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Optimistic Bearing

Staying bullish on ethanol even in the trough of negative margins.
By Susanne Retka Schill | January 16, 2013

Ethanol might experience strong headwinds in 2013 but four marketers still see good things ahead.  Yes, ethanol stocks have climbed, indicating the blend wall is here. Corn prices have been at record heights and supplies are tight, pushing the basis up for many corn buyers. On the other hand, ethanol prices have remained at a discount to gasoline, the renewable fuel standard (RFS) was not waived and the adoption of E15 is under way.

“Ethanol’s value proposition, as a very cost-effective molecule in the motor gasoline pool, has proven itself over time, and we’re very confident of that in the future,” says Jason Searl, vice president of ethanol marketing and trading at Poet Ethanol Products. “From January to November of last year, ethanol traded between 55 and 65 cents a gallon on average underneath gasoline,” he says. Looking back even further, ethanol has competed with gasoline very effectively. “Its high octane benefits are really necessary to end users who have largely converted their gasoline refineries to subgrades.”

For Doug Punke, CEO of the Renewable Products Marketing Group LLC, the drop in gasoline prices before Christmas was a positive sign. “Ethanol demand is dependent on gasoline demand,” he says. “I’m encouraged with the recent drop in gasoline prices. It will certainly slow down the demand destruction we’ve had due to higher gas prices.” He also believes that the ethanol margins have bottomed out, although he can’t project how long the trough could last.

John Litterio, head of CHS ethanol marketing group, finds declining inventory levels an encouraging sign. “Since December of last year, we’ve had 34 to 36 days-of-demand in inventory,” he points out. “Since that time, we’ve gone to 23 days-of-demand in supply. Once you’re in the low 20s, that’s when you may see some shortages in some areas of the country.” That, in turn, gives some negotiating room for ethanol marketers, he explains.  In December, the U.S. ethanol industry was operating at 12.4 billion gallons on an annualized basis, compared to a fundamental demand of 13.2 billion gallons, he says. “That is why the inventory is coming down pretty quickly.”

Commodity markets are notoriously cyclical and the frequent tight, negative margins have ethanol marketers looking to shave pennies off costs. “In our marketplace, one-half of one cent per gallon is a big deal to us,” says Josh Bailey, vice president of marketing and trading for Eco-Energy Inc., a Tennessee-based company that couples distribution services with ethanol marketing. “We are making investments and working with blenders and railroads to really reduce the supply chain costs and create something that is long term and efficient, that ultimately will result in a better price for the blender and for the producer.” 

Global Markets
Bailey is also bullish on the future for the global ethanol market. As the industry is maturing, ethanol is joining the many commodities that have transitioned to a global market. “We’ve opened our trade opportunities with the globe. And, even with reducing tax subsidies and trade barriers, we are the lowest priced and most efficient octane enhancer when you compare ethanol with other octanes. We are a very competitive product in the motor fuel supply chain, and I think that is a tremendous statement, especially considering we did have a bad corn crop this, and corn prices are relatively high.”

Bailey sees some real opportunities in international trade, which Eco-Energy has acted upon in a new partnership with Copersucar, the largest sugar and ethanol trader in Brazil, finalized just before Christmas.  Brazilian ethanol is being imported into the U.S., Bailey points out, to fulfill the advanced biofuels requirement in the renewable fuels standard, which “creates a trade flow between us and them, and that creates opportunity.” 

University of Illinois economists, Scott Irwin and Darrel Good, wrote in their Dec. 7 FarmDocDaily newsletter that ethanol imports from Brazil have been driven more by the imported ethanol’s price relative to biodiesel than to U.S. ethanol. They noted that Brazilian ethanol delivered to the U.S. Gulf was $2.85 on Nov. 29, when U.S.-produced ethanol at Gulf terminals was $2.60 per gallon. That same day, conventional blendstock for oxygenate blending (CBOB) was $2.52 per gallon—a 33-cent spread. That is far more favorable than ultra-low sulfur diesel at the Gulf at $3.03 per gallon and B100 at $4.08, a spread of $1.05. “One final conversion must be done to make a fair comparison,” the analysis continues. “Since biodiesel is worth 1.5 gallons of ethanol in the RFS math, we need to divide the net profit for diesel blending by 1.5 to arrive at a net profit of -$1.05/1.5 = -70 cents per gallon. This makes biodiesel almost twice as expensive as imported Brazilian ethanol when it comes to meeting the advanced RFS mandate. And that is the reason why Brazilian ethanol imports are surging into the U.S. during recent months.”

There are other factors suggesting the global ethanol industry can cooperate more. The two countries’ seasons mirror each other, says Bailey. “They’re producing at a time when our demand is typically the highest—June, July and August—and that’s typically at the same time when we are at the end of our corn crop. As we start to get new corn in October, November, December, they stop producing ethanol. It is summer for them, so their driving season is at a peak.” The two biggest ethanol-producing companies in the world can also cooperate to stimulate greater ethanol use in global markets, Bailey adds.

