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With Oil Prices Falling, Can Ethanol Stay Competitive?
Recent reports show fuel prices are falling, and though this represents just a piece of the crop input picture, an extended downturn in fuel costs could eventually lead to enough overall savings to make up for lost revenue on grain farms from lower corn and soybean prices.
But, there's a flipside; extended lower fuel prices could eat the margin between gasoline and ethanol, making the latter less cost-competitive and ultimately holding the potential to cut demand, thereby lowering corn prices.
The breakeven price for ethanol is essentially the wholesale gasoline price (CBOB). When it falls below CBOB, it's profitable. Above that level, ethanol is in the red. In recent weeks, the 2 fuels have converged in price, a dangerous point for ethanol returns, according to a report from University of Illinois Extension ag economists Scott Irwin and Darrel Good.
"Positive ethanol blending margins result from ethanol prices that are below the price of CBOB gasoline and vice versa. Positive (negative) margins result from blenders purchasing ethanol at a lower (higher) price per gallon than CBOB and selling the blend at the retail level at an equivalent price to CBOB," according to Irwin and Good. "Convergence has been driven by the drop in CBOB prices as well as the sharp recovery of ethanol prices in recent weeks. The net result, from a conventional standpoint, is that ethanol blending margins are basically at the breakeven level and any further declines in CBOB or increases in ethanol will drive margins into the red."
In the last 4 years, there's been a negative blending margin for ethanol for only 7 weeks, the economists add.
The implications for ethanol's price relative to wholesale gasoline run all the way to the refinery, the point at which fuel producers pull the trigger on additives like ethanol and how much to include in the overall fuel complex to yield the most cost-competitive mix to pump through to the fuel consumer. And, some analysis has actually shown ethanol has something of a competitive advantage over other octane boosters, which could push the breakeven price slightly higher and still make it worthy of inclusion into consumer gasoline.
"An engineering analysis by the U.S. Department of Energy in November 2012 calculated a 'breakeven price of ethanol, above which it is more economic for the refiner to reduce ethanol volumes and alternatively produce more octane within the refinery.' That analysis indicated the breakeven ethanol price is about 10% higher than the price of CBOB gasoline," according to Irwin and Good. "In other words, if the price of ethanol is less than 1.1 times the price of CBOB gasoline, there are positive economic returns to blending E10 for octane enhancement rather than producing octane from other petroleum processes in the refinery."
But, other analysis shows that because of ethanol's effect on fuel efficiency (as confirmed by a federal study), that 10% gain could become a wash, especially considering the transportation logistics of getting the biofuel to the refiner.
"If this loss in efficiency is fully reflected in consumer demand it would feedback to a lower wholesale price of ethanol, with the discount as large as 33 percent. Second, ethanol entails higher transportation costs than conventional gasoline because ethanol generally cannot be shipped via pipelines but must instead be shipped via truck and rail," say Irwin and Good. "While there is considerable uncertainty about the impact of fuel efficiency discounts and extra transportation and distribution costs on the marginal valuation of ethanol by blenders, it certainly seems plausible that the overall impact is non-negligible. For this reason, we are persuaded that a breakeven ratio of 1.0 is more likely to be an accurate representation of the true breakeven than 1.1."
With these variables in play, the economists emphasize that it's important not to look only at the price ratio between ethanol and CBOB gasoline, but "the marginal value of ethanol to blenders." Lately, that's been a bright spot in the ethanol market considering the surplus the industry's produced. As long as that remains the case moving forward, demand will likely continue to be strong.
Another scenario that could play out, Irwin and Good say, is if fuel prices fall enough to push ethanol above the breakeven point. Two things could happen in this scenario; first, if blending slows down, demand could fall, ultimately having a negative impact on the ethanol and, in turn, corn market. But, there's still the chance that the margin between the 2 fuel costs could widen beyond the breakeven point with no response, meaning the market would recover.
"A...possibility is that the ratio will continue to increase and move above a breakeven level for ethanol, but without a measurable response in either RINs prices or the rate of domestic blending," the economists say. "A lack of response would imply that the actual breakeven ratio is higher than assumed here or that a price ratio exceeding the breakeven value for ethanol is expected to be short-lived."
Regardless of how oil and fuel prices move in the near term, however, ethanol's place in the overall fuel complex can be maintained at cost-competitive levels if the industry can adjust to any supply issues that would otherwise knock ethanol above its breakeven point with gasoline.
"Recent market history also suggests the ethanol/CBOB price ratio is not likely to move above 1.0 for any length of time and that market adjustments to maintain the competitive position of ethanol are likely to be rapid," according to Irwin and Good. "Higher ethanol production and lower ethanol prices have proven quite effective in the past at maintaining ethanol's place in gasoline blends and are likely to continue to do so in the future."