DOE report: Ethanol
trails own market tempo
Dec 4, 2008 4:11 PM
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, according to the following report from the Department of Energy (DOE).
In fact, ethanol was already in a bust period when the current financial crisis, which has now added to the industry’s problems, hit. Short-term profit margins for dry mill ethanol producers have been consistently low by historic standards since the last quarter of 2007, even as the prices of crude oil and gasoline rose through mid-July and have since fallen dramatically. Profit margins during the first half of 2008, when oil and gasoline prices were rising, were held down by high input costs and a substantial growth in production capacity in the wake of the 2006 boom in ethanol markets.
Short-term profit margins for dry mill ethanol producers have been consistently low by historic standards since the last quarter of 2007, even as the prices of crude oil and gasoline rose through mid-July and have since fallen dramatically. Profit margins during the first half of 2008, when oil and gasoline prices were rising, were held down by high input costs and a substantial growth in production capacity in the wake of the 2006 boom in ethanol markets.
For decades, fuel ethanol has been a blendstock for gasoline, serving at various times as a volume enhancer, an oxygenate, an octane booster, and, more recently, as an alternative to methyl tertiary butyl ether (MTBE) for blending into reformulated gasoline (RFG).
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. Producers have built new, more efficient plants to meet this growing demand. 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.
Most new facilities have been dry mill plants. These plants are smaller and less complex than their wet mill counterparts and, hence, less expensive and quicker to construct.
The Department of Energy (DOE) can estimate the profitability trends of dry mill ethanol plants by estimating a variable cost margin--that is, comparing spot prices for variable cost inputs and revenue outputs with all prices converted to their ethanol equivalent in cents per gallon (cpg).
The cost side of ethanol includes the net cost of corn--that is, the full cost of the corn, less the value of an important ethanol byproduct used as an animal feed--dried distiller’s grains with solubles (DDGS). It also includes the cost of energy used to make ethanol, mostly electric power and natural gas, as well as a series of other costs.
The producer’s variable margin was quite high in 2006, but has been low in 2008 even as the price of ethanol rose during the first half of the year. Part of the reason for the low margins has been the fact that both corn and energy prices rose rapidly during the first half of the year. But that is not the whole story. Generally speaking, ethanol roughly tracks the gasoline price, with occasional excursions below (in 2005) and above (in 2006). But from the middle of 2007 until the very recent dramatic fall in gasoline prices, the price of ethanol lagged far behind that of gasoline.
A major reason is that the ethanol industry invested in a significant amount of new production capacity in response to the boom of late 2005 and 2006, but infrastructure to deliver and blend the ethanol into gasoline has not expanded as rapidly, creating supply surplus relative to demand.
To see why this happened, it helps to understand the recent boom-bust cycles for ethanol. The first bust for the ethanol industry occurred in the early months of 2005, following a period of rising ethanol demand from 2003 through 2004 as it replaced MTBE in response to state bans over concerns about groundwater contamination. The increased demand for ethanol helped increase producer margins in 2004, but the boost in margins was short lived.
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