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Biodiesel- A growing source of alternative energy?

Biodiesel is an increasingly important use for soybean oil, with a projected
170% increase in use this year to 245 million gallons, or a 490-fold increase
since 1999. Projections are that this year the growth will consume about 13% of
the bean oil consumption, up from 5% last year.

Biodiesel is a biofuel substitute for diesel, and is made mostly from soybean
oil (over 90%), but also other oilseed crops are used including palm oil, animal
fats, and recycled oils. With similar properties to diesel, it can be blended
in almost any ratio with diesel in vehicles, often at the 20% level (B20).

In 2000, USDA created the CCC Bioenergy Program that encouraged biodiesel
production through cash payments to producers. Production jumped from 500,000
gallons in 1999 to 28 million gallons by 2004. In 2005, 91 million gallons were
funded and USDA forecasts 2006 to hit 245 million gallons. These are huge jumps
in a few short years! Although costs of producing biodiesel are forecast to be
about $2.45/gallon to produce, and over $3 once marketing/construction costs are
included, recent legislation has granted biodiesel a $1/gallon excise tax credit
and a $.10/gallon small producer tax credit. Government incentives along with
higher diesel prices in the past year have made biodiesel a viable and
profitable alternative.

Although the Bioenergy Program authorization ends in FY 2006, with high diesel
prices and new tax incentives, USDA forecasts biodiesel production will reach 245
million gallons in 2006. The National Biodiesel Board indicates there are 65
commercial US biodiesel plants, with annual production capacity ranging from
200,000 gallons to 30 million gallons (most plants under 6 mln gallons, but 7
plants above 15 mln gallons), with total capacity of 400 million gallons. Newer
plants tend to be larger. They also report that 50 new plants are under
construction as of April 2006 that are expected to add another 700 million
gallons annual capacity. Over 100 plants are forecast to be on-line by 2007.

Soybean oil is the most common feedstock supply, but the largest plant under
construction at 85 million gallons capacity uses canola oil. Judging by the
capacity built by investors, biodiesel production is expected to continue
growing rapidly over the next few years. Current projections include a slowdown
in growth as it reaches a higher level, but projections still call for just
under 400 million gallons to be produced in 2007.

In 2006/07, the 2.6 billion lbs used for biodiesel production accounts for the
oil from 229 million bushels of soybeans, or about 8% of estimated soybean
production in 2006. Although biodiesel is growing at a faster pace than ethanol
on a percentage basis, both biodiesel and ethanol may have a difficult time
making a dent in gasoline demand as feedstock supplies of both corn and bean oil
are small relative to the size of the overall fuel market.

In fact, while 20%
of the US corn crop is used for ethanol this year, the energy content of that
production is only equivalent to 1.5% of US crude oil imports. Crude oil
imports account for about 58% of our energy needs. That gives you an idea of
how vastly large the overall market for energy is compared to the US corn and
soybean crop. If the entire corn crop were used this year for ethanol, only
7.5% of US crude oil imports would be met. There just isn't enough
corn/soybeans to meet this demand at this time.

In the end, perhaps our Chief USDA Economist, Dr Keith Collins, summed it up
adequately when he said, "...raising market share to the point that US crude oil
imports are materially reduced poses many issues which may not be overcome ....
We need to think broadly about the implications for farm and fuel markets, the
environment, food, feed and fuel consumers, and taxpayers. We need to attack
the challenges on multiple fronts with market-based policies and smart public-
private efforts and partnerships. While markets will work in the longer term,
the allocation function of market prices can mean substantial costs for some
sectors, so the evolution of ethanol bears close monitoring."

Clearly we are already entering the period where markets are trying to do that
allocation rationing, with feed, ethanol, and export usages currently competing
on a scale to use up current corn and soybean supply. For 2006/07, it's the
corn that looks to be somewhat limited in supply to meet all the demands placed
on it. In future years (perhaps 2008???), its soybean supply which will suffer
as additional acres are switched over to corn in 2007 and 2008.

We very well might need to cut corn demand in 2006/07 by 300 mb or more to help
get corn supply and demand back in balance for 2007 (even with a large 2007
acreage hike in corn). As of today, its uncertain how high prices will need to
go to cut this demand.

Adding to the troubles are exports at a pace much larger
than currently needed to meet 2006/07 projections, making it that much more
difficult to allocate the supply. Once prices get high enough to limit demand
(whatever level that is), those prices might need to stay high in 2007 to keep
the demand smaller than currently projected to come up with an acceptable level
of 2007/08 corn carryover (even with an average 2007 'trend' yields or better).
The big unknown is 2007 acres - how high or low will they be, and how much does
the corn market have to ration demand based on the 2007 acres? This might
determine in large part corn price direction (as well as other markets as a
secondary reaction to 2007 corn acres).

While the growth of biofuels is impressive, the pressure it is placing on the
grain production industry to respond with increased production has been compared
to the demand shock of Russian grain buying in the 70's. If this comparison is
at all relevant, we could have a very interesting winter! And it could continue
for more than just one year, with impacts echoing throughout the grain industry
(including minor crops) - the perfect situation for grain producers, but not
necessarily attractive for grain users.

Biodiesel is an increasingly important use for soybean oil, with a projected 170% increase in use this year to 245 million gallons, or a 490-fold increase since 1999. Projections are that this year the growth will consume about 13% of the bean oil consumption, up from 5% last year.

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