Ethanol Margins Are Improving as Production Falls
Ethanol Margins Are Improving as Production Falls
Unrelenting large weekly production runs, record-level stocks, compressed industry-wide margins and meddlesome politics in Washington, D.C. contributed to largely negative effects on U.S. ethanol for most of the 2018/19 marketing year. By late summer, the industry started to take necessary steps toward recovery. Faced with the threat of tightening corn supplies and a strengthening basis in many of key ethanol producing states. While production cuts and stocks draws have helped estimated gross ethanol producer margins return to a positive level, the downside has been lower overall corn use. We believe that lower corn use for ethanol can be a negative for disappearance.
Weekly production cuts and stock draws have been key
For almost the entire 2018/19 marketing year, the domestic ethanol industry was plagued with record large stocks. Part of the stocks build in early 2019 can be attributed to robust export business to Brazil, Canada and India, and part was to satisfy seasonal driving demand. The demand side of the equation had worsened for U.S. ethanol by the second half of 2019: Export pace had declined, there was still no trade deal with China and the spread between reformulated gasoline and ethanol was narrowing, making ethanol less competitively priced. Add to this lackluster sales of the much-heralded e-15 and the summer stocks continued to achieve record-high levels.
By August 2019, weekly YoY U.S. ethanol production levels started to decline. Part of the production decline can be attributed to the compressing and negative estimated gross margin structure, and part can be attributed to maintenance and plants being idled. In 2019, 15 ethanol refineries across the U.S. closed, including in Iowa, South Dakota and Michigan, resulting in reduced production capacity.
Weekly production also fell as downstream gasoline refiners were facing negative margins and exercised the small refiners production waivers (SRW) that were guaranteed by the federal government. According to the Renewable Fuels Association, the Trump Administration has granted waivers to 85 oil refineries since 2016, deterring an estimated 1.4 billion bushels of corn from being used to make ethanol.
From August to late November, weekly ethanol production declined by an average of 4 percent. Using the most recent data from the U.S. Department of Energy’s Energy Information Agency (EIA) and the USDA, decline in corn use correlated with the decline in weekly ethanol production.
Assuming a 2.85 gallon-to-bushel ethanol yield and that 2 percent of the weekly domestic ethanol production is from sorghum, weekly corn for ethanol use declined sharply during the first three months of the 19/20 marketing year.
Using production data from the first 12 weeks of the marketing year is averaging 101.537 million bushels (MBU) a week suggesting corn for ethanol use is roughly 5.279 billion bushels—well below the USDA’s estimate of 5.375BBU. FBN is estimating corn for ethanol use during the marketing year to be at 5.300 BBU.
Current demand for U.S. ethanol has illustrated some recent improvement, but FBN believes that ethanol remains vulnerable. Monthly reported ethanol exports of U.S. ethanol for September were +8 percent from 2018, but exports as a percentage of domestic production has shrunk during the second half of 2019. Also serving as a negative for ethanol disappearance is the decline in weekly exports of gasoline. Since September, weekly U.S. gasoline exports have declined by an average of 8 percent YoY.
Since the start of the 2019/20 marketing year in September, the production pace of U.S. ethanol has declined from 2018 rates. The recent 10-week run of weekly higher ethanol production is a positive for corn demand, but the total corn for ethanol use suggests approximately 5.275 billion bushels—roughly 100MBU below the USDA’s estimate of 5.375BBU. We believe that if margins exist for the ethanol refiner, then there is an incentive to produce. An incentive to produce is positive for corn disappearance. Add to this the lowest stocks level since 2017 and we believe that the recent production trend could persist, which would be a positive for corn demand. But at FBN we remain cautiously optimistic: Small refinery waivers combined with a loss of production capacity can keep production below levels observed during the 2018/19 marketing year.
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