Ethanol Industry Challenges Intensify With USDA August Crop Forecasts
Dr. Robert Wisner
University Professor Emeritus
Iowa State University and
USDA’s National Agricultural Statistics Service (NASS) August 10 Crop Report provided the first field-based estimate of the nation’s 2012 corn, sorghum, and soybean crops (http://usda.mannlib.cornell.edu/MannUsda/viewDocumentInfo.do?documentID=1046). Estimates for both corn and soybeans were moderately below average trade expectations and indicated that substantial rationing of use will be needed in the year ahead to match demand with the limited available supplies. The 2012-13 season average prices for all three of these crops are expected to be at record-high levels. With very tight U.S. supplies, grain traders will focus both on later U.S. crop estimates and prospects for South American crops that will be planted this fall, as well as indicators of domestic use and exports.
The market’s way of rationing tight supplies is through prices high enough to cause some or all users to reduce use. Indicated U.S. corn production from the August forecast was 10.77 billion bushels, sharply below 2011-12 marketing year utilization that is expected to be around 12.5 billion bushels. Carryover stocks on September 1, 2012 probably can be reduced by around 400 to 450 million bushels in the year ahead to partially offset the production shortfall. Even so, the current crop estimate indicates corn use will need to be reduced by around 1.32 billion bushels or 10 to 12 percent from the marketing year just ending. That’s assuming the final corn crop estimate is near the August forecast. A number of private forecasters believe the final crop estimate will be moderately lower than the USDA forecast. As we indicated last month, a key question for all users of corn will be “Which users will cut back and by how much?” A closely related question is “How high will prices have to be to cause the needed rationing of demand?”
USDA economists have provided an early look at their expected answers to these two questions. Their assessment indicates all four major categories of users will reduce usage. The major use categories are (1) feed and residual, (2) ethanol processing, (3) food and other industrial utilization, and (4) exports. The “residual” portion of the feed and residual utilization represents handling losses and statistical errors. USDA August 10 projections of these utilization categories and season average farm prices for the 2011-12 marketing year ending August 31, 2012 as well as the early projections for the year ahead are shown in the table above.
Ethanol Industry Corn Use
USDA economists anticipate that corn processing at ethanol plants in the year ahead will be reduced by 500 million bushels or a decline of 10% from the marketing year just ending. However, the exact reduction is uncertain and will be influenced by a number of variables including corn quality as it affects the ethanol yield per bushel and the number of unexpired excess RINs that ethanol blenders decide to use as substitutes for actual ethanol blending.
Corn Quality & Ethanol Production
Ethanol production per bushel of corn can be affected by corn quality, especially the test weight per bushel. Variations in test weights affect the nutrient content of corn and have long been used as one of several measures of corn quality. Premature death of the corn plant, which appears to be widespread this year, can lead to low test weights per bushel, as well as other corn quality problems. With a normal un-denatured ethanol yield of 2.75 gallons per bushel of corn, USDA’s projected corn processing by the ethanol industry would produce 12.38 billion gallons of ethanol. That would be a decline of 1.38 billion gallons from production in the marketing year just ending.
With recent annual U.S. gasoline use at 131 billion gallons (1), the projected corn use for ethanol with a normal ethanol yield would give a U.S. average ethanol blend of about 9.4% if net ethanol exports decline to zero. However, this year’s corn crop almost certainly will have a considerably lower average test weight than normal and ethanol exports likely will not decline to zero. . A lower average corn test weight likely will result in a lower ethanol yield than normal. We would expect that to result from less starch per kernel. A lower ethanol yield very likely would (1) require more bushels to produce 12.38 billion gallons of ethanol or (2) cause production of less ethanol than normally would be expected from the 4.5 billion bushels projected to be processed at ethanol plants.
Here are some indications of how variations in ethanol yields per bushel might affect the industry’s total production. For example, 12.38 billion gallons of ethanol produced by an average yield of 2.70 gallons of un-denatured ethanol per bushel would require 4.59 billion bushels. An ethanol yield of 2.68 gallons per bushel (2.5% less than normal) would require 4.62 billion bushels of corn. A 9% decline in the average ethanol yield (2.51 gallons per bushel) would require about 4.95 billion bushels of corn to produce 12.38 billion gallons of ethanol. That would be only a 50 million bushel decline in corn use for ethanol when compared with 2011-12, but would be a 1.37 billion gallon or 10% reduction in ethanol production.
