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.