Should the EPA's RFS Matter to Corn Prices?
May 29, 2015
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On Friday the Environmental Protection Agency (EPA) released their new Renewable Fuel Standards, or RFS. For ethanol the EPA target is now set at 13.4 billion gallons in 2015 and 14 billion gallons in 2016. This is well below the 2017 law of 15 million gallons and was largely seen as a disappointment by the ethanol industry and the corn market as a whole. However, with good profit margins and strong demand should the RFS really matter for ethanol production or corn prices in the foreseeable future?
The Renewable Fuel Standard (RFS) is the mandate that dictates how much ethanol needs to be used in the US each year. Until recently this also meant how much ethanol needed to be produced in the US, but a few weeks ago the EPA opened the doors to South American ethanol to help fill the quotas set forth. So while the higher the RFS number, the more ethanol we need to use keep in mind that some, or a large portion of this could come from South America if needed. In years like 2012 this may certainly be the case.
With the RFS mandate coming in less then the 15 million gallons set by 2007 law this was disappointing to the market. However, with crude oil prices on the rise again and corn prices near lows profit margins for ethanol are very good. Domestic and export demand are both good as well. With strong demand and good profit margins we are making ethanol at a healthy pace regardless of the RFS. This is how a free market works, and as long as these factors are in place there is no reason to see change in the near future.
Where this may come intro play would be another short production year like the drought stricken 2012 crop where we have little corn to go around and very high prices make ethanol profit margins hugely negative. However, not that the doors have been opened to South American product we would likely look offshore to source ethanol to fill the RFS anyway.
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The bottom line, is that I am not sure that the RFS is necessary for corn demand and therefore corn prices. While this may not be a popular opinion with the ethanol industry or corn producers I really feel that a free model market works best in this situation. To put it simply, if there is profit to be had we will continue to produce ethanol at full capacity. Conversely, in years where corn is scarce and prices are high less ethanol will be produced (at least domestically) meaning less competition for the end users of corn, cattlemen for example. If it were not for the RFS mandate in 2012 corn prices may not have gone as high and it is possible that our cattle heard would not have gotten tinned out as much, an effect we are still feeling. The bottom line is that in 2012 even the largest ethanol producers were asking the EPA to relax the RFS, as were the livestock associations.
To date we are on pace to hit the USDA's corn demand for ethanol target of 5.2 billion bushels. This is well above what the RFS mandate is for 2015. At the same time profit margins are on the rise, production is increasing and stocks are decreasing. These are all great signs of a healthy market. So given good profit margins and strong demand we can easily outpace the RFS anyway. In the long run a lower RFS number may have an impact on corn demand, but it would likely be in a year where crude prices are ultra cheep or corn prices are ultra high or a combo of the two. In most years however, the market will produce more ethanol than the RFS mandates even at the 2007 level.
The bottom line is that in my mind the RFS is mostly an arbitrary number. If the market conditions are there we will out pace the RFS mandate in most years. The key going forward will be demand. Rather than worrying about RFS, I believe the Ethanol industry and the corn growers of America should spend more time and money developing the demand for ethanol. If we can build demand for ethanol in the blend and for e85 we will be producing ethanol well above way EPA mandated figure. This starts with educating the consumer which to this point we have done a terrible job of.
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July Corn Daily chart:
July Soybeans Daily chart:
July Wheat Daily chart:
Producers looking to hedge all or a portion of their production may be rather interested in some of the options / options-futures strategies that I am currently using.
In my mind there has to be a balance. Neither technical nor fundamental analysis alone is enough to be consistent. Please give me a call for a trade recommendation, and we can put together a trade strategy tailored to your needs. Be safe!
Ted Seifried (312) 277-0113 or email@example.com
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