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Ethanol tops out

Chuck Woodside, CEO of KAAPA Ethanol near Minden, Nebraska, is obsessed with corn this fall. By October, he had heard of irrigated yields as high as 250 to 300 bushels an acre farther east in the Platte River valley. He asked other ethanol plant managers at a board meeting of the Renewable Fuels Association and was told by several that local yields were better than they expected.

Still, corn is scarce, and margins are as narrow as he can remember since his farmer-owned plant started in 2003. He knows that some ethanol makers will continue the pattern of temporary shut-downs that started last summer.

“You're going to see dislocations that will be based on local corn supply, and I think it's going to be this way for a lot of the year,” says Woodside, who just wrapped up two years as RFA chair.

Every year but one since 1980, the corn ethanol industry has grown. The 2012-2013 marketing year will be the first time since calendar 1996 when production will fall. (In 1996, the industry was squeezed between a low gasoline price of $1.27 a gallon and corn that averaged $3.81 per bushel.)

A recent Rabobank analysis forecasts a decline of 11% “within the bounds of the ethanol mandate, dictated by the needs of gasoline refineries, with further declines possible (but not likely).”

Earlier this fall, the U.S. Department of Energy reported that the nation's ethanol production fell to 785,000 barrels a day (or almost 33 million gallons). That's the lowest level since the DOE started tracking production in 2010.

Production was running at an annual rate of 12.43 billion gallons.

That's far below the 2011 record of 13.9 billion gallons. And it's on track to meet Rabobank's projection of an 11% decline in output for the 2012-2013 marketing year that began in September.

USDA also expects lower marketing-year ethanol production, which translates into 500 million fewer bushels of corn being distilled into fuel in the current marketing year than last year. The industry will likely buy 4.5 billion bushels of corn, off from last year's 5 billion, according to USDA's monthly Supply and Demand estimates.

All of this means that the ethanol growth that has driven corn prices is sputtering as it nears the maximum 15 billion gallons allowed under federal mandates by 2015.

“I think from here on out, I like to call it a steadying influence,” says Iowa State University economist Chad Hart. “It won't continue to pressure prices higher, but it will help to maintain a floor.”

Six years ago, USDA long-term projections for corn prices were around $2.50 a bushel. Last spring before the drought, USDA projected corn at about $4.50 a bushel. “What's the change? The change is ethanol,” Hart says.

Red Ink arrives

By summer of 2012, many ethanol makers were losing money. Among the few publicly traded companies devoted mainly to ethanol production, Green Plains Renewable Energy in Omaha, Nebraska, and Golden Grain Energy in Mason City, Iowa, are windows into industry losses.

In its second quarter (ending June 30), Green Plains, the nation's fourth largest ethanol maker, lost $7.6 million. It had net income of $5 million in the same three months of 2011. It reports that it has hedged some profitable margins for the end of this calendar year.

Golden Grain lost almost $2.4 million in its second quarter ending July 31. The same three months in 2011 brought almost $6.7 million in net income. In October, it told shareholders it expects “minimal taxable income for 2012,” and that “2013 will be difficult.”

This fall, Iowa State University (ISU) was estimating ethanol plant operating margins at about 6¢ a gallon – well below the 25¢ a gallon needed to cover capital costs and approach profitability. ISU factors in corn and natural gas futures with labor and other costs, subtracting those from ethanol futures and distillers' grain prices to estimate margins. Current projections show that it will be next fall before ethanol margins hit 25¢ a gallon.

“We're running a lot closer to breakeven than a lot of these plants would care for,” says ISU economist Hart.

A tougher industry?

Hart doesn't expect to see a big wave of consolidation like the one that followed the last down cycle for ethanol makers in 2008. That's when one of the largest companies, VeraSun Energy, filed for bankruptcy.

This time, ethanol makers had more cash on hand and less debt. They profitted from some of the industry's best returns in recent years during the last half of 2011.

It may be a good sign that Valero Energy Corporation (the oil refiner that bought part of VeraSun) restarted in September three plants it had idled last June. The Nebraska and Indiana plants were unprofitable at the time. All 10 plants owned by the nation's third biggest ethanol maker were producing this fall.

Asked if the worst may be behind the industry for now, Hart replies, “To tell you the truth, my guess would be, yes.”

The industry is also making more money on ethanol coproducts, especially distillers' grains and corn oil.

In the first half of 2012, coproducts made up 23% of the grind margin for 56 plants participating in the Biofuels Benchmarking project run by the Willmar, Minnesota, accounting firm Christianson & Associates PLLP. In 2008, only 16% of the margin came from coproducts. The benchmarking group includes small plants (less than 60 million gallons of annual production capacity) and large. It's about a fourth of the some 200 ethanol plants operating in the U.S.

The accounting firm's Biofuels Benchmarking Industry Report says plants making corn oil have increased revenue more than those that don't, bringing in another 4¢ for each gallon of ethanol produced.

The drought has also increased the value of distillers' grains, says KAAPA Ethanol's Woodside.

“Summer is typically a low-demand time frame for wet distillers' grains, but you didn't see that this year,” he says.

KAAPA Ethanol saves energy costs by not completely drying distillers' grains. Dried distillers' grain with solubles (DDGS) made at some plants can be economically shipped longer distances. Two years ago, DDGS was selling for about 70% of the value of corn. Last summer DDGS brought 90% to 100%, he says.

Still, Woodside is less optimistic than Hart about what 2013 holds for his industry. “I think there will be additional consolidation in the industry in 2013 because of the poor financial performance of some of these plants,” he says.

On one thing, they do agree. Last year, the industry had a market for about 1 billion gallons of ethanol exports, thanks to a poor sugarcane crop that cut Brazil's ethanol output. This year that market shrank as cane production came back. So the U.S. industry has about 1 billion gallons of ethanol in storage, Hart says.

Woodside adds, “We're way overproducing, and I'm not quite sure why.”

As Production Lags, Still No RFS Shortage

The effective EPA mandate for corn ethanol use in the 2012-2013 marketing year is 13.6 billion gallons, according to the Food and Agricultural Policy Research Institute (FAPRI) at the University of Missouri. If this year's production of about 12.4 billion gallons continues into next year, that appears to be setting up a shortage.

It's not, says Iowa State University economist Chad Hart.

First, due to lower U.S. ethanol exports, a struggling industry is still managing to put out a surplus of about 1 billion gallons. That alone almost meets the RFS.

Second, under the EPA's complex trading system for blending credits known as RINs (renewable identification numbers), oil companies can carry 20% of unused RINs into the following year. There are roughly 2.5 billion gallons in RINs that companies can use to get credit for blending in the new year.

Third, the marketplace needs ethanol. “We've always exceeded the standard (RFS) every year, even this year, because of market demand,” says Hart. Currently ethanol is priced about 40¢ a gallon under gasoline. Refiners are set up to make cheap, 84 octane gasoline blending stock. Then low-cost ethanol is added to it, bringing E-10 gasoline up to 87 octane.

Even if the EPA grants a waiver from the RFS that affects the 2012-2013 marketing year, it might lower corn prices by only 4¢ a bushel, according to a recent analysis by FAPRI. No one knows how EPA would administer RINs under a waiver, but if blenders can carry them into 2013-2014, then corn prices would fall another 17¢ (from $5.22 a bushel to $5.05, if yields hit normal trends).

Ultimately, the marketplace and the RFS could collide, however. That's because by 2022, the RFS mandates the use of 36 billion gallons of all biofuels (including up to 15 billion from corn-based ethanol). That would be more than a fourth of today's gasoline use of about 135 billion gallons a year – a market that has been shrinking.

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