Impact of Crude Oil Price Collapse on Corn Starch Ethanol
AgMRC Renewable Fuels Monthly Report
Dr. Robert Wisner
University Professor Emeritus Iowa State University
and Biofuels Economist
From late September 2014 to late January 2015, global crude oil prices fell by 51%, as shown in Figure 1 below. The decline was triggered when the Organization of Petroleum Exporting Countries (OPEC) deviated from past policies and decided not to reduce production to compensate for increasing production in non-OPEC countries. With increasing production in North America, Saudi Arabia has shifted from the world’s largest to the second largest oil producer and was a key country in this decision. Most of the recent global production increase has occurred in the U.S. and Canada, so OPEC’s action was targeted at halting the increased production in North America.
Declining crude oil prices triggered a sharp decline in gasoline prices, with a resulting sharp decline in ethanol prices. Since U.S. ethanol is produced primarily from corn starch and is widely used in the nation’s gasoline, these dramatic price changes raise important questions for ethanol producers, farmers who produce corn as an ethanol feedstock, industries that provide inputs to corn production, the transport sector, the petroleum industry including refiners and local retail stations, motorists, and other users of petroleum and biofuel products. Important questions include 1. whether ethanol can continue to be competitive as a motor fuel at current relatively low gasoline prices, 2. possible impacts on corn prices, 3. how long the low energy prices may continue, and 4. whether U.S. ethanol exports can remain competitive. In this article, we address a few of these questions. We will examine some of these concerns in more detail in future articles.
The Energy Price Collapse (1)
Figure 1 shows historical price patterns and the recent relationship between U.S. national average gasoline prices and crude oil prices. It is not surprising that there is a close relationship between these two price series. Sometimes one price series lags slightly behind the other. The differential between crude oil and gasoline prices also fluctuates somewhat over time depending on refiner and retail margins, prices for non-gasoline petroleum products, and other influences. Even so, there is a close correspondence between the two price series. A quick glance at this chart shows that in the 2005-early 2007 period, gasoline prices were as low as or lower than in early 2015. That was a time of rapid expansion in the ethanol industry and profits were favorable. However, there were two significant differences from the current period. First, corn prices were considerably lower, thus creating a lower ethanol production cost. Secondly, ethanol production was encouraged by an ethanol blenders’ tax credit that has since expired. A third difference was that ethanol production had not yet reached the 10% “Blend Wall” and there was ample room for domestic market expansion.
Figure 2 shows the relationship of gasoline and ethanol prices over the last 10 years. Ethanol prices have fluctuated moderately relative to gasoline although the trend in the two prices has been similar in the last five years. Early in the period shown in the chart, ethanol prices were much closer to gasoline and at times were briefly above gasoline due to a shortage of supplies to replace MTBE, an octane and oxygen enhancing additive that was needed to meet clean air regulations but was being banned in several important U.S. markets. The wider differential between ethanol and gasoline prices starting in 2007 reflected the large increase in supplies and approach of the 10% blend wall at which the domestic market was approximately saturated.
The decline in gasoline prices in late 2014 and early 2015 was accompanied by a substantial decline in ethanol prices, although the differential between the two price series has narrowed when compared to a few months ago.
Despite lower ethanol prices, ethanol production has been at record levels for much of the current corn marketing year, as shown in Figure 3. Production declined briefly in late January but continued to exceed production in 2011-12, the previous year of record production. USDA’s February 12 World Agriculture Supply Demand projections indicate corn use for ethanol and DDGS production will total 5.25 billion bushels in the current September 2014-August 2015 marketing year (2). If attained, that would be an increase of 2.3% from last season and 13.1% from two years earlier. Production for the first five and one-half months of the current marketing year suggests the projection is attainable.
Figure 4 shows estimated weekly ethanol returns over direct costs and weekly production for the last few years, through mid-February 2015. Direct costs are costs that would not be incurred if the plant was shut down. The returns shown in the chart are based on spot market prices, although actual returns at ethanol plants may include feedstock purchases, and ethanol and co-product sales through forward contracts or hedges. For that reason, actual returns may vary significantly from those shown.
