Thursday, August 19, 2010

E85 - Is It the Solution?

During the last several months, the key advocacy groups for ethanol have been split on the long term policy they want to advocate for ethanol in the face of the looming expiration of the tax credit and import tariff.  Growth Energy took the lead and changed directions from the drum beat of tax credit renewal exclusively to advocate Flex Fuel Vehicles (FFV) and the construction of E85 fueling stations.  The argument is that the ethanol industry, once provided its own fuels market via E85 that is not controlled by the US refining industry, will then control its own destiny and profitability.

On the surface, this idea has substantial appeal in that it gives the ethanol industry the opportunity to compete with hydrocarbon gasoline on an equal playing field.  In our opinion, for E85 to be successful long term, it must be cost competitive to the consumer on an energy-delivered basis compared to gasoline.  The simple facts are that a gallon of ethanol contains 75,700 btu/gallon, whereas hydrocarbon gasoline contains 115,000 btu/gallon, which calculates as a 35% disadvantage for ethanol.

The three keys to E85’s success are:

  •          Expand the FFV fleet substantially to create demand density

o   Legislation has been introduced to force the auto industry to produce more FFVs
  •          Build E85 Fueling stations

o   The industry estimates that it needs 200,000-300,000  stations
o   Currently, there are 2,500 stations
o   Legislation has been introduced to provide tax credits to build E85 fueling stations
  •          E85 price meets or beats gasoline parity

o   This is the issue

The price parity issue is the one piece of the E85 puzzle that is not falling into place. We have analyzed the price parity issue from two perspectives using Chicago physical prices for gasoline and ethanol.  This analysis assumes no ethanol tax credit is available.  The first perspective is comparing gasoline prices to market ethanol prices and plotting them against the hypothetical E85 energy content parity price.  The following graph shows that the price of ethanol has never dropped low enough to value E85 below the energy parity line during the last 2 ½ years.

The second perspective is to see if E85 can be competitive from a cost-of-production basis, which removes ethanol market influences. The value of ethanol in this analysis is based on CBOT corn plus 30 cpg.  We used this value for ethanol in the following graph and, once again, E85, using this ethanol value, is never less expensive than the E85 parity line.

These results are startling from the perspective that ethanol is unable to compete against hydrocarbon gasoline on an energy content basis without government incentives.  The difficulty is the relationship between agricultural prices and crude oil prices. The question becomes, will the corn price versus crude price separate enough in the future to overcome this differential?  In the near term, the differential is actually going in the opposite direction, with a corn/crude margin squeeze that we will discuss in our next segment.

Tuesday, August 17, 2010

Ethanol Tax Credit- $4 CORN - $75 Crude

Recently, the price of unleaded 87 gasoline in the USGC and NYH has fallen below the price of ethanol in those markets. The 45 cpg ethanol tax credit (VEETC) and RFS2 mandate have now become the driving force for blending ethanol into gasoline.  The VEETC will become the primary economic driver for blending ethanol into gasoline as the ethanol/gasoline differential becomes negative.  Ethanol blending is exceeding RFS2 mandates of the obligated parties, as evidenced by very low RIN prices in the 1.0-1.25 cpg range.

Corn, at $4 per bushel with a 30 cpg crush margin, yields an ethanol price at $1.75 per gallon FOB Chicago and 180-185 cpg ($75-$78 per barrel) in the major market areas.

Crude is now in the $75 per barrel range, and gasoline cracks of $8-$10 per barrel are falling, having lowered by almost $4 per barrel to $79 per barrel last week, and continues to go lower.

Corn prices are being driven by issues in the wheat market due to the projected wheat shortfall in Europe and Russia.  China continues to be a large importer of numerous agricultural products, thereby supporting agricultural prices. Corn prices appear to have solid fundamentals that endure into 2011.

The economic drivers in the corn market (feedstock costs) do not appear to have a relationship with the price of ethanol as a transportation fuel.  The economic drivers for inputs and outputs for an ethanol plant are disconnected and headed for a possible collision.

If you take away the VEETC by not renewing it for next year, and with crude/gasoline prices deteriorating to $70 per barrel or less, the ethanol producer is going to be put into a margin squeeze.  With no VEETC to incentivize blending and lower crude/gasoline values, ethanol demand will drop sharply as non-obligated parties discontinue discretionary blending, and obligated parties minimize blending to their specific RFS2-mandated volume. The market will eventually correct itself in one of two ways: either a significant number of ethanol plants will shut down to affect corn’s supply/demand balance and drive the price of corn down, allowing ethanol production at a lower price, or, there will be a shortage of RINs, driving their price up to motivate obligated parties to pay an ethanol premium to gasoline.  RIN prices will move up accordingly, providing an incentive to blend ethanol to the obligated parties, even though the actual physical price is uneconomic.

In summary, there is a danger of a severe margin squeeze in 2011 if the VEETC is not renewed and the corn-to-crude relationship shrinks further below today’s price relationship.  This margin squeeze will result in plant capacity shutdowns to cope with the negative market signals.

Wednesday, August 11, 2010

Ethanol Market Commentary - August 11th

The agriculture markets have calmed down from last week's volatility caused by the Russian ban on wheat exports.

