The Energy Information Administration said in a weekly report on the petroleum markets that short-term profit margins for dry mill ethanol producers have been consistently low by historic standards since the last quarter of 2007, failing to catch an updraft through the first half of 2008 when crude and gasoline prices spiked to record highs, and have since fallen dramatically. Earlier in the year, ethanol plant margins were held down by climbing feedstock costs and rapid growth in new production in response to spiking ethanol prices in 2006.
“The bottom line: In spite of being the recipient of government subsidies and mandates, ethanol has not avoided the boom and bust cycles seen in other commodities, though it has followed a different tempo,” said the EIA. “In fact, ethanol was already in a bust period when the current financial crisis, which has now added to the industry’s problems, hit.”
The EIA recounts the various roles ethanol as a blendstock has had in the gasoline pool, noting that for decades it served as a either a volume enhancer, an oxygenate, an octane booster, and, starting in late 2003, as an alternative to methyl tertiary butyl ether for blending into reformulated gasoline.
“Demand for ethanol has grown rapidly since about 2003 in response to State bans on MTBE, federal mandates to blend more fuel ethanol into motor gasoline, and, especially in recent years, attractive prices relative to gasoline,” explains the EIA.
In response to an increasing consumption rate, producers built new plants, plants more efficient than in the past.
“Yet in spite of increases in demand and far more efficient production overall, profitability has varied widely, especially in one portion of the industry–the dry mill sector, which represented about 80 percent of ethanol production in 2007,” said the analysts.
During the ethanol construction boom, most new plants constructed were dry mills, which are smaller and less complex to build than wet mills. They were less costly to build, with construction completed much quicker than the wet mills.
The primary input costs at dry mills includes the net cost of corn, which refers to the price paid for corn minus the value received in producing an animal feed, such as dried distiller’s grains with solubles. Additionally, costs include the energy used to produce ethanol, primarily electricity and natural gas.
In offering a recent history for the industry, the EIA said the first bust occurred in early 2005 following an increase in demand in 2003 and 2004 as ethanol began replacing MTBE in states that banned the chemical additive because of concerns about groundwater contamination, including California, New York, and Connecticut. While the state bans supported an increase in producer profit margins in 2004, a federal court in the fall of that year stayed the EPA’s requirement for Atlanta, Georgia, to begin using RFG.
“As a result, the extra production and stock build-up intended to serve the new regional market for ethanol turned into a glut that drove spot prices and the spot margin down nearly 75 cpg during the first months of 2005,” said the EIA.
By May 2005, the spot margin began to rebound, and by June 2006, had spiked from 3.5cts gal to $2.85 gal.
“Hurricanes Rita and Katrina accentuated the boom when they struck in the fall of 2005. The spike in the weekly fuel ethanol margin topped out temporarily on September 1 at almost $1.50 per gallon before falling back. Although energy costs to produce ethanol rose during the second half of 2005, these increases had little effect on the margin since they were largely offset by a 9-month, 20-cent decline in the net corn price,” said the EIA.
In August 2005, the Energy Policy Act of 2005 was signed into law, which included 7.5 billion gallon per year Renewable Fuel Standard by 2012.
“A more immediate impact of EPAct, however, arose as it became evident that refiners had decided to quickly eliminate the use of MTBE in response to litigation concerns falling out of the legislation. All refiners that had not already eliminated MTBE discontinued it before or during the winter-summer switchover in spring 2006,” said the EIA.
The switchover triggered a surge in ethanol demand and led to the highest price peak in its history at more than $4 gal on June 22, 2006, with the margin reaching $2.85 gal. The supply-demand balance was extremely tight during the period, with ethanol holding a premium to gasoline from April through July 2006.
The price spike triggered a construction boom, with domestic production increasing 29 percent over the 12-month period from December 2005 to December 2006. The high prices also sparked a sharp increase in imports, and, in the 14 weeks after the June peak, the spot price lost about 58 percent. The profit margin tumbled from $2.85 gal to 53cts.
“For the long term, the most important aspect of the 2005-06 boom was that it led to a continuing increase in production capacity, as many new ethanol plants entered operation and others began construction. Furthermore, dry mill plants had become larger and more efficient since 2005,” said the EIA. “Supply now outpaced demand, and ethanol prices continued to slide for much of 2007, in spite of increasing demand.”
To add to the woes of producers, production costs were increasing, namely corn which began rising in the fall of 2006.
“The ethanol producer margin approached zero in late September and October 2007. It is likely that some plants even experienced negative margins at this time,” said the EIA.
“By mid-October, corn prices started a steeper rise and put upward pressure on fuel ethanol prices. Still, the value of fuel ethanol at blending terminals remained at a discount to gasoline until just recently, as gasoline prices have cratered along with crude oil prices,” said the EIA. “Costs have fallen since July of 2008, and ethanol prices have fallen in tandem, with margins staying low.”
EIA estimates total ethanol production capacity in August at 10.2 billion gallons per year, with potential increases from planned or ongoing construction up to 13.2 billion gallons per year by the end of 2009.