Alternatively, 4.5 billion bushels of corn processed into ethanol with a 9% reduction in the average ethanol yield per bushel would produce 11.26 billion gallons of ethanol, about 2.5 billion gallons less than in the marketing year ending August 31, 2012. That would provide an approximate U.S. average ethanol blend of 8.6% if net ethanol exports are zero and would be significantly lower than the average ethanol-gasoline blend of the past 12 to 14 months that has been at or very close to 10%. If net U.S. ethanol exports in the year ahead total 600 million gallons (down about 27% from the recent annual rate), the U.S. average ethanol-gasoline blend with a 9% reduction in ethanol yield per bushel would be approximately 8.1%. Since much of the ethanol blended with gasoline is used to increase the octane content, it is not certain whether the U.S. gasoline refining industry would be willing to allow the average ethanol blend to drop to that level. From the petroleum industry’s standpoint, the alternative would be to bid ethanol prices high enough to encourage large enough production and/or imports to maintain a 10% U.S. average blend.
A 9% drop in the average ethanol yield per bushel might be associated with a decline in the U.S. average corn test weight from a normal 56 pounds per bushel to around 48 to 51 pounds per bushel. With this year’s widespread and extensive drought, such a decline cannot be ruled out.
Aflatoxin is a carcinogenic toxin produced by a mold. It often occurs in areas of serious drought. Government regulations severely limit aflatoxin-contaminated corn’s use for feed or food purposes. Aflatoxin-contaminated corn is even more unsuited for ethanol plants than for feeding because its aflatoxin concentration is multiplied approximately three-fold in the distillers grain. Normally, occurrence of this toxin in corn is limited to small geographic areas. However, this year’s widespread drought creates the potential for more extensive aflatoxin problems than in the past. It is possible that a significant amount of 2012 corn might not be usable for food, feed, exports, or ethanol.
Excess RINs and Ethanol Production
RINs or Renewable Information Numbers, as we have noted previously (2), are 38-digit numbers assigned to each gallon of corn-starch ethanol and other biofuels when they are produced. The RINs are part of the mechanism EPA uses to enforce blending at the mandated levels. Over the past several years, the ethanol industry has produced more ethanol than mandated for blending with gasoline. Annual ethanol production in excess of the mandated level generates excess RINs that are accumulated and can be substituted for actual ethanol blending in future years when conditions might cause less favorable blending economics. Excess RINs available at the start of calendar year 2012 are estimated by trade and University sources (3) at 2.4 to 2.6 billion gallons. With a normal ethanol yield per bushel of 2.75 gallons per bushel, 2.6 billion gallons of RINs could be substituted for the ethanol production from 945 million bushels of corn. Thus, USDA projections – which appear to assume normal ethanol yields per bushel -- indicate about 53% of the outstanding excess RINs would be used in the 2012-13 marketing year.
A normal ethanol yield per bushel and the USDA 4.5 billion bushels of corn processed at ethanol plants would produce about 12.375 billion gallons of ethanol. Corn needed for this ethanol production level with varying ethanol yields per bushel is shown below. With the lowest ethanol yield per bushel, corn needed for this level of ethanol output would be only 55 million bushels less than in the 2011-12 marketing year.