Corn futures in the US remain in the $4/bushel range for front month futures.

The EIA stats this week for ethanol are neutral.  Production remained essentially unchanged.  Inventories fell another 200,000 bbls but remain 1,000,000 bbls higher than the first week of June.

Gasoline production continues to decline dropping 350,000 bpd over the last two weeks.  Gasoline blended with ethanol declined slightly.  The ethanol blending penetration was 84.5%.

Wheat prices in Europe have backed off the peaks reached last week.

The USDA WASDE report is due on Thursday - this has the potential to stir up agriculture price volatility.

European T1 prices have paused for the moment as shipments from the US begin to appear in the market.  The arbitrage from the US to Europe has tightened.  T2 prices have caught up with the big rise in T1 prices but there is noise in the market about the high cost of wheat pushing T2 prices further.

Brazil prices remain steady.

Thursday, August 5, 2010

Wheat Rally to Affect Ethanol Price

The big news in the grains markets has been the big shortfall in wheat production from Russia and the Ukraine.  The extent of the heat damage to the crop is not clear but there are strong rumors in the market that Russia is going to ban exports.  How does this impact ethanol?

Corn prices in the US are being pulled by the wheat markets.  The wheat futures are up 60 cents/bushel in early trading today in response to developments in Europe.  Corn has pushed into $4.10/bushel range for the September contract in response to the wheat move.  The ethanol/corn crush margins are falling back into the 27-29 cpg range from 32 cpg earlier this week.

In Europe, approximately one third of the fuel ethanol production is wheat based.  The incremental gallon in Europe is produced from wheat.  This is going to drive prices in Europe which will translate into continued demand for US ethanol to fill Europe's ethanol requirements. 

Ethanol prices will need to move up in the US to keep pace with corn prices and the tug of exports to Europe.

Wednesday, August 4, 2010

EIA Ethanol Data - August 4th

The cut in ethanol production did not last long with production rebounding from its recent low of 816,000 bpd to 876,000 bpd, a 6.5% increase in one week.  Total ethanol stocks stayed essentially flat.  PADD II, which covers the Midwest producing area, showed a small increase of 50,000 barrels.  The PADD I, which covers the USEC, showed a drop from 8,445,000 to 8,271,000 barrels.  The drop on the USEC is supportive of the strong price differential for NYH material over Chicago that has been a feature of the ethanol market during the last 10 days.

No significant change in gasoline production using ethanol.  Gasoline blended with ethanol fell slightly from 7,911,000 bpd to 7,983,000 bpd yielding a 84% ethanol blending penetration rate.

The large increase in ethanol production is a bearish sign for the ethanol market.  ADM annouced that their expansion at Cedar Rapids, Iowa is coming on line this month, which if it produces at nameplate will add 20,000 bpd to production.   

On the bullish side, the export arbitrage to Europe is still open albeit a little tougher to capture.  The European market continues to move up on price for T1 product to draw more material to a net short European market.  Latest T1 deal was $585/cbm FOB Rotterdam for Aguust delivery.  EN spec grade material in the US is somewhere in the 25-30 cpg premium to CBOT delivered to a coastal terminal,

Prompt CBOT corn/ethanol crush margins had moved from 22 to 32 cpg over the last two weeks. The December crush margin falls to 22 cpg.  This margin differential will continue to support a backwardated shaped market.

Tuesday, August 3, 2010

Ethanol Market Volatility

So what is going in the ethanol markets? What is driving the recent surge in ethanol prices and will it continue?

1)Agriculture prices are up. The US corn crop looks like it is going to meet market expectations but the potential shortfall in the wheat harvest across Europe and Russia due to heat stress this summer is driving corn prices higher as an alternative feed grain. The extent of the impact on wheat in Europe/Russia will become clearer over the next few weeks with the harvest just getting started.

2)Brazilian ethanol producers are exhibiting much greater discipline this year by holding onto inventory and not participating in panic selling to raise cash in the early part of the sugarcane harvest. Brazilian exports of ethanol are 50% lower than same time last year. Sugar prices are also strong adding to financial strength to hold ethanol inventory

3)European prices are being pressured by wheat prices that have increased 35% in the last 45 days due to potential crop yield problems mentioned earlier. Europe also is net short ethanol and must import to meet its biofuel requirements. In the past Brazil has filled that role but with anhydrous ethanol at $600/cbm FOB Santos and European T1 prices at only $565/cbm FOB Rotterdam, Europe is turning to US material to fill the gap.

4)In the US, the EIA reported that ethanol producers had slowed down their production by approximately 5% to 816,000 bpd and traders consummated export deals that will soak up another 10,000 bpd over the next 20-30 days. This caused NYH prices to blow out and trade at 18 cpg over Chicago versus typical differentials of 10 cpg over Chicago.

5) The US market has moved into a 3-5 cpg backwardation that appears to have staying power as a market feature if producers maintain production discipline and exports continue at a 10,000 bpd pace. Record gasoline production is also helping on the domestic demand side and it remains to be seen if this level of production will continue for the summer driving season.

The Wednesday release of EIA data will be very interesting to see if these trends continue in both ethanol (down) and gasoline (up) production.