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Special Report: Ethanol plant margins strong in uncertain times

By Susanne Retka Schill | January 21, 2014

AgMRC tracks ethanol plant profit margins using a model built on the typical yields, costs and revenues for a hypothetical northern Iowa ethanol plant. AgMarketing Resource Center AgMRC tracks ethanol plant profit margins using a model built on the typical yields, costs and revenues for a hypothetical northern Iowa ethanol plant.

AgMarketing Resource Center
Ethanol producers are enjoying generous margins in recent weeks, even as uncertainty over the fate of the renewable fuels standard (RFS) weighs upon the long-term outlook.

Late November saw the best ethanol margins since the height of the 2006 boom. That was preceded, however, by 14-months of thin margins and some of the deepest losses ever seen by the industry.

Jordan Godwin, biofuels analyst for Platts, explained that temporary shortages of ethanol caused by rail logistic issues drove prices up in late November just as the final corn crop numbers drove corn prices down. The shortage of rail cars contributing to the ethanol price increase was due to competition from shale oil movements. Ethanol prices went up 25 cents on Platt’s Argo assessment, he said, in the same period that corn prices took off 50 cents, from $6.21 per bushel in the nearby futures contract to $5.76 two weeks later.

Extrapolating those market movements into ethanol plant profit margins, however, is dependent upon economic models that simulate input costs and revenues, with multiple assumptions built in for ethanol yield, operating and fixed costs.

Model Profits

In the Platts model, based on a typical 50 MMgy Midwestern dry mill ethanol plant, 2013 started out with a margin of around 30 cents per gallon and stayed around that level until fall, Godwin explained. “The week ending Aug. 23, margins stood at 60 cents and two weeks later were over $1 per gallon,” he said. The profit margin for the model hit its peak at $1.45 per gallon for the week ending Nov. 22. Since then, both the ethanol and corn markets have stabilized, with corn trading around the $4.29 mark and the Argo assessment hovering around $2.40 and margins dropping in the Platts model to under $1.

Rick Kment, biofuels analyst for Telvent DTN, tracks ethanol profitability through the DTN model dubbed Neeley Ethanol, which includes depreciation and debt service. That model showed more modest, but still very strong profits. Neeley Ethanol was seeing a 62-cent-per-gallon profit in early January, down a bit from a high of 80 cents per gallon a couple of months earlier in November, Kment said. The model showed red ink for most of 2012 and the first two-thirds of last year, he added, with losses running between 20 and 30 cents per gallon of ethanol produced. The negative margins reflected tight corn supplies and high corn prices as well as struggling energy demand from the gasoline and ethanol markets that kept inventories high and margins low, he explained.

A third model ethanol plant, developed by now retired Iowa State University ag economist Don Hofstrand, shows the average November net return per gallon at 46 cents and a big jump in the December average to 82 cents per gallon of ethanol produced.

The differences in modeled margins is due to the basic assumptions. A model based on nearby future prices for ethanol and corn will give a different margin than a model based on regional cash prices. One based on futures prices would give a better estimation of hedging opportunities, whereas one based on regional cash prices would give an indication of a spot margin. Ethanol producers will often use a mix of both approaches as they develop their risk management strategies.

The assumptions for the Iowa economic model are given in a downloadable spreadsheet that is updated monthly. (Available at the Ag Marketing Resource Center’s website, under the renewable energy heading and labeled “ethanol profitability.”) In this model, the prices used for ethanol, corn and distillers grains are pulled from USDA reports of Iowa-based cash prices. The ethanol yield is based on 2.8 gallons per bushel of corn processed and other assumptions, such as debt service, labor and other operating costs are given.

The Iowa model showed negative returns over all costs through all of 2012 and the first two months of 2013, ranging between a negative 21 cents per gallon to break even. That 14-month negative margin period was more than twice as long as the previous longest industry downturn -- a six-month downturn starting in December 2008 and continuing through May 2009. The low point in that negative-margin period was negative 12 cents per gallon.

According to the Iowa model, the 82 cent profit margin for the Iowa State model plant last month in December is the best for years. November 2011 is the next most recent peak at 68 cents per gallon. That brief peak in margins preceded the long trough of negative returns through all of 2012. One has to go back to early 2007 in the model to find other net returns above the 60 cent-per-gallon mark. The all-time high in this model, which began in January 2006, was $2.02 in June of that year.

Dynamic Interplay

This unusual profit potential for the ethanol industry right now is the result of positive factors in all the multiple moving targets that impact ethanol margins. One is the price of ethanol itself, influenced by fluctuating production and inventory levels as well as periodic supply issues. When supplies are relatively tight, as they are now, logistic slowdowns due to weather conditions or competition with other product movement such as shale oil will boost regional spot markets.

The second big factor is the energy market. Ethanol demand is tied to gasoline demand, with increases in gasoline use boosting ethanol use for blending. Gasoline markets, of course, follow their own supply and demand dynamics as well as the global oil market.

Third, with corn comprising around 80 percent of the cost of production for ethanol producers, ethanol profitability also hinges on the grain market.

A fourth dimension in plant margins is the sale of the ethanol process coproducts, distillers grains and corn oil. The strong corn price and drought-reduced supply meant demand was strong for distillers grain, keeping prices high in both domestic and export markets. Corn supplies are plentiful this year, but distillers grains prices are not dropping as fast as corn has due to the global demand for protein. Corn oil extraction has grown rapidly in the industry, and while the total revenue from oil is small in comparison to ethanol and distillers grains sales, many were saying it was making the difference between negative and positive margins during the slim months.