Corn needed for 12.375 billion gallons of ethanol with varying ethanol yields
- 2.75 gallons per bushel: 4,500 million bushels
- 2.70 gallons per bushel: 4,580 million bushels
- 2.68 gallons per bushel: 4.620 million bushels
- 2.503 gallons per bushel: 4,945 million bushels
- Preliminary corn use for ethanol in 2011-12: 5.0 billion bushels
The comparisons below show how many ethanol-equivalent bushels of corn would be replaced by using 53% of the outstanding excess RINs in the 2012-13 marketing year with varying ethanol yields per bushel—before adjusting for reduced DGS production.. At the lowest ethanol yield per bushel, 53% of excess RINs would replace 125 million fewer gallons of ethanol than would be replaced with a normal ethanol yield. In that case, extra processing of corn for ethanol might be needed to produce the desired amount of ethanol. If so, corn use for ethanol in the year ahead might actually be slightly larger than in the year just ending, even with the use of 53% of the excess RINs. Alternatively, blenders might use more than 53% of the outstanding RINs as substitutes for actual ethanol blending. If so, fewer RINs would be available to help the industry to adjust to sharp increases in the 2014 and 2015 mandates that may push required blending above the blend wall.
Billion gallons of actual ethanol replaced by substituting 53% of excess RINs for ethanol blending in 2012-13
- 2.75 gallons per bushel: 1.375 billion gallons
- 2.70 gallons per bushel: 1.350 billion gallons
- 2.68 gallons per bushel: 1.340 billion gallons
- 2.503 gallons per bushel: 1,250 billion gallons
Will Blenders Want to Retain Some Excess RINs for Use in 2014 and 2015?
Market conditions and future mandates will determine what percentage of outstanding corn-starch ethanol RINs fuel blenders will use in the 2012-13 marketing year in adjusting to tight corn supplies and high ethanol prices. As we noted last month, conventional (corn-starch) ethanol mandates in the 2007 energy legislation increase from 13.2 billion gallons in 2012 to 13.8 billion gallons in 2013, 14.75 billion gallons in 2014, and 15 billion gallons in 2015 (4). Recent U.S. annual gasoline use has been about 131 billion gallons and has been declining for more than two years. The current 10% blend wall, unless E-15 sales become widespread, will be a major constraint for ethanol blenders and may cause them to retain a sizable amount of the outstanding RINs for use in 2014 and 2015. If so, that also could encourage more corn use for ethanol in 2012-13 than currently projected.
Would a Partial Ethanol Mandate Waver Reduce Corn Use for Ethanol?
This is an unanswered question. Recent analysis at the University of Illinois and Iowa State University (5) indicate the value of corn for octane enhancement may be a major determinant of ethanol blender demand and ethanol production when corn supplies are as tight as this year. Logic behind their conclusions is that almost all gasoline now produced in the U.S. is 74 octane and ethanol is used to upgrade it to 77 octane. A quick shift of refiners back to producing 77 octane gasoline through additional refining and reduced ethanol blending reportedly would increase costs and would be difficult to accomplish in the short run. If so, wholesale ethanol prices might at times move to a premium over gasoline prices. In recent weeks, wholesale or rack ethanol prices have been well above their gasoline-equivalent in energy value. Gasoline price levels also will be a key influence on corn use for ethanol, the shut-down corn price at ethanol plants, and the degree of competition that other corn users face from the ethanol industry. As this is being written, the average corn shut-down price for ethanol plants was in the $8.50 to lower $9 range. Shut-down corn prices are the prices at which the purchases of additional corn and processing it into ethanol and distillers grain would not cover the variable costs incurred. Variable costs are the costs that would not be incurred if the plant is shut down. They include labor, corn and other related inputs required to produce ethanol. Actual shut-down prices vary from one plant to another, depending on size, access to rail transportation, size and design of the plant, local demand for DGS and other factors. While these shut-down prices are a rough average, some individual plants have higher and/or lower shut-down prices. If wholesale gasoline prices rise relative to corn prices, shut-down prices will increase.
Corn Feed and Residual Use
This category of use represents value-added processing of corn into human food through livestock and poultry feeding. The amount of corn used for feed in the year ahead will be affected by a number of factors including the cost of the corn and other feed ingredients, livestock prices, livestock marketing weights, and corn quality. Alternative feed ingredients include wheat, grain sorghum, hay, pasture, protein meal, and other forage crops including drought-damaged corn harvested for forage and silage rather than grain. These alternative feed ingredients are higher priced than in recent years, and many are in tight supply. That also is true of soybean meal, which is expected to be in tighter supply than corn until at least late winter. Record-high prices of soybean meal and tight global protein meal supplies have pushed distillers grain and solubles (DGS) prices 3% to 10% above the price of corn on a pound-for-pound basis. Foreign demand for DGS may also affect its availability for domestic feeding.
