Selected Developments Impacting the Ethanol Industry
AgMRC Renewable Energy & Climate Change Newsletter
Dr. Robert Wisner
University Professor Emeritus
Iowa State University
Profit margins in the ethanol industry have been quite variable in the last two years, due to fluctuations in both corn and ethanol. Strength in corn prices in late June put net returns strongly in the negative range for many firms, with the exact impact depending on the local basis, the extent to which margins were protected through hedging, whether the plant(s) remove corn oil – (thus generating an additional income stream), the amount of outstanding debt carried by the firm, and a number of other variables. Ethanol prices have trended downward for several months, reflecting loss of the VEETC blenders’ tax credit, declining use of gasoline by the nation’s motorists and weaker gasoline and world crude petroleum prices. These negative developments were tempered slightly by strong demand for distillers grain (DGS) and DGS prices that have been at a higher percentage of corn prices than normally would be expected at this time of the year. Ethanol profit margins also have been influenced by the rapidly approaching arrival of a domestic blend wall (saturated market) for ethanol. An additional factor adversely influencing returns is EU’s decision to increase tariffs on imports of U.S. ethanol. In this setting, farmers and other businesses affected by the ethanol industry are asking what may be ahead. This article examines several of these developments.
Declining Gasoline Use
U.S. gasoline use reached a peak in June 2007 and has since been in a downward trend as shown in Figure 1. Factors contributing to the decline include historically high gasoline prices, the weak economy, historically very high unemployment, improved fuel mileage of newer vehicles, and replacement of gasoline with ethanol. As gasoline use declines, it reduces the potential market size for ethanol. Future gasoline use likely will depend partly on the state of the economy and the price of gasoline.
Weekly Ethanol Production
USDA in its June 12 World Agriculture Supply-Demand report raised its projection of corn use by the ethanol industry in the current September 1, 2011-August 31, 2012 marketing year to 5.05 billion bushels. That was an increase of 50 million bushels from its month-earlier projection. (1) Figure 2 shows weekly ethanol production reported by the Energy Information Agency (EIA) through June 15, 2012 along with production in the same weeks of last year and average production levels needed to reach the latest projection. Production was quite large from October through December as the petroleum industry sought to maximize ethanol blending to take advantage of the soon-to-expire blenders’ tax credit. Production slowed considerably from January through April but for most of the period remained above last year. Since April, production has increased modestly and has remained above the level needed to reach the USDA projection. Whether corn use for ethanol and DGS will exceed the USDA projection will depend heavily on the relationship of corn prices to ethanol prices from now through the end of August. With recent higher corn prices, a 110 million gallon per year ethanol plant in Nebraska has closed for an indefinite period. If old-crop corn prices continue to rise, it would not be surprising to see additional plant closings for part or all of the remainder of summer.
Corn Cost and Availability
The cost of corn is by far the largest expense in producing corn-starch ethanol. In mid-May 2012, corn accounted for about 79% of the cost of producing ethanol. (2) Old-crop corn prices have been at historically high prices for most of the current marketing year, reflecting tight supplies that stem from two consecutive years of below-trend U.S. corn yields and a severe drought that sharply reduced Argentina’s corn harvest earlier this year. Along with historically high corn futures prices, the basis (cash price vs. futures differential) throughout most of the U.S. has been very strong. For example, local corn bids in Champaign, Illinois in mid-June were $0.40 above July futures prices, along with average Iowa cash corn bids $0.21 above July futures.
Corn prices for harvest delivery in Central Iowa on June 25 were about $0.90 per bushel lower than prices for immediate delivery. New-crop prices reflect USDA projections of a potentially much larger corn supply in the 2012-13 corn marketing year than in the current season, but weather from now through summer will determine whether that potential materializes. A large part of the Corn Belt has been in a modest to moderate drought situation and timely rains will be needed through summer for the projected large crop to materialize. At this writing, new-crop corn prices are quite volatile in response to forecasts of continuing hot and dry weather across much of the Corn Belt, and central and southern Great Plains. For the Midwest, the most critical area extends from southeastern Iowa across Illinois, Indiana, northern Ohio, and Michigan. Late June rains in other parts of Iowa, Nebraska, and South Dakota have provided temporary relief from corn stress, but timely rains will be needed through the summer to maintain late June yield potential. If June 25 price relationships should materialize this fall, the lower corn prices would reduce the cost of producing ethanol by 35 to 40 cents per gallon, depending on basis relationships.
Summer weather as well as USDA’s June 29 Grain Stocks and Planted Acreage reports will be important influences on corn prices for the rest of the year. The grain stocks data will allow analysts to estimate how much corn was used for domestic feeding in the March-May quarter and will indicate how much corn is available for summer usage. Planted acreage data from the June 30 report will indicate whether very strong planting-time soybean prices caused farmers to plant less corn and more soybeans than were indicated by a late winter USDA farmer planting intentions survey.
