Crude Oil Pressures Ethanol

Tue. Aug 25, 2015 11:42 AM

By Todd Neeley
DTN Staff Reporter

OMAHA (DTN) -- It has become the question of the day for U.S. ethanol producers: What happens to the industry if crude oil prices continue to tumble?

Crude oil prices fell below $39 a barrel Monday for the first time since 2009, just ahead of the end-of-the-summer driving season and expected lower demand for gasoline to come.

Though the price of crude oil is one of many factors ethanol producers watch -- along with the price of corn and other feedstocks -- to produce ethanol, a major impetus for the passage of the Renewable Fuel Standard in 2005 and an even more aggressive RFS in 2007 was the steady rise in crude oil prices that peaked at around $145 a barrel in 2008.

Donna Funk, certified public accountant with K-Coe Isom in Lenexa, Kansas, who works with more than 10 ethanol plants, said producers are closely watching the crude market along with the current corn crop.

"Yes, ethanol plants I talk to are definitely feeling the squeeze in margins," she said.

"Financial results definitely vary depending on the location of the plant and the corn basis they are experiencing. I think producers are obviously watching crude, corn and gasoline prices daily as well as imports. I don't think they watch just crude prices as ethanol prices do not always follow crude directly. Commodity pricing can be as big a factor as crude prices if corn gets low enough, then crude can stay low."

Funk said ethanol producers are keeping a close eye on their production volumes and commodity prices with harvest approaching.

"I think a lot of plants are focused on what they can do today with available cash, financing, etc., to distinguish themselves from a traditional corn starch ethanol plant so that they are in a different place in a year or so," she said.

If crude, gasoline and ethanol prices continue to slide and demand doesn't increase, "I think it is almost certain we will see plants slow down even more or shut down; this could also lead to more consolidation in the market," Funk said.

MARGINS NARROW

Ethanol margins in the past month or two already have been narrow to negative based on DTN's hypothetical ethanol plant.

A bump in corn prices Monday pushed production costs at the hypothetical Neeley Biofuels ethanol plant higher, resulting in a net loss of 2.4 cents per gallon. The hypothetical plant is used to measure how changes in commodity markets might affect actual plant margins.

DTN Analyst Rick Kment said margins have been hovering around breakeven for the past month or so.

"The fact that corn prices are still well manageable with the national cash index value for corn under $3.50 is easing production costs and allowing plants to stay at breakeven or profitable levels even with lower gasoline and crude oil prices," he said. "Even though crude oil prices have moved below $40 per barrel, the softness in gasoline prices has helped at least temporarily to maintain firm demand support across the country, allowing prices to stabilize."

Ethanol futures still are trading at a discount to the RBOB gasoline market, he said, "Although the current discount is the narrowest level since January 2015."

If ethanol prices move to a premium to gasoline for a long period of time, Kment said, some moderate demand pressure is likely and could limit plant and product margins.

"There is still a lot of uncertainty surrounding the corn crop currently in the field," he said. "This will have a significant impact on not only cost of production for ethanol plants over the next year, but also the availability of corn moving to these plants."

CRUDE OIL STORY

Brian Milne, energy editor and product manager for DTN's parent company Schneider Electric, said ethanol producers have benefitted from a spike in gasoline demand and record gasoline production this summer that led to increased ethanol blending.

As a result, gasoline prices have declined less than they would have otherwise because of the sell-off in crude futures.

"A lingering refinery issue in California and more recent outage in Indiana have also had outsized influences in supporting higher gasoline prices," Milne said.

"Low retail prices have been a primary factor in greater gasoline demand, and should continue to support higher demand compared with a year ago going forward, which leads to more blending with ethanol. However, we are near the end of the peak driving season, and demand will drop from August to September as it consistently does."

Crude oil prices dropped sharply from June 2014 through January, he said, and then domestic crude oil prices dropped through March on a realization there was too much oil in the market.

The oversupply story is the result of resurgence in U.S. crude production, which reached the highest point since the early 1970s while inventory is at the highest point in more than 80 years, Milne said.

In addition, a non-declared price war by Saudi Arabia, surging oil production by Iraq and Russia, and the Iranian nuclear deal that's set to release more oil into the global market, he said, likely will lead to "too much supply."

NYMEX October gasoline futures traded at about a 21-cent-per-gallon discount to September on Monday.

The September contract expires next Monday, Milne said, so based on the seasonal feature "gasoline prices are set to drop sharply as we move into September."

Milne said NYMEX West Texas Intermediate crude futures likely will continue to fall to the $32.40 support level established during the 2008 recession. Some analysts believe the price could fall as far to the mid-$20s per barrel. Either way, he said he expects the crude price will drop another $5.

"This will hurt (ethanol) profitability no doubt," Milne said. "Demand should remain strong compared with a year ago because of lower retail prices, but nonetheless will decline from the current demand rate because of the aforementioned seasonal factors. Compounding the low gasoline price environment, there's too much ethanol plant capacity."

Todd Neeley can be reached at todd.neeley@dtn.com

Follow him on Twitter @ToddNeeleyDTN

(CZ/AG)

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