The returns in Figure 4 do not include net returns for extracting corn oil from the distillers grain, which may also understate actual returns. Many ethanol plants now extract corn oil to be used for biodiesel production or in the feed industry, thus providing additional revenue.
Revenue streams for dry mill ethanol producers also include sales of distillers grain and solubles (DGS). DGS is a medium protein feed ingredient for livestock and poultry, with part of the supply sold dry (DDGS) and part sold wet or partially dried. It is best suited for cattle but can also be used for pork and poultry production.
Figure 5 indicates DGS prices recently have been somewhat higher than normal when compared to corn on a pound for pound basis (3). An important reason for the relatively high DGS prices is that China has resolved its concerns about a biotech variety of corn it previously had not approved for import. With those concerns, it halted its DGS purchases in mid-2014. The Chinese government has since approved the corn variety and its feed industry has returned to the DDGS market. Chinese policies favor imports of DGS over corn and appear to be encouraging its feed industry to pay a price premium for DGS. The higher than normal DGS prices help support returns for ethanol production during this period of low gasoline and ethanol prices. However, past history of DDGS prices indicates they are volatile and could change quickly.
Key Influences on ethanol production in addition to ethanol and DGS prices
Attaining USDA’s projected level of ethanol will depend heavily on three additional factors: 1. anticipated government mandates for the minimum amount of ethanol to be blended in U.S. gasoline, 2. the use of ethanol to increase the octane content of gasoline, and 3. export demand. The Environmental Protection Agency (EPA) is responsible for announcing and implementing biofuels blending mandates specified in the December 2007 Energy Independence and Security Act (EISA). The EISA requires that the mandates for 2014 were to have been announced by November 2013 and this year’s mandates were to have been announced by November 2014. Neither of these sets of mandates had been announced at this writing, although recent information from EPA suggests they will be announced this spring (4). The 2015 mandate for corn starch ethanol is expected to be set somewhere between 13.6 and 15.0 billion gallons (5). The upper end of the range is the level required by EISA for 2015. The lower level would be approximately a 10% blend of ethanol in the nation’s gasoline supply. A mandate at the high end of the range would create an incentive to promote E-15 to increase the size of the ethanol market. The lower end of the range plus 700 million gallons of ethanol exports would meet USDA’s projected 2014-15 corn use for ethanol and DGS production. Mandates could at times provide an incentive for blending of ethanol in the nation’s fuel supply even with a further decline in gasoline prices and with ethanol prices moderately above those of gasoline.
There is an additional factor besides government mandates that will very likely encourage continued ethanol production even if wholesale prices equal or modestly exceed those of gasoline. The petroleum industry uses ethanol to upgrade the octane content of gasoline to acceptable levels. Ethanol has 2/3 the energy content of gasoline but it’s much higher octane content adds value beyond just energy content. Other additives can be used to upgrade gasoline’s octane content but they appear to be more expensive than ethanol at current ethanol and crude oil prices. A U.S. Department of Energy (DOE) study focusing on the economics of raising gasoline octane with ethanol indicates fuel ethanol demand will continue at wholesale prices modestly above gasoline. By using a refinery model to estimate costs of alternative octane enhancement methods, the study created an ethanol demand curve for 2012 and 2013 at varying price ratios of ethanol to gasoline(6). At wholesale prices up to 10% above gasoline, reductions in ethanol use based on this study appear to be minimal. DOE indicates impacts of higher ethanol prices would vary with the type of blending used, infrastructure considerations, operations in individual petroleum refineries, and other factors. At ethanol prices above gasoline, reductions were expected to occur sooner for splash blending than when octane is increased at petroleum refineries. In splash blending, a specific quantity of ethanol is blended with a specific amount of gasoline in shipping containers to attain the desired percentage ethanol blend. This may occur as gasoline and ethanol are loaded into trucks or other containers.