USDA economists project corn feed and residual use in the 2012-13 marketing year to decline by 475 million bushels. At first glance, this would indicate that feed and residual use is expected to decline slightly less than corn use for ethanol processing. However, the projected decline in corn processing for ethanol also will reduce DGS production, thus creating additional tightness in feed supplies. With 500 million fewer bushels of corn processed into ethanol, the corn equivalent volume of DGS would be reduced by about 120 million bushels. Assuming 25% is exported, this would create a need for an additional 90 million bushels of corn or other grains to replace the reduced DGS production. Thus, the equivalent net reduction in corn feed and residual use would be about 565 million bushels or a 12.4% reduction from the marketing year just ending. This is only an approximate amount. The exact amount will depend on the final size of the corn crop, how corn quality affects feed conversion efficiency and DGS yields per bushel, the actual amount of corn used by ethanol producers, and the strength of DGS export demand.
Increased domestic wheat feeding will almost certainly replace some corn. We expect domestic wheat prices for most of the 2012-13 corn marketing year to be at levels that will encourage moderate wheat feeding as a replacement for corn. USDA’s August 10 U.S. wheat supply-demand projections show a 57 million bushel increase from last season in 2012-13 wheat feed and residual use (6). Since the wheat marketing year begins on June 1, part of the projected wheat feeding reflects wheat that was fed in June-August of this year. Next summer will be a key time for wheat feeding from the 2013 crop to replace 2012 corn in domestic feed rations. It is too early to estimate how large wheat feeding next summer may be at that time.
Corn acreage used for forage and silage is estimated to be substantially larger than in recent years. However, the larger area may be partially or completely offset by less tonnage per acre, fewer ears per acre than normal, and less feeding value per acre than normal.
Corn Direct Food and Other Industrial Uses
These uses of corn normally account for only about 10% to 11% of the total uses of U.S. corn, including exports. For corn processed directly into food products, the cost of the corn typically is only a small part of the total retail price. For example, with corn at $8 per bushel, the cost of corn in a 16-ounce box of corn flakes is about $0.15. Most of the retail price reflects processing, packaging, advertising, transportation, labor, and other related expenses. For that reason, direct food use is not very sensitive to the price of corn. The same is true of non-ethanol industrial products made from corn. With a relatively inelastic (price-insensitive) demand, USDA projects this category of corn use to decline by about 2.9% in the marketing year beginning September 1.
U.S. corn exports have declined considerably as a percentage of the total demand for U.S. corn in the last half-dozen years, although they still are an important influence on corn prices. USDA economists project U.S. corn exports to decline by 250 million bushels or 16% in the year ahead. That would be the largest percentage decline of the four main corn use categories and would reduce exports to slightly less than 12% of the total demand for U.S. corn.
Several developments will determine whether this projection materializes, including (1) the size of next spring’s South American corn harvest, (2) Chinese import demand, (3) final wheat crop production numbers for former Soviet republics (FSU), Argentina, and Australia. In USDA’s August 10 World Supply-Demand Report, Foreign Agriculture Service (FAS) projects combined Argentine and Brazilian corn production for harvest starting in early spring 2013 to be 4.2 million tons (165 million bushels) larger than in the current year. Argentina’s crop is expected to recover sharply from last season’s drought but Brazil’s corn crop is projected to decline modestly because of an expected sharp increase in soybean plantings and a shift from very favorable weather for its second-crop corn this year to a more normal weather pattern in 2013. Corn and soybean prices this fall will reflect a South American acreage battle between corn and soybeans.
In the marketing year just ending, China purchased about 200 million bushels of 2011-crop U.S. corn. That was a very large increase from the previous marketing year and occurred despite reported record Chinese corn yields and production. China’s shift to a substantial corn importer reflects its rapidly growing consumer demand for higher protein diets as average incomes increase. USDA’s August 10 forecasts indicate Chinese corn production will reach another record high this year. Even so, China’s 2012-13 corn import needs remain uncertain.
