If the MIRR is higher than the WACC, the project will be profitable, since it will generate a return higher than the cost of capital. If the MIRR is lower than the WACC, the project may struggle to generate enough profit to justify the investment, making it less financially attractive.

The Farm Scenario Being Analyzed

The farm operates on 1,034 acres of land, with 1,000 acres dedicated to annual crops. The remaining acreage is used for farm facilities and housing 675 dairy cows, which generate approximately 4.4 million gallons of manure annually. The anaerobic digester, a complete mix system with a 25-day residence time, processes a combination of manure and food waste from local sources. The system produces biogas used for electricity and heating on the farm, with surplus energy sold to the electricity grid.

Financial Overview:

• Capital Expenditure (CAPEX): $1.3 million (including generation equipment, interconnection, development costs, and a solids separator).
• Annual Operating Costs: Approximately $15,000 (maintenance, sludge cleanout, and engine rebuild/replacement every 2.5 years).
• Revenue Streams: Primarily tipping fees for processing food waste from local suppliers and electricity sales.
• Cost Savings: On-farm electricity and heating, fertilizer, and bedding.
• Funding Sources: Grants (ex. USDA REAP) and tax credits.
• Cost Structure: Based on a 20-year digester lifetime with 2% inflation.

So, What Drives Profitability?

How could changes in the digester's critical factors affect profitability? Let's look at five important variables:

• Food Waste: Adding different amounts of food waste to a manure-processing digester.
• Tipping Fees: Payments are received to accept food waste from local suppliers.
• Energy Prices: Revenue generated from energy sales.
• Grant Funding: Percentage of CAPEX covered.
• Tax Credits: Renewable energy project incentives covering upfront and ongoing costs.

As we noted above, the base case scenario has an NPV of $884,048 and a PBP of 10.2 years. The IRR in our base case scenario is 31%, with an MIRR of 10.51% and a WACC of 6.37%. Taken as a whole, it looks like a profitable project.

In our base case setup, the farm has secured grants to cover 50% of the initial and major costs for the digester. The farm also receives ongoing tax credits, which are paid to the farm at a rate of 1.93 cents per kWh of electricity produced. The electricity leftover after powering the farm is sold at an average rate of $0.1401 per kWh. After processing the farm's manure, the digester's tank capacity has 20% more room to accept food waste from other nearby farms, restaurants, grocery stores, and food processing plants. The farm charges $24.26 per ton of food waste processed. By changing these variables one at a time, we explored the effects they have on the digester's financial performance:

1. Food Waste Content

Processing food waste content had the largest impact on both the project value and payback period. By adding more food waste, the digester could potentially reach over $3.2 million in value. Increasing the food waste content can also shorten the payback period to 4.9 years, leading to a fast return on your investment. On the other hand, if no food waste is processed, the payback period could be an unrealistic 35.6 years- 15 years longer than the digester's lifetime. With no food waste, the project value would be under $200,000. The NPV and IRR lines in Figure 2 show that adding more food waste generally increases the project's value, but the rate of return on your investment is slower to increase with high levels of food waste. The payback period (red line) drops dramatically with the first 20% of tank capacity added for food waste. While increasing the food waste ratio is a great way to boost profitability, too much food waste can disrupt the digester's chemical balance, overload the nutrient balance of your land, and increase operational risks. Market constraints and local resources should also be considered when deciding what ratio of food waste to process in a digester.

2. Tipping Fees

Higher tipping fees moderately enhance profitability, shortening the payback time and boosting the project value and rate of return. At a higher tipping fee of $55 per ton of food waste, the digester's value reaches nearly $1.5 million with a payback period of just over 6 years. Without tipping fees, the value drops to just over $400,000, lengthening the payback time to nearly 22 years. In our full analysis, we found that by adjusting the tipping fee and food waste content at the same time, the digester can go from under $200,000 in value with no food waste to nearly $6 million with a $55 per ton tipping fee and 90% added tank capacity for food waste processing. Before setting high tipping fees, however, you should consider local market conditions like waste management facility fees and local competition, while prioritizing relationships with suppliers to maintain a consistent supply. 

3. Grant Funding

Grant funding has the largest effect on the digester's rate of return. Securing grant funding to cover 100% of the initial investments and major spending costs increases the rate of return to 84%. Without grant funding to help cover the investment costs, the returns are just 18.8%. Grant funding is also a key factor in reducing the time to get your money back, with the potential to shorten the payback period to less than 5 years with total grant funding or lengthen the payback period to over 22 years with no funding. In Figure 4, the IRR curve is shallow at low levels of funding and steepens with more grant funding. This means that a large amount of grant funding boosts the project returns exponentially. This makes grant funding an important factor to focus on for maximizing the digester's rate of return and recover your investment back in a reasonable amount of time.

