Recent developments in the ethanol market
The outlook for the U.S. ethanol market is very confusing. Ethanol production has declines significantly this year, with annualized production in the last few weeks down between 12 million and 12.5 billion gallons. That clearly suggests a tight market with the RFS mandate at 13.8 billion gallons for 2013. The supply-demand balance is further complicated by the “blend wall’ that suggests a market for only about 13.4 billion gallons of ethanol. How this all gets resolved is far from clear at this point in time.
Poor profits have caused a drop in ethanol production. The 2012 drought has driven up corn prices and the higher input prices have squeezed ethanol production margins. With poor margins some plants have shut down and other plants have reduced output. The RFS mandate specifies how much gets blended – and does not directly impact production. While corn futures prices have been drifting lower, cash corn prices are actually higher than they were at the beginning of the year. Ethanol production margins over variable costs are estimated at about 25 cents per gallon, not really high enough to significantly boost production.
Blending margins provide incentives to use ethanol. Wholesale gasoline prices at the gulf are near $2.95 per gallon while ethanol prices are around $2.30 per gallon. Even considering transportation costs, the blending margin is around 40 cents to 50 cents per gallon. The blending margins may fall if gasoline prices decline but blenders still have to pay enough for ethanol to encourage production.
The market for RINs has heated up recently. Blenders can also satisfy their blending mandate by using RINs (Renewable Identification Numbers). Producers or importers must generate RINs for every gallon of ethanol. The RINs follow the ethanol through to use, but blenders can save the RINs for later once they satisfy their annual mandate. So with the use of RINs, the mandate could be satisfied this year with 12.5 billion gallons of production and 1.3 billion gallons of RINs carried over from 2012. The market value of RINs has recently increased sharply suggesting that blenders are trying to stock up because of the low ethanol production.
Meeting the mandate in 2014 and 2015 will be even more difficult. The mandate goes to 14.4 billion gallons while the size of the market is expected to stay down near 13.4 billion gallons. The size of the market is somewhat restricted to 10 percent of overall gasoline use which is about 134 billion gallons per year. But by next year the supply of RINs is expected to be much smaller than it is this year. According to USDA’s long range forecast released last month shows ethanol production rebounding to only about 13 billion gallons next year. That leaves a pretty large deficit between mandated use and production.