Impact of Low Ethanol Prices on the Corn Market

AgMRC Renewable Fuels Monthly Report
March 2015 

Robert Wisner                                                      
Professor of Economics and Energy Economist
Ag Marketing Resources Center
Iowa State University
rwwisner@iastate.edu

The sharp decline in crude petroleum prices in recent months has triggered a substantial decline in ethanol prices to keep it competitive with gasoline.   That in turn is raising questions about impacts on corn prices this spring, summer, and fall.   Processing for ethanol and distillers grain has become the largest or second-largest user of U.S. corn.  Whether its position is number 1 or number 2 depends on the volume of corn feed and residual disappearance, which varies considerably from year to year and will be updated after the March 31 Grain Stocks report.  Either way, corn use for ethanol is a very big influence on the corn supply-demand balance, ending carryover stocks, and prices.   As farmers finalize their 2015 cropping plans, the impact of low ethanol prices on the corn market becomes critically important to their decisions.   In this report, we focus on this issue, including a perspective on whether low energy prices might strongly temper the up-side potential in the corn market in case of spring or summer weather concerns.

Key developments in U.S. energy situation

The current U.S. and world energy situation reflects several key developments including

1. Very large U.S. crude oil inventories that may challenge available storage capacity,
2. A sharp decline in the number of operating drilling rigs,
3. A continued but slowing upward trend in U.S. crude oil production, 
4. A 15% recovery in U.S. wholesale gasoline prices from the January low with a recovery of more than 20% in retail prices despite the largest gasoline inventories in several years, and 
5. A very strong U.S. dollar, which reduces domestic oil prices. 

Most of the increase in world crude oil production in the last three years has been in the U.S. and Canada so developments here are important drivers of crude oil prices.  We caution that energy markets are complicated by geo-politics and a number of other factors.  Recognizing this uncertainty, some industry analysts indicate another 18 to 25 percent decline in crude oil prices is possible in the next several months before the market reaches a bottom. (1)  If that were to happen, it would almost certainly have a negative impact on ethanol prices unless offset by announcement of ethanol blending mandates near those specified in the 2007 Energy Independence and Security Act (EISA). (2)  It is more likely that the mandates will be near the 10% blend wall, about 10% below the EISA mandate for 2015.

Ethanol-Corn price relationships and Ethanol Margins

Insights into the ethanol-corn price relationship are available by looking at USDA’s Agricultural Marketing Service (AMS) weekly reports showing approximate gross margins for dry mill ethanol and distillers grain and solubles (DDGS) producers.  These reports are available for four states: Iowa, Nebraska, South Dakota, and Illinois. They are labeled as processing values and are based on a format used for many years in the soybean processing industry.  The reports are not intended to show precise margins of firms.   However, they show contributions of ethanol and distillers grain to the value of corn processed through dry mill plants.   A modified example from mid-March 2015 and 2014 for Iowa is shown above, with additional data from other sources. (3) 

The table shows ethanol yields per bushel and gross margins base on a dry distillers grain and solubles (DDGS) yield of 15.5 pounds per bushel.   USDA uses 17.75 pounds per bushel, which originated decades ago.  The lower DDGS yield is used here because we have heard from some processors and analysts that as the ethanol yield per bushel increased over time, the DDGS yield has declined.   Also, the majority of dry mill plants now remove corn oil from the DDGS, thus reducing its pounds per bushel.  

In the gross returns, we assume some corn oil is extracted and a net return of $0.03 per bushel for corn oil is included in the 2015 return over variable cost along with a $0.05 return the previous year.  Actual returns for corn oil removal will vary from one plant to another, depending on technology, the amount of oil removed, and how it is priced.

Key elements influencing what ethanol plants can pay for corn

The middle part of the table shows key elements influencing how much ethanol plants can pay for corn.  These include the contributions of ethanol and DDGS to the value of corn processed in the plants.   Below that are the gross returns over corn costs and the returns over variable costs using estimated variable costs from the AgMRC model. (4)  Below returns over variable costs, we show the corn prices that would cause this example plant to shut down with the mid-March ethanol and DDGS prices, and also the shut-down price if DDGS prices were to drop to 100% of the value of corn rather than the recent 130% of corn prices on a pound for pound basis.  With the lower DDGS price, the plant’s corn shut-down price would be $0.20 per bushel lower than using actual mid-March 2015 prices.

Variable costs are expenses that would not be incurred if the plant was not operating.  The shut-down price is the level where a higher corn price would not allow the plant to cover its variable costs and it would be less costly to close the plant temporarily than to operate it.  In the example plant shown in the table above, the corn shut-down price using actual DDGS prices is $4.19 per bushel.  That’s approximately 10% above actual mid-March cash prices.

Fixed costs are incurred whether the plant is operating or closed down.  Fixed costs in the AgMRC model in late February were $0.598 per bushel.   Actual fixed costs can vary substantially from one plant to another.  When fixed costs are included, the AgMRC data show a modest loss in mid-March vs. a substantial profit a year earlier.  Actual costs, profitability, and shut-down prices will vary from plant to plant.   Also, actual returns at individual plants will vary with the timing and amount of forward pricing of corn, ethanol, and DDGS. 