Feed wheat from former Soviet republics and Australia was a major competitor of U.S. corn exports this past year. August 10 USDA projections indicate 2012 wheat crops in Russia, Ukraine, and Kazakhstan may be down 24, 32, and 52 percent respectively from last year. Trade sources indicate these crops may be even smaller and that export embargos or controls by these countries cannot be ruled out. USDA August 10 estimates indicate this year’s EU wheat harvest was 3.3% less than last season. USDA projections placed Australia’s wheat crop at 12% less than last year. Drought is a concern in parts of its Wheat Belt. The other major Southern Hemisphere wheat producer is Argentina. Its wheat harvest is projected to be 23% less than last season. Southern Hemisphere wheat crops will be harvested from November through early January. Expected smaller Southern Hemisphere wheat crops will be partially offset by increased production in the U.S. and Canada. These seven countries and the EU are the world’s major wheat exporters. With prospects for reduced production, U.S. corn exports may face less intense feed wheat competition than in 2011-12.
Limited Foreign Buyer Coverage of Import Needs
With USDA June projections showing prospects for a bumper U.S. corn crop and much lower prices than in the last two years, foreign buyers appear to have been caught off guard by the U.S. drought. Even the July projections did not show extreme tightness in U.S. supplies. Mid-August 2012-crop U.S. corn export sales support the conclusion that foreign buyers had little forward coverage ahead of the August crop forecasts. For that reason, there also is considerable uncertainty about the actual size of U.S. corn exports for the year ahead.
Summary and Concluding Comments
Extreme tightness in U.S. corn supplies will require much more rationing of use through high prices than has occurred in recent years. Potential corn use in three of the four major demand categories in the year ahead are quite uncertain. Actual use will depend on the cost and availability of corn substitutes, especially domestic and foreign feed wheat. Corn quality also will be an important influence on the amount of corn needed for feed and ethanol. Other factors influencing feed use will include livestock prices and marketing weights, DGS supplies available to the domestic livestock and poultry industries, pasture conditions through next summer, tonnages and feeding value of this year’s corn silage and other forage crops.
Corn use for ethanol will be a key determinant of the amount of corn available for feeding and exports. Excess RINs are available to substitute for ethanol blending with gasoline, but it is unclear what percentage of those RINs blenders will want to use in 2013 vs. in 2014 and 2015 when increased EISA mandates will make the blend wall a greater constraint for the ethanol blending industry. Also, the year ahead will provide a better indication of ethanol’s value for enhancing gasoline’s octane ratings. Ethanol use for octane enhancement appears to have significant value beyond its energy-equivalent value, and may become a key determinant of the amount of corn used for ethanol in case a partial waiver of the mandate should be applied. The price of gasoline also will be a key influence of corn use for ethanol and the shut-down price of corn at ethanol plants.
September 12 and October 11 USDA crop reports and the September 28 U.S. Grain Stocks Report will provide updated indications of this year’s available corn supplies.
2 R. N. Wisner, “Renewable Identification Numbers (RINs) and Government Biofuels Blending Mandates”, Renewable Energy Newsletter, Ag Marketing Resource Center, April 2009 and W. Thompson, S. Meyer, and P. Westoff, “Renewable Information Numbers are the tracking instrument and bellweather of U.S. biofuels mandates, “ Euro Choices, Vol. 8, Issue 3, June 15, 2009.
3 Darrel Good and Scott Irwin, “Rationing the 2012 Corn Crop Revisited”, FarmDoc Daily, University of Illinois, August 15, 2012
Bruce Babcock, “Updated Assessment of the Drought's Impacts on Crop Prices and Biofuel Production” CARD Policy Briefs, Center for Agricultural and Rural Development, Iowa State University
4 R. Wisner, ”Implications for Ethanol and Other Corn Users of the Shrinking Corn Crop” Renewable Energy Newsletter, Ag Marketing Resource Center, August 2012 and Energy Independence and Security Act, December 2007, U.S. Congress.
5 Babcock Op. Cit. and Darrell Good and Scott Irwin, Op. Cit.
6 ERS, USDA, Wheat Situation, August 10, 2012