Natural Gas Prices Help Lower Ethanol Production Costs
Most ethanol plants use natural gas as a heat source for the distillation process. With the discovery of large new U.S. natural gas supplies, natural gas prices have dropped sharply in the last few years. From July 2008 to February2012, the estimated cost of natural gas required to produce a gallon of ethanol declined from $0.36 to $0.16. (3)
With the U.S. domestic ethanol market almost saturated, exports will continue to be an important influence on ethanol demand, production levels, and the amount of corn being processed into ethanol and distillers grain (DGS). Exports have helped the industry to produce more ethanol than required by the RFS 2 mandates.
U.S. ethanol exports were quite strong last fall and in the early part of winter, but weakened substantially when the EU altered its customs tax classification for imports of U.S. ethanol, effective early April of this year. (4) The action was in response to concerns of the EU ethanol industry about unfair competition from U.S. supplies. For ethanol blended with up to 30% gasoline, the change increased EU import taxes from 6.5% ad valorem taxes or around Eur35/cubic meter to a flat tax of Eur102/cubic meter ($134/cu m). EU’s action resulted in a sharp decline in U.S. ethanol exports.
Global sugar supply and demand conditions are and will continue to be another important influence on U.S. ethanol exports. Brazil and India are the world’s largest producers of sugar. Weather problems in Brazil during the past year have created tight world sugar supplies and relatively high sugar prices. The high prices have encouraged processing of more sugar cane for sugar production and have limited the availability of Brazilian supplies for ethanol production. That in turn has reduced Brazil’s exports and global competition facing U.S. exports. Early USDA estimates of Brazil’s 2012 sugar harvest indicate production will be up about 2% from last year, but an increased share of the crop is projected to be used for sugar production, with relatively less for ethanol. (5) If so, that should be a supportive influence on U.S. ethanol export demand until at least February of 2013.
For further detail on U.S. ethanol exports, see Wisner, “Ethanol Exports: A Way to Scale the Blend Wall ”. (6)
California Clean Air Regulations and Midwest Corn-starch Ethanol
California’s Air Resources Board in 2009 established stringent Greenhouse Gas (GHG) emission requirements through its Low Carbon Fuel Standards (LCFS) that would prevent most Midwest-produced’ ethanol from being blended with gasoline in the state. (7) Early this year, a lower court over-turned these requirements, thus allowing Midwest ethanol to continue being used in California. However, the decision was appealed to the 9th Circuit U.S. Court of Appeals and on April 23, 2012 that court over-ruled the earlier decision. (8) This action allows California to continue enforcing its LCFS. The net impact on the Midwest ethanol industry is not clear, but one possible outcome could be increased California imports of lower-carbon Brazilian sugar cane ethanol and offsetting increases in U.S. exports of corn-starch ethanol to Brazil. From a global perspective, if that happens, little or no GHG emissions impact would be expected from the California standards that are intended to reduce GHG emissions.
Relationship of Ethanol and Gasoline Prices in Absence of VEETC
In the past, blending of ethanol with gasoline was encouraged by the VEETC blenders’ tax credit that provided a $0.45 incentive per gallon of ethanol for blending the mandated ethanol volumes. The tax credit was eliminated on December 31, 2011, thus removing that blending incentive. However the government mandated volumes continue in effect.
Ethanol and gasoline markets quickly adjusted to the change, as shown in Figure 1. Price spreads shown are ethanol futures prices minus RBOB gasoline futures prices for selected delivery months, for the selected trading days shown in the upper left hand box. RBOB gasoline is a type of fuel formulated for blending with ethanol. In November, while the blenders’ tax credit was still in effect, ethanol futures prices in the near-by delivery month were slightly above those for gasoline. However, for later delivery months, ethanol futures prices were sharply below those of RBOB gasoline. That pattern has continued throughout 2012, with ethanol futures ranging from about $0.40 to $1.00 per gallon below RBOB gasoline prices. The discount of ethanol prices to gasoline has created a strong incentive for ethanol blending even in the absence of the blenders’ tax credit. Fluctuations in the price differentials reflect variations in current and expected future supply-demand conditions. The narrowing spread from the April 10, 2012 to June 13, 2012 may in part reflect anticipation of increased motor fuel demand during the summer vacation season. The bottom-line conclusion from this chart is that the market has adjusted to the loss of the VEETC and continues to offer a significant incentive for blending ethanol with gasoline.
Uncertain E-15 Demand
After extensive tests, EPA approved the use of E-15 gasoline blends in 2001 and newer cars and light trucks. Additional regulations were recently completed, thus paving the way for marketing of E-15. Retail fuel station and motorists acceptance of this higher ethanol blend will be very important to the ethanol industry, since E-85 offers a potential way to raise the blend wall and allow additional growth in the corn-starch ethanol industry as well as an anticipated large future cellulosic ethanol industry. Early indications are that the retail motor fuel industry may be slow to convert to sales of E-85.
