Ethanol producers face dueling impacts

Ethanol producers face dueling impacts

New report predicts 2016 will bring lean, yet positive margins for ethanol plant operators

Following 18 months of record earnings, the U.S. ethanol industry has rebalanced in 2015. As energy prices collapsed in late 2014, so did ethanol prices and plant margins. However, ethanol's supply and demand has remained well balanced, and producers have maintained positive earnings, according to a new report from CoBank titled, "Ethanol Industry Rebalances."

Related: Broin returning as CEO of ethanol producer POET

Looking ahead through 2016, the report says plant operators will face dueling positive and negative shifts in the market that are likely to result in lean, yet positive margins.

Corn grows near Adkins Energy Oct. 4, 2004, near Lena, Ill. (Photo by Scott Olson/Getty Images)

U.S. and global corn supplies are expected to be ample in 2015-16, and corn futures prices are forecast to average near or below $4.00 into 2017. Subdued corn input costs make it possible for plants to generate positive margins despite ethanol prices that have tested 5-year lows.

"With corn prices expected to remain relatively static, it will be the prices of distillers grains and ethanol that determine the direction of earnings," explained Dan Kowalski, the report's author, and director of CoBank's Knowledge Exchange Division. "Ethanol profitability will largely hinge on two key factors: the volatility of energy prices and the industry's ability to maintain strong export sales," said Kowalski. The report also points to the importance of sustained discipline in growing production capacity and output.

The report indicated that both production and inventories have moved higher in 2015, but supply/demand has remained well balanced. "That has allowed ethanol to maintain its pricing power relative to gasoline.

"Margins are likely to remain lean for most of the remainder of 2015 and 2016, which will reduce operators' incentive to push production boundaries, limiting the upward movement in stocks," the report said.

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With lean margins expected in 2015-16, ethanol capacity expansions are expected to be limited. CoBank estimated conservatively a 1% increase in both 2016 and 2017. "If these estimates are confirmed, the industry will need to grow ethanol exports by roughly 200-350 million gallons (22-39%) over the next two years to maintain capacity utilization of 90%," the report said. "If capacity utilization declines, it will negatively impact margins."

The industry will see little growth in domestic sales as a result of improving fuel efficiency in the nation's vehicles and changes to the EPA's renewable fuels blending mandate. The EPA's proposed alteration to the Renewable Fuel Standard is expected to be approved later this year, and will set a floor beneath the current 10% blending level. However, the new policy will not incentivize retailers to sell higher ethanol-blended fuels.

Related: Group: Ethanol doesn't increase food price, UN data shows

"Somewhat counterbalancing the domestic picture is the potential for increased export sales," said Kowalski. "Brazil has increased its domestic ethanol blending rate to 27%, which has impeded its ability to supply product to foreign markets, and U.S. producers will continue to benefit as their share of world trade increases."

The report cautions foreign markets also pose a risk to ethanol producers. China, which currently imports 60% of U.S. distillers grains, is expected to change its grain policies to discourage the import of corn-alternative feed grains. These changes could significantly impact producers' bottom lines.

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