The final quarter of the calendar year is typically the busiest for U.S. ethanol manufacturers as the large swell in local corn supplies help to lower the cost of their chief input and propel operating margins into profitable territory.
Since the U.S. Energy Information Administration began reporting ethanol production on a weekly basis in 2010, U.S. ethanol output has persistently been higher during the October to December period than during the previous quarter, even in 2012 when drought conditions across the Midwest caused a sharp drop in fresh corn supplies.
And at first glance, positive production margins combined with a record-large corn harvest suggest that ethanol output levels look set to pick up once again this year.
But complicating that outlook this year is the fact that ethanol prices have recently climbed to a rare premium to gasoline, threatening to curb demand from wholesale fuel refiners who are used to being able to acquire ethanol at a roughly 50 cents a gallon discount to gasoline. If fuel blender demand for ethanol drops off as a result, ethanol producers may see operating margins slip and may be forced to cap production rates over the coming weeks even as available corn supplies continue to mount.
Promising Demand Potential
Strong production margins throughout 2014 have helped push U.S. ethanol production to record levels this year, with manufacturers averaging around 916 barrels per day through the first week of November compared with an average run-rate of around 842 bpd for the same period in 2013.
Substantially lower corn costs have been the chief driver behind the roughly 9 percent increase in production rates, with the slump in corn prices to four-year lows helping to beef up average production margins to above-average levels for most of 2014.
Margins have started to decline lately as corn values rebounded from early-harvest lows, but remain quite robust for this time of year and so should encourage ethanol plants to maintain high operating rates for the foreseeable future.
This in turn bodes well for corn sellers, as corn-based ethanol production accounts for roughly 40 percent of total U.S. corn demand and is projected to chew through around 1.3 billion bushels of corn each quarter for the 2014/15 crop year.
Blender Demand on the Wane?
While ethanol producers are concerned mainly with the price of corn, fuel blenders are motivated by the relative price of ethanol and gasoline – the two main ingredients in the U.S. fuel stream. Of the two, gasoline remains by far the chief ingredient, but fuel blenders can add as much as 10 percent ethanol to the total mix should it make economic sense to do so.
Ethanol’s typical 45-50 cents a gallon discount to gasoline usually makes that calculus worthwhile. But occasionally, ethanol prices prove uneconomical to add to the mix, as was the case in 2010 and 2012 when poor growing conditions in the U.S. led to a drop in corn supplies and forced ethanol production to contract.
Lately, ethanol values have returned to uneconomical territory versus gasoline, but this time the main driver has been robust ethanol demand rather than any concerns with corn availability.
Even so, from the perspective of the main ethanol buyers – the blenders – the impact is the same: a lower economic motivation to add more ethanol into the fuel stream for the time being.
Indeed, there are already some signs that blender demand is cooling, with the latest statistics revealing the “net input” of ethanol has dropped from around 878 bpd in mid-October to 860 bpd in the first week of November. This comes after ethanol prices rallied just over 50 cents a gallon since early October and gasoline prices sank by a similar amount. Gasoline prices have declined by more than a third since June on the back of the heavy slump in crude oil prices.
The next EIA data release on Wednesday will reveal the latest usage rates, and will capture the period when ethanol prices pushed above gasoline values for the first time since April. Should that release show further cuts to blender demand, that would push current-year demand rates below those of a year ago.
Even so, few ethanol producers will view that as a cause for alarm unless operating margins also tank sharply or inventories climb to burdensome levels.
Such an inventory climb would likely require weeks of poor demand coupled with brisk output, and so is unlikely to develop any time soon. And in the meantime ethanol producers are likely to forge ahead with production plans given the increasing availability of corn and profitable operating margins.
But if ethanol buyers balk at paying up for ethanol while gasoline is available at a lower price, ethanol producer margins are likely to deteriorate, and could drag on corn demand potential over the remainder of the year.