Ethanol Fundamentals

Ethanol prices went from their yearly high in May, 2013, of $2.74 per gallon, Kment said, dropping a dollar through the summer to $1.77 in early September, when looking at the front month contract. Since then, the ethanol market has been choppy, trading in a 40 cent range in the past four months from more than $2 per gallon to $1.67.

“At the beginning of 2013 we were talking about an ethanol glut,” Kment explained. The tight margins slowed ethanol production and stocks were drawn down to the point where at the end of the year they reached their lowest level since 2010, when the Energy Information Administration began weekly reporting. Thus, the market is no longer weighed down by a glut and there are enough supplies on hand so there are few concerns about shortages. Supply is tight enough, however, that close attention is being paid to the weekly fluctuations in ethanol production and stocks, resulting in the choppy market. In addition, Kment said, “we’re seeing ups and downs in ethanol demand that are not characteristic of the normal trends.”

The strong margins have done their duty to draw more ethanol production online. During the extended industry downturn, several plants went off line and many ethanol producers ratcheted down production for a total pull back of about 15 percent for the year. Most of that capacity is now back online, rebuilding ethanol stocks.

Godwin cited the EIA numbers to illustrate. Average daily production in December was 928,000 barrels per day rebounding from 2012’s figure of 822,000. In 2011, December’s production figure hit 952,000 bpd on average. “There typically is a seasonal drop of 30,000 bpd in January and February,” Godwin added. Some are predicting that it will drop more this year due to the effects of cold temperatures on rail shipments. If it does dip by 50,000 bpd day, it will tighten supplies further and potentially give ethanol prices another boost. “Stocks are extremely tight compared to the last three years,” Godwin said. “In December they were around 15.5 million barrels, where when you look at 2012, it was in the low 20 million barrels. Things are a lot tighter. A lot of our traders are saying that the tightness is going to ease soon, but it hasn’t yet.”

Energy Markets

With nearly all of the nation’s gasoline supply now being blended as E10, ethanol demand is closely tied to gasoline. “In 2014, if the economy keeps rolling on there’s also the potential for some moderate gasoline demand improvement through the spring and summer,” Kment said. Typically summer vacation driving boosts gasoline demand, he added, and the rebounding construction industry is improving demand as well. “Any growth in the gasoline market will carry growth into the ethanol market.” The low gasoline prices seen before Christmas were caused by higher-than-normal gasoline stocks, and as those are drawn down, gasoline should increase which in turn impacts the spread between ethanol and gasoline.

Ethanol/Gas Spread

Traders track the relationship between the ethanol and energy markets by watching the spread. Ethanol usually trades below the price of gasoline, or at a discount.

The spread between ethanol and gasoline is also experiencing volatility, according to Kment, hitting a September high of nearly $1. In the second week of January it was 74 cents, and has been moving between 70 cent and 90 cents per gallon in the past two to three months. There have been some short-lived dives in the spread to about 25 cents, he added, generally when futures contracts switched months. Blenders appear to be comfortable in the current market, Kment added, as they aren’t bidding ethanol prices up based on the current availability of ethanol and production levels.

Corn Market

With a bumper harvest replenishing corn supplies, corn prices have stabilized. While corn traded around $6 per bushel for much of 2013, Kment explained, after harvest the corn market plummeted and has been trading between $4.25 and $4.50 per bushel. It was the big drop in the corn market coinciding with tight ethanol supplies due to competition for rail that contributed to the unusual margins in November.

The low corn prices are likely here to stay for a while, Godwin said. “I haven’t heard anyone say corn is going to take off anytime soon. I talked to some analysts who said they wouldn’t be surprised if, within the next two months or so, corn might go below $4.”

RFS Concerns

The biggest irony, of course, is that these strong ethanol margins are being experienced just as the industry faces a serious threat from the quarter that used to be the bedrock of support for renewable fuels. The U.S. EPA has proposed renewable volume obligations (RVO) for 2014 that would scale back the incremental increases in mandated blending required under the renewable fuel standard (RFS). The ethanol industry and Corn Belt state interests are making a full court press to convince the EPA not to scale back the RVO.

The markets, Kment and Godwin agreed, have already factored in the proposed rule. “It’s not significantly impacting prices in the short term, looking through spring and summer of 2014,” Kment said. “It’s not overturning the market in the short term, but it has long-term implications.”

“As far as Q1, I don’t think the EPA decision will weigh too heavy on margins or demand,” Godwin agreed. Traders have built in the expected impact of reduced RVOs, not wanting to be caught in a bad position, he said. “A lot of people I talk to are optimistic that during this comment period, they’ll be able to sway things and come up with some type of better compromise for a scale-back than what’s been proposed,” he added. “But we’re projecting that won’t come out until June or July at the earliest.”

The biggest impact of a scaled-back RVO will be on long-term investment, Godwin said. “People investing will see there will be lower demand.” He expects margins will remain steady and strong in the next three to six months. “No one is expecting a major disruption in corn or the supply demand fundamentals of ethanol prices.”

“There’s a lot of optimism where we are now compared to where we were six months ago,” Kment said, adding there’s a lot of uncertainty going into 2014. “There is a potential for a lot more volatility in the market through 2014,” he said. While little new ethanol is to come online, “there’s enough infrastructure in place that has potential to increase production. Assuming demand stays stable, this could put us into high inventory situation, and that could reduce overall prices and margins. That’s one of the reasons creating the volatility on week-to-week basis, when these inventory and production numbers come out.”

And, as spring planting season gets closer, analysts are speculating whether farmers will move more acres into soybeans and away from corn, potentially lifting corn prices. Or, will corn acres stay at the recent record levels producing more record corn crops. That, of course, hinges on Mother Nature cooperating. Given recent extreme weather events, the markets – corn, ethanol, energy – are all facing uncertainty.
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