4. Energy Prices

Adjusting the energy price boosts the project value to over $1 million from $700,000, shortening the payback time from nearly 13 years to just over 8. This is a relatively small effect compared to some other variables, but energy prices can have a significant impact on profitability when combined with variations in other factors like food waste. The amount of energy your digester produces depends partially on the amount of food waste being processed, as well as manure and other feedstock. This means that food waste content indirectly impacts the revenue you earn from selling surplus energy. In our full analysis, we found that selling surplus energy to the grid at a higher price can boost the project value from under $100,000 to nearly $4 million and shorten the payback period from an unreasonable 75 years to 4.2 years. When combined with adjustments of other variables, like food waste, advocating for a higher energy price may make the difference between an unviable digester and a profitable one.

5. Tax Credits

While the tax credit rates in this article have a relatively small impact on project profitability, federal tax incentives can be a valuable source of external funding. In Figure 6, the Upfront Credit points represent a one-time credit that lets you write off a percentage of the digester's installation cost. The Ongoing Credit points represent an ongoing tax credit where the amount the taxpayer receives is based on the amount of electricity (in kWh) generated. If we assume you can only claim one of these credits, it can be helpful to look at your project economics when deciding which credits to prioritize. Looking at Figure 6, we can see that the farm should apply for the Upfront Credit rather than the Ongoing Credit, because it yields a higher project value (over $1 million compared to $959,000) and rate of return (44% compared to 33%) comparatively. Taking this a step further, we can look at which tax credit is most profitable when we change other variables as well. In our full analysis, we adjusted the food waste content at the same time. Since the Ongoing Credit is paid in cents per kWh of electricity produced, different amounts of energy generated from changes in food waste would affect the Ongoing Credit amount the farm qualifies for. We found that the Upfront Credit still leads to a higher rate of return and project value than the Ongoing Credit, no matter how much food waste is processed.

Best and Worst Case Scenarios

To understand the range of financial outcomes for our farm's digester, we modeled three scenarios: Worst-Case, Base-Case, and Best-Case. These scenarios explore how profitability shifts when adjusting key factors like food waste content, tipping fees, grant funding, energy prices, and tax credits within realistic ranges. The following table summarizes those findings: 

Worst-Case Scenario: In the most challenging conditions, the digester operates at a loss. With only 10% added capacity for food waste, no tipping fees, no grant funding, and the lowest available tax credits and energy prices, the project's MIRR falls below its WACC, indicating an unprofitable system. The NPV is negative, and the payback period stretches to over 50 years, making the project financially unfeasible.

Base-Case Scenario: Under more moderate conditions, the digester is a solid investment. With 20% added capacity for food waste, a $24.26 per ton tipping fee, grant funding to cover 50% of capital spending, and average energy prices and tax credits, the project generates a positive NPV of over $800,000. The MIRR is higher than the WACC, and the payback period is just over 10 years, showing a viable, long-term return on investment.

Best-Case Scenario: With desirable conditions, the digester becomes an extremely profitable asset for the farm. At 90% added capacity for food waste, tipping fees of $55 per ton, grant funding covering all capital spending, high energy prices, and an Upfront tax credit covering 30% of the upfront costs, the project's NPV skyrockets to over $7.5 million. The MIRR is much higher than the WACC, and the payback period drops to just 1.3 years, meaning the initial investment is recovered very fast.

What Does This Mean? Practical Strategies for Farmers

Economic analysis measures are all useful, but changes to the digester's economics tend to impact the various indicators differently. Therefore, it's best to look at multiple economic indicators when deciding how to manage your digester. In this analysis, four practical strategies emerge with respect to digester economic performance:

1. Secure Reliable Food Waste Sources: Partner with local businesses to maintain steady food waste supply. Prioritizing partnerships with reliable suppliers can help maintain consistent and profitable digester performance.
2. Leverage External Funding Opportunities: Tax credits and programs like USDA REAP can significantly reduce capital expenditure and mitigate financial risks. Farmers should prioritize these applications to maximize financial returns.
3. Set Competitive Tipping Fees: While higher fees improve profitability, they must remain competitive to maintain supplier relationships. Aim for a tipping fee that balances profitability while considering market supply and local waste management facility fees.
4. Monitor Energy Markets & Advocate for Yourself: Keep track of energy price trends to forecast long-term revenues and adapt accordingly. Advocating for yourself to secure a competitive market price when selling surplus energy will help you set realistic expectations and improve your project's financial outlook.

Conclusions: Driving Economic Sustainability and Profitability

This analysis demonstrates how financial metrics can be used as a tool to improve the economics of on-farm digesters. For farmers, the ability to adjust variables like food waste content and tipping fees provides a degree of control over profitability. Additionally, pursuing grant funding can greatly improve financial outcomes, reducing risk, and ensuring quicker returns.

While the findings highlight opportunities for increasing returns, there are practical challenges that should be kept in mind. For instance, achieving high food waste ratios or tipping fees requires careful negotiation and market analysis. Similarly, grant applications can be time-consuming but are essential for reducing upfront costs.

Constructing and operating a successful on-farm digester project requires a strategic approach to variables like food waste content, tipping fees, and grant funding. By knowing how these factors can affect economic performance, you can build a digester that is both profitable and sustainable, contributing to a thriving agricultural sector.

Prepared by Josephine Erb and Daniel Ciolkosz.  Reviewed by Mary Akingbasote