Several months ago I wrote about the relationship of corn and ethanol and how inflated corn prices, among other factors, were causing the ethanol industry to come to a crossroad. If you remember, ethanol producer margins were struggling and financial demand incentives for their product were basically nil. The chart of the week is the economic incentive for gasoline blenders to utilize ethanol. What in the world does this have to do with the food commodity markets? A lot and then some.
Why? Because ethanol in the U.S. is primarily made from corn, and corn is one of the major feed ingredients (and thus input costs) for protein and dairy farmers. Ethanol in the U.S. is almost entirely used to blend with gasoline at a 10% blend or less. As a matter of fact, ethanol is most likely in your gas tank as you read this. Roughly 5.5 billion gallons of ethanol annually have to be blended with gasoline in high-pollutant areas of the U. S. per the 1991 Clean Air Act. However, there is an additional 7.2 billion gallons of annual ethanol production capacity in the U.S. (and it is growing) that is driven by economics.
In other words, does it make financial sense (or cents) for gasoline blenders to blend with ethanol or not? The formula for the blenders’ incentive is simple; so long as the blenders' cost for ethanol is below the cost of wholesale gasoline, it is a profitable endeavor. With the existing $.45 per gallon subsidy that blenders receive for utilizing ethanol, the existing incentive is roughly $.70 a gallon…much better than earlier this year. Models indicate that ethanol producer margins are solidly in the black as well. And let’s not forget that the EPA is expected to soon increase the maximum blend percentage of ethanol from 10% to 12%, which could further increase demand. In short, ethanol and corn are not only once again dancing, they’re also boogying. The ethanol producers just have to make sure that a notably bearish crude oil market or late corn crop catastrophe doesn’t try to cut in on their groove.
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