The DOE demand curve indicated reductions in ethanol blending for 2012 and 2013 would begin if ethanol prices exceed gasoline by more than 10%. At ethanol prices 50% above gasoline, substantial demand for ethanol was still indicated.
There is a long time lag in U.S. Energy Information Administration reporting of ethanol export data although imports are reported weekly. The most recent export data in mid-February were for November of last year. Ethanol exports from July through November 2014 were at an annual rate of 837 million gallons, and November exports showed an uptrend. Imports in most weeks over that time period have been zero. Brazil is the major influence on U.S. exports. Its 2014 sugar crop was adversely affected by dry weather and is limiting its ethanol production to some extent. Also, the Brazilian government increased its mandated minimum ethanol blend in gasoline from 20 to 25% last year and is increasing it to 27% this spring. These conditions suggest Brazil’s ethanol exports will be restrained in the next few months. That in turn should help support U.S. ethanol exports. Also, one of the largest ethanol plants in EU, a UK plant, is being shut down due to adverse economics (7). That is an indication that ethanol plants in other countries may have difficulty supplying government mandated quantities, which in some cases may support U.S. ethanol exports.
Is more downside potential ahead in gasoline markets?
Petroleum markets have a volatile history and no one knows for certain what is ahead. We plan to discuss this subject in more detail next month, but one current indicator to watch is the continued increase in U.S. gasoline inventories. As shown in Figure 6, gasoline inventories are at the highest level in several years and were still trending upward in mid-February. Large inventories tend to put pressure on prices at some point unless the upward trend is halted. Ethanol inventories also have increased. However, unlike gasoline, they remain below the highs of previous years.
The sharp decline in crude oil and gasoline prices in the last few months has caused a sharp decline in ethanol prices and net returns for ethanol producers. Even so, U.S. ethanol production through mid-February remained at near-record levels and was in line with the latest USDA projections showing a 2.3% increase from last season in corn processing for ethanol in the current marketing year. Factors tempering the impact of the decline in ethanol prices on ethanol processors include the expected biofuels mandates to be announced by EPA, ethanol’s value and widespread use for octane enhancement of gasoline, strong DDGS prices, and favorable export demand through at least the first half of the current marketing year. Current indications are that profits for the ethanol industry in the second half of the marketing year and for calendar year 2015 will be considerably less than last year. Profitability in the months ahead will be influenced by the trend in gasoline prices, the final size of corn crops in South America and Ukraine, and weather and crop conditions in the U.S. Current tentative projections of 2015 world grain production show continued large supplies and feedstock prices for ethanol plants that are likely to remain well below the levels of 2012 through early 2014.
1 Source of data for Figures 1 and 2: Ann Johanns, AgMRC web site for fuel and grain prices: • Fuel and Grain Price Historical Comparisons : Annual Comparison - Energy Prices vs Grain Prices Monthly Comparison - Energy prices vs Grain prices
2 World Agricultural Outlook Board, U.S. Department of Agriculture, World Agricultural Supply Demand Estimates, February 10
3 Ann Johanns, Op. Cit.
4 “US EPA to base 2014 RFS on actual output; blend wall to factor in 2015/2016 rule”
5 See Scott Irwin and Darrel Good for further discussion on these issues: “What if the EPA Implements RFS Mandates for Renewable Fuels at Statutory Levels?, Department of Agricultural and Consumer Economics, University of Illinois, farmdoc daily (5):31, February 19, 2015
6 “Ethanol Demand Curve for 2012 and 2013”, Department of Energy Analyses in Support of the EPA Evaluation of Waivers of the Renewable Fuel Standard, November 2012: ( EPA-HQ-OAR-2012-0632 )
7 Georgina Prodhan and Ludwig Burger, additional reporting by Michael Hogan; Editing by Kirsti Knolle, Pravin Char and David Evans, “CropEnergies suspends bioethanol production in Britain”, Reuters, February 18, 2015