Costs of corn production

Below the corn shut-down prices, we show Iowa State University estimated corn variable production costs plus land rent for two different cropping programs.  The first is for a rotation with corn following a soybean crop the previous year.  The second set of costs is for a corn-following-corn rotation, where yields are lower and costs are higher than for the corn-soybean rotation.  Both comparisons are based on normal, 200 and 185 bushels per acre respectively. (5)  The estimated fixed costs per bushel, excluding land rent, for these two rotations are $0.49 and $0.52 per bushel, respectively.  When the fixed costs are added, corn production costs exceed the ethanol plant shut-down prices.  

Harvest-delivery corn bids in north central Iowa in late March are shown in the last line of the table.   At $3.75 per bushel, they are low enough with current ethanol and DDGS prices so that ethanol plants can afford to buy corn for processing.  However, if prices are at that level at harvest time, farmers will face losses for corn production – unless yields are well above normal.

Risk of lower DDGS prices

DDGS in the table above on March 13, 2015 contributed 26% of the combined DDGS and ethanol value from processing the corn.  The price of DDGS in mid-March was 130% percent of the corn price on a pound-per-pound basis.  That’s considerably higher than the feed value of DDGS relative to corn in most animal nutrition formulations although it was lower than a year earlier.   Much of the time since early 2007, Iowa DDGS prices have been 75% to 105% of the price of corn and have a strong tendency to decline in the spring. (6)  Prices in the past two years are an exception and have been influenced by high soybean meal prices as well as China’s emergence as a huge export market for U.S. DDGS.  Prices almost certainly will be influenced in the months ahead by China’s import volume.  Chinese trade policies give DDGS imports a competitive advantage over domestically produced feed ingredients and imported corn.  However, its policies and import volumes have fluctuated with alleged concerns about some varieties of biotech corn.  Figure 1 shows a dramatic increase in China’s U.S. brewers grain imports, most of which are DDGS, in the last few years and especially last season.  In the 2013-14 marketing year, China accounted for 52% of total U.S. brewers grain exports.  Because there is a time lag in releasing U.S. DDGS export data, current monthly exports to China are not available. However, trade sources indicate the Chinese continue to be major buyers of DDGS. That should help support DDGS prices and may keep the DDGS/corn price ratio above the historical average this spring. (7)  Even so, a seasonal decline in prices should be expected again this year because of the normal seasonal decline in domestic use by beef cow-calf producers. 

 

The extent of any seasonal DDGS price decline will depend on the volume of corn processed into ethanol the rest of the marketing year. Through mid-March, as shown in Figure 2, weekly ethanol production has remained above the record 2011-12 and 2013-14 levels despite the “blend wall”, disappointing profits, and reduced gasoline and ethanol prices.   Recent weekly production has been at an annual rate near USDA’s 5.2 billion bushel projection of corn processed for ethanol for the current marketing year.  In mid-March, April ethanol futures prices were approximately 17% below RBOB gasoline futures prices.   As we indicated in last month’s report, ethanol’s widespread use to increase gasoline octane levels would allow ethanol prices to move closer to or even slightly above gasoline without serious negative effects on demand if conditions unexpectedly tighten corn supplies and increase corn prices.  However, when compared to two or three years ago, even with ethanol prices moving closer to gasoline, current weak petroleum and gasoline prices would temper weather-related corn price rallies if they should develop.

 

Conclusions

The big picture indicates that without a substantial change in energy market conditions, returns for the rest of the year may be near break-even levels for ethanol producers and below break-even for many Midwest corn growers.  Unless U.S. energy market conditions strengthen substantially, depressed ethanol industry returns are likely to temper the upside potential in corn prices and their sensitivity to weather concerns.    

With the sharp decline in U.S. energy prices, ethanol processing values are much lower than in the last few years and limit prices that the ethanol industry can pay for corn.   Market conditions in mid-March indicated ethanol producers could pay about 10% more than the current cash corn price before reaching the plant shut-down level.  Recent shut-down prices also have been about 13% more than late March harvest-delivery bids for new-crop corn in central Iowa.   However, these maximum prices ethanol processors could pay for corn are not high enough to cover typical old and new-crop break-even prices for corn producers.

References

1   Citi Research,  “US EIA Petroleum Statistics, Top oil market indicators to watch point to 2Q’15 WTI weakness.” Has extensive EIA data on U.S. petroleum production, stocks, refinery margins, imports, and related petroleum industry information

2  The Energy Independence and Security Act, December 2007, U.S. Congress

3  Data sources for the table are USDA-MO Dept of Ag Market News Service, Saint Joseph, MO and the AgMRC website.

4  Tracking Ethanol Profitability - Don Hofstrand and Ann Johanns - updated monthly and Ethanol Profitability Spreadsheet, AgMRC.

5  These costs are available from Ag Decision Maker, Iowa State University, “Crop Production Costs.” 

6  For detail on seasonality of DDGS prices see Scott Irwin and Darrel Good, “Ethanol Production Profits: The Risk from Lower Prices of Distillers Grains,” Farm Doc Daily, March 12, 2015 and Linwood Hoffman and Allen Baker “Market Issues and Prospects for U.S. Distillers’ Grains Supply, Use, and Price Relationships,” December 2010, Economic Research Service, USDA. 

7 Ethanol Producer Magazine, Sean Broderick, “Commodities: Longevity, depth of Chinese market at top of mind,”  March 24, 2015