Ethanol Going Ugly Turns Bush Plan Into Obama Test

Source: By Mario Parker Businessweek • Posted: Thursday, November 8, 2012

U.S. ethanol production is headed for the first decline in 16 years, jeopardizing the nation’s drive to boost alternative fuels, as higher costs and lower demand close plants.

Shrinking distilling margins have resulted in a 14 percent drop in output this year to 827,000 barrels a day, or 12.7 billion gallons annually, Energy Department data show, 500 million gallons short of the amount refiners are mandated to use under a 2007 law that calls for escalating consumption of the biofuel. That would be the first yearly decrease since 1996.

As many as 10 companies, from Valero Energy Corp. (VLO) to Biofuel Energy Corp. (BIOF), have closed distilleries after the worst drought since the 1950s sent the price of corn to a record just as gasoline demand slumped. President Barack Obama’s administration has until Nov. 13 to decide whether to agree to calls from a bipartisan group of lawmakers for the suspension of the law, which was the centerpiece of George W. Bush’s plan to wean the U.S. off oil. Ethanol accounts for about 9.2 percent of total gasoline consumption, according to the Energy Department.

“It’s an ugly situation that continues to get worse,” Jason Ward, an analyst at Northstar Commodity Investments LLC, a Minneapolis-based risk management company that specializes in agribusiness and renewable fuel, said in a telephone interview on Oct. 26. “The margin simply isn’t enough to run full capacity or in some cases even at all. You can lower the standard but the market is going to take care of itself.”

Not Enough

Ethanol, made in the U.S. by fermenting starches from corn to create an alcohol similar to moonshine, has gained 6.4 percent this year to $2.344 a gallon on the Chicago Board of Trade, not enough to make distilling it profitable. Prices are down 12 percent from a year ago.

Corn futures for delivery in December rose 3.25 cents, or 0.4 percent to $7.4425 a bushel in Chicago. Prices for the most- active corn contract rose to a record $8.49 a bushel on Aug. 10.

Based on December contracts for ethanol and corn, producers are losing about 36 cents on each gallon of the biofuel made, according to data compiled by Bloomberg. They were earning 24 cents a gallon a year ago. The numbers don’t include profit from the sale of dried distillers’ grains, a byproduct of ethanol production that can be fed to livestock.

“Right now, it is the toughest time ever to run an ethanol plant,” said Bruce Babcock, an energy and farm economist at Iowa State University in Ames. “It’s never been this bad in the last four years.”

More than a dozen producers, including Brookings, South Dakota-based VeraSun Energy Corp., once the largest American distiller, filed for bankruptcy protection over an 18-month period starting in October 2008.

Renewable Standard

The 2007 law enacted under President Bush, known as the Renewable Fuels Standard, or RFS, requires refiners to mix 13.2 billion gallons of biofuels, such as ethanol, with gasoline in 2012 and 15 billion by 2015, a 67 percent increase from the 2008 target.

In its latest Short-Term Energy Outlook yesterday, the Energy Department estimated that ethanol production will fall to 13 billion gallons next year, 5.6 percent below the 13.8 billion consumption target.

The 2012 corn harvest in the U.S., the largest grower and exporter, will total 10.706 billion bushels, the lowest in six years, the Agriculture Department said Oct. 11, of which 42 percent will go toward ethanol. Last year farmers grew 12.358 billion bushels and 40 percent was used to make the biofuel.

Decision Time

Lawmakers, including the governors of Arkansas, North Carolina, Maryland, Delaware and Georgia, and a bipartisan group of legislators in both chambers of Congress asked the Environmental Protection Agency, which governs the program, to suspend the mandate because of the potential impact on food prices with a smaller corn crop.

EPA Administrator Lisa Jackson has 90 days from the Aug. 13 date when Arkansas Governor Mike Beebe, a Democrat, filed the waiver request, saying the drought is having a severe economic impact on his state’s poultry and cattle sectors.

The threshold to suspend the program, evidence that it’s causing economic harm, isn’t likely to be met and the Obama administration may also be hesitant to cross farm-state lawmakers in the Corn Belt, including Iowa, the nation’s largest ethanol producer, in an election year, said Divya Reddy, an analyst at Eurasia Group in Washington.

“It’s a constituency that’s in every party’s interest not to antagonize,” Reddy said. “The political side makes it very complicated.”

Rising Supply

The drop in output hasn’t been enough to draw down a supply glut of the fuel, said Garret Toay, founder of Toay Commodity Futures Group LLC in Clive, Iowa.

Stockpiles slumped 5.6 percent to 18.1 million barrels in the week ended Nov. 2, 10 percent higher than a year earlier, according to Energy Department data. Inventories reached a record 22.7 million barrels in March.

“A lot of these smaller plants are under the gun,” Toay said. “It’s going to be decision-making time on whether to keep running or close shop. It’s going to be a pretty tough environment.”

The situation is being exacerbated by imports from Brazil, where ethanol is made mostly from sugarcane, said Mike Blackford, a consultant at INTL FCStone Group in Des Moines, Iowa.

Imports in the week ended Nov. 2 averaged 60,000 barrels a day, compared with none a year earlier, government data show.

Production Credits

Each gallon of ethanol is assigned a Renewable Identification Number, or RIN, which helps the agency track whether obligated parties, or refiners, are complying with the blending rules.

There are about 2.5 billion excess RINS in the market, created from overproduction the past two years. Refiners can use the credits in lieu of blending a physical gallon, Geoff Cooper, vice president of research and analysis at the Renewable Fuels Association, a Washington-based trade organization, said in an interview.

New Energy Corp. said this week that it stopped production at its 28-year-old plant in South Bend, Indiana, because making the additive has become unprofitable.

Valero, the biggest U.S. refiner by processing capacity and the third-biggest ethanol producer, idled distilleries in Albion, Nebraska, and Linden, Indiana, until it’s profitable for the plants to make the fuel, Bill Day, a company spokesman based in San Antonio, said in an Oct. 30 e-mail.

Three of the company’s distilleries are operating at reduced rates until margins improve, Valero said last week on a conference call with analysts and investors. Valero has capacity to produce 1.2 billion gallons of ethanol at 10 plants.

Plant Closings

That followed Bunge-Ergon Vicksburg LLC’s announcement to temporarily shutter its Mississippi ethanol mill by Nov. 30. Biofuel Energy, a U.S. producer of the additive partially owned by venture capitalists David Einhorn and Daniel Loeb, said in September that it closed its operation in Fairmont, Minnesota.

Southwest Georgia Ethanol LLC shut its mill in Camilla, Georgia, possibly until next year’s corn harvest if necessary, the company said Oct. 24.

Abengoa SA (ABG), a Spanish engineering and renewable energy company, resumed output at its Madison, Illinois, ethanol mill after temporarily idling it in October for maintenance and because of poor margins.

“They’re going to run until they can’t or the banks say otherwise,” Toay said. “Eventually it will cure itself. You slow down ethanol production so much that it rations supply.”