Industry concerns include vehicle warranty issues and liability implications, as well as investment and space requirements to accommodate additional pumps and tanks for E-85 sales. In some cases, using blender pumps or eliminating mid-grade gasoline sales may help reduce investment costs. E-15 sales appear likely to emerge first in the Midwest before spreading to other parts of the country.
When Congress passed the 2007 Energy Independence and Security Act, it envisioned a much more rapid emergence of the cellulosic ethanol industry than has actually occurred. Mandates in the legislation call for half a billion gallons of cellulosic ethanol to be blended with gasoline this year and a billion gallons to be blended in 2013. Due to much slower development of the industry than planned, the effective mandates for 2011 and 2012 were reduced to only 6.5 million gallons and 10.45 million conventional ethanol equivalent gallons respectively through EPA waivers. It looks virtually certain that the EISA cellulosic ethanol mandates will be reduced sharply again in 2013 and for the next few years. For 2022, the legislation calls for 16 billion gallons of ethanol to be blended with gasoline. If that level of production is attained, the U.S. average ethanol-gasoline blend likely will have to be significantly greater than E-15.
Distillers Grain Exports
U.S. distillers Grain (DGS) exports have trended upward for several years, with a large increase in 2010 in shipments to China. In the 2009-10 marketing year, China accounted for 26% of the total U.S. DGS exports. The large imports of U.S. DGS caused concern in the Chinese ethanol industry. As a result, China initiated restraints on U.S. imports while it initiated an investigation to determine if the U.S. exports were being unfairly subsidized. That resulted in a sharp decline in U.S. DGS exports to China. On June 22 of this year, China ended its investigation of possible U.S. export subsidies. (9) That action is expected to bring a sharp increase in DGS exports in the months ahead and may set the stage for long-term growth in that market.
Removal of Oil from DGS
In the last few years, the number of ethanol plants removing corn oil from DGS has increased substantially. The amount of oil removed ranges from a relatively low level for plants using centrifuge technology to larger amounts for the few plants using more complex end stream technology or up-front technology to fractionate the corn kernel and remove the oil. One of the drivers of increased oil removal is the need for feedstocks for biodiesel production. Biodiesel production is being driven by two EISA mandates, 1. those for biodiesel and 2. those for advanced biofuels. Biodiesel is the only domestically produced advanced biofuel produced in significant commercial quantities, due to the slow emergence of cellulosic ethanol.
Removal of corn oil from DGS lowers its energy content as a feed ingredient but increases its protein content somewhat. Pork and poultry producers have expressed concern about potential negative impacts on its feed value for their species. Additional research is needed to determine how reduced-oil DGS can be most effectively utilized by these two species and the impacts on its value vs. corn and other feed ingredients. Ruminants, with their ability to utilize energy from the fiber in DGS, may have an advantage over hogs and poultry in using this modified version of DGS. Another important question that may emerge as low-oil DGS becomes more widespread is its potential impact on export demand. DGS exports tend to be used more extensively for hogs, poultry, and sea food production than in the U.S.
Many dynamic variables are affecting the U.S. ethanol industry. The three most important ones are 1. the rapidly approaching blend wall, 2. potential costs of corn as a feedstock for ethanol production, and 3. the much slower than expected emergence of the cellulosic ethanol industry. Corn use for ethanol and DGS production so far this marketing year has exceeded USDA projections. Whether that will continue through summer depends heavily on weather across the Corn Belt and prospects for 2012 U.S. corn production. Other developments affecting the industry include foreign country trade policies relating to U.S. ethanol and DGS exports, the size of the Brazil sugar crop, the speed of adoption of E-15 by gasoline retailers, and changing value of DGS due to removal of oil for biodiesel production.
1 World Agriculture Outlook Board, USDA, World Agricultural Supply and Demand Estimates, June 12, 2012.
2 Ag Marketing Resource Center, “Ethanol Profitability Spreadsheet, ” May 12, 2012
4 Holly Jessen, “EU draft regulation would close E90 import loophole, ePURE says”, Ethanol Producer Magazine,
October 18, 2011, “EU implements higher import taxes for ethanol fuel blends with 30% gasoline” London (Platts)--13Mar2012 , and Agence France-Presse, “Europe launches U.S. Bio-Ethanol Anti-Dumping Probe,” Industry Week, November 25, 2011
5 USDA, Foreign Agricultural Service, Sugar: World Market and Trade Circular, May 2012
6 R. Wisner, “Ethanol Exports: A Way to Scale the Blend Wall”, Renewable Fuels and Climate Change Newsletter, Ag Marketing Resource Center, February 2012
7 For details and potential impacts, see R. Wisner, “Biofuels and Greenhouse Gas Emissions on a Collision Course,” Renewable Fuels and Climate Change Newsletter, Ag Marketing Resource Center, June 2009
8 DTN, “Court Allows Calif to Enforce LCFS”, April 24, 2012
9 Pro-Farmer “First Thing Today, ” China ends anti-dumping probe against U.S. DDGS”, June 21, 2012