How Long can Corn Demand for Ethanol Hold Up?
Dec 23, 2014
~~TRADING COMMODITY FUTURES AND OPTIONS INVOLVES SUBSTANTIAL RISK OF LOSS AND MAY NOT BE SUITABLE FOR ALL INVESTORS. YOU SHOULD CAREFULLY CONSIDER WHETHER TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES, KNOWLEDGE AND FINANCIAL RESOURCES.
Since October 1st Corn futures have managed to rally almost 85 cents off of lows. One of the bullish factors that has been aiding the rally has been strong demand for corn used for ethanol. Profit margins for ethanol have been good due to low input costs and good demand for ethanol and DDGs. However, with the price of crude oil and unleaded gasoline sharply off of highs how long can ethanol demand stay strong?
For the last 5 weeks straight corn use for ethanol production has come in well above the average needed to hit the USDA's marketing year estimate. This has been a function of a positive ethanol profit margin on a national average. At the same time ethanol production is sharply higher over last year while stocks are lower. This suggests strong ethanol demand. However, gas prices have fallen sharply in recent weeks as well and this may cause strong competition for ethanol demand.
On one hand lower crude prices support ethanol profit margins because it means lower energy input costs for the production of ethanol. On the other hand lower crude prices also mean lower gasoline prices which are a direct competitor for ethanol. While low priced corn has also helped ethanol profit margins the recent run up in corn prices will start to take away from profits. Much of the ethanol produced in recent weeks has been produced with corn that was purchased near the lows or at much lower prices. As higher priced corn makes its way to ethanol plants profit margins may suffer.
Aside from rising corn prices demand is the other factor that may be an issue going forward. I can weigh in on a personal level on this one. Earlier this year I converted my vehicle to be able to run e85. My vehicle was not a flex fuel vehicle so this was not an easy process. However, I am a big proponent of corn farmers and the ethanol industry (although certainly have some bones to pick). At the time I was able to justify the expense because of the potential savings I could see by using lower priced ethanol. At the time e85 was running 40-50 cents below 87 octane "regular" gasoline and 70-90 cents under 93 octane "premium" gasoline which my vehicle insists upon.
Now this value proposition has a much different look to it. Currently my local e85 prices are 20-30 cents ABOVE regular 87 octane gasoline and 10-20 cents below 93 octane premium gasoline. And, while e85 is still cheaper per gallon than the 93 octane premium fuel I can use as an alternative in my car my MPG is about 1.4 lower on e85 which more than negates any saving at the pump.
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As for myself I will continue to use e85 because it is something I have committed to supporting and (my #1 reason to be honest) because I get a 70 HP bump at the rear wheels over 93 octane. For me the difference is cost is not as severe because I am replacing premium fuel rather then regular gasoline. I also use e85 for much different reasons than most consumers, but I am not the average e85 consumer. My concern is the "average consumer".
For reasons I will not get into right now I feel like the ethanol industry has dropped the ball on gaining consumers and educating would be consumers. But, despite itself the ethanol industry has managed to build a consumer base out there. This consumer base for the most part was looking at e85 for a cheaper alternative to high priced 87 octane "regular gasoline" for their flex fuel vehicles. They used e85 because it saved them money. For the most part flex fuel vehicles do not see much if any performance increases because the car's computer is burning e85 like it is regular gasoline and at the same time MPG suffers (more on this as well on a future article).
So for the average consumer the motivation to use e85 was cost based and for now that motivation has been taken away all together. In fact it is much cheaper in most areas to run regular gasoline under the current price structure. This could very well mean that the small consumer base of e85, or a large percentage of it, will shy away from e85 and move back to regular gasoline until the cost benefit returns.
Now domestic use of ethanol is only part of the story. Ethanol exports have been strong as well, but lower crude prices are a global issue. And while gasoline prices may not have taken as big of a drop in other countries it will have a similar effect. On top of this South America is getting closer to harvesting a new crop and ramping up their ethanol production as well. Do not get me wrong, ethanol will continue to be blended with gasoline here and abroad but percentages may drop t to higher prices.
The other component of the strong ethanol profit margins is DDG (Dried Distillers Grains, a by product of ethanol) demand. Strong DDG demand is in part a function of high priced soybean meal. Soybean meal prices are very high because for all intensive purposes we ran out of soybeans last year with a 92 million bushel carry over and there was not enough soybeans around to crush and make meal with. Meal demand stayed strong even though the crush dropped near 10 year lows and prices shot higher in an attempt to ration demand. As part of that demand rationing end users looked to soybean meal substitutes and DDGs work for many applications.
However, the tight soybean balance sheet of last year has been replaced by a record soybean crop. And, when you combine a record soybean crop with record high crush margins we start crushing soybeans to make meal like its going out of style. It will take time for soybean crushers to catch back up with meal demand but when they do they may overshoot the mark and meal prices could be much lower in the next few months. This could mean lower demand and possible lower prices for DDGs as well and this would also cut into the ethanol profit margins.
The bottom line is that corn demand for ethanol has been much stronger then expected in recent weeks and that has helped support corn on it's rally off of lows but there is a question of how long this will continue. Ethanol exports and soybean meal prices may be the key going forward. We certainly will not stop using ethanol all together domestically but e85 users may make the switch back to gasoline due to low prices and blenders may use less ethanol due to comparatively high prices. We have high hopes for a budding ethanol industry in the US but given the current set up we are concerned the good profit margins for ethanol plants may be difficult to sustain in the short term.
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March Corn Daily chart:
January Soybeans Daily chart:
March Wheat Daily chart:
All this means that speculators should be looking for opportunities and producers need to look to lock up some prices. Give me a call for some ideas. In particular, 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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