Brazil has additional market flexibility—another positive for ethanol marketers—Searl points out. “That’s a luxury that we don’t have in the U.S. Brazil has announced that in June they’ll move from 20 to 25 percent blends.” The blend rate was restored to 20 percent this past year, after being dropped due to a poor sugar crop and resulting reduced ethanol production the year before. Brazil’s increasing ethanol blend mandate is a good sign that there will be room for U.S. exports to Brazil.

E15 Expansion
In the U.S., the move from E10 to E15, a long, still hotly contested battle, is seen as essential for the ethanol industry. The U.S. EPA’s published volume for conventional renewable fuel (predominantly corn ethanol) to meet the renewable fuel standard amounted to 13.2 billion gallons for 2012. It goes up for each of the next two years until corn-to-ethanol volume fulfilling the RFS is capped at 15 billion gallons in 2015. Total U.S. corn-ethanol capacity is currently estimated at being very close to that already, depending on how one categorizes certain plants. In late December, however, production had slowed significantly. “There’s a good amount of ethanol capacity that is curtailed and plants that are not running full out, but running 10 to 15 percent slower,” Litterio says. He estimates that 500 million to 600 million gallons of capacity won’t likely be returned to production.

Gasoline demand is looking to remain steady at around 133 billion gallons, and E10 provides room for just 13.3 billion gallons of ethanol. Consumers choosing higher blends for their flex-fuel vehicles create some demand above that, but ethanol marketers are looking for E15 to take the pressure off the blend wall and to make room for the expanding renewable fuel volumes called for by the RFS.  “I am very encouraged by what I see as we look beyond 2013 from a demand standpoint,” says Punke. “That will lift the supply and demand ratio to the point where we will have positive margins. Specifically, I look at E15 and the demand for the RINs (renewable identification numbers used to show compliance with the RFS).”

The combination of favorable blend economics due to ethanol’s discount to gasoline along with the growing mandated volume for conventional renewable fuel is going to help drive the adoption of E15. Searl points out that it really wasn’t until midsummer that the EPA finalized its E15 rules. “The stakeholders have had time to digest it the last half of 2012. 2013 will be when they initiate their plans by company and by region, trying to solve how they can utilize E15 most appropriately in their systems.” Logistics and compliance issues have to be worked out state-by-state, he points out, but he expects a steady increase in E15 throughout 2013 and 2014. “The full saturation of E15 will be in the course of years,” he adds. For one, the state of California—the nation’s single largest market—limits blending to 10 percent, in addition to its low carbon fuel standard that favors sugarcane ethanol over corn ethanol.

Litterio agrees that E15 inclusion will slowly build in 2013. “We’ve got to have a billion gallons to find its way into E15 by 2014,” he adds, predicting that the smaller retailers will bring it on first. “If ethanol prices stay lower than gasoline, E15 will be competitively priced. Retailers will have to step up, or be left behind.” Litterio’s ethanol marketing group at CHS works with eight ethanol producers, but on the retail side, the nation’s largest farmer-owned cooperative has 1,300 retail gas stations. “We’re the largest single retailer with blender pumps and E85,” he says, adding that CHS is committed to higher blends and will move into E15 as various issues are overcome.

New Crop Outlook
Based as it is on corn, ethanol’s fortunes for late 2013 and into 2014 lie with the new crop prospects: Will the drought become history and production rebound and perhaps even set new records?  By mid-December, eastern Corn Belt moisture conditions had greatly improved, says Rich Tinker, a meteorologist who works on the U.S. Drought Monitor. “The drought seems to have moved westward.”  Winter is usually a dry season for much of the western Corn Belt, he adds, generally receiving just 5 to 10 percent of its annual precipitation in December, January and February, while the eastern Corn Belt will get 15 to 20 percent in that time period. In mid-December, Tinker says his team was expecting higher-than-normal temperatures for the Corn Belt, “but as far as wet or dry, we’re just not sure.” The months of March, April and May are the critical time of year for making up a soil moisture deficit, Tinker says, when climate data shows the Corn Belt receiving one-quarter of its annual rainfall.  Heading into those months, he says, “it’s not too late to set us up for a decent spring season.” Summer is actually the wettest time period, he adds, when Corn Belt states receive a greater proportion of rainfall during the growing season itself. What no one can predict is whether a hot summer will exacerbate lingering dry conditions. 

Like the weather and the corn market, it’s well known that the ethanol industry is cyclical.  “This industry has seen difficult times numerous times in the past five years,” Bailey says, “but I am optimistic. We have a great product. We have the capacity to produce it. We’ve shown that our industry can be somewhat disciplined and we will reduce production. And we also have a mandated structure that has today worked very well in allowing obligated parties to meet their mandate with RIN credits. I think that those speak to very positive things. There are the obvious headwinds that we have to overcome in the short term with the 10 percent blend wall and the state-level issues with E15, but as those get solved it’s a good opportunity for the industry.”

________________
Author: Susanne Retka Schill
Contributions Editor, Ethanol Producer Magazine
701-738-4922
sretkaschill@bbiinternational.com

 

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