Ethanol industry aims to cut glut as subsidy ends

Source: Ben Lefebvre • Wall Street Journal  • Posted: Wednesday, February 22, 2012

A surge in U.S. ethanol production and falling export demand are driving down prices for the corn-based fuel, curbing producer profits and causing some plants to shut.

Ethanol inventories ballooned late last year as producers rushed to take advantage of a government subsidy that expired Dec. 31. Around the same time, exports started to slide and domestic demand weakened for gasoline, with which ethanol is blended. Futures for the biofuel trade 11.6% below year-ago levels, closing at $2.215 a gallon at the Chicago Board of Trade on Friday.

The weak market is expected to cut into the profits of ethanol makers such as Archer Daniels Midland Co. (ADM -0.09%) and privately held POET, LLC. Some producers are cutting output, with Green Plains Renewable Energy Inc. (GPRE +5.72%) announcing last week it would reduce production by 30% at two of its nine plants and consider further cuts.

“There is an overcapacity problem,” Morningstar analyst Min Tang-Varner said. “It will take a couple of large plants shutting down to make a difference.”

The U.S. has ethanol production capacity of 14.8 billion gallons a year, according to the Renewable Fuels Association. In the past week, producers have announced shutdowns totaling a combined 101 million gallons a year.

Ethanol producers say the supply glut is a temporary issue the industry will burn through in the coming months. Still, returning to normal supply levels soon will require a combination of recovering export demand and a seasonal jump in domestic gasoline usage, said Sander Cohen, analyst at energy consultancy ESAI Inc.

“The glut is more likely to stick around than go away,” Cohen said.

Fuel blenders had since 2004 enjoyed a subsidy that awarded them 45 cents for every gallon of ethanol they blended into motor gasoline, driving up demand for the biofuel. That subsidy expired at the end of 2011.

Added production ahead of the subsidy’s end helped build ethanol inventories to an all-time high of 21 million barrels during the first week of February, up 7% from a year ago, according to federal data.

Previous gluts have usually resolved themselves by demand growing each year as federal requirements for ethanol uses continued to kick in. But producers already are blending retail gasoline with 10% ethanol, leaving little room for additional gains under government mandates.

So with domestic hunger for ethanol slowing, overseas demand will be a bigger factor in draining the glut, said Don Roose, president of U.S. Commodities, a Des Moines brokerage that advises ethanol plants

U.S. ethanol exports reached a record 1.2 billion gallons in 2011, more than triple the 2010 export total of 396 million gallons, according to the Renewable Fuels Association

The export market may be losing steam, however. Official statistics for January aren’t yet available, but ADM, Green Plains and the Renewable Fuels Association have all in recent weeks said they expect 2012 exports to fall by half as a weakened Brazilian currency gives importers there less buying power. About 40% of all U.S. ethanol exports went to Brazil last year.

In one example of how low margins have fallen, Valero Energy Corp. VLO +0.08% , the largest independent refiner in the U.S. and one of the largest ethanol producers in the U.S. by volume, saw profit margins in January dwindle to a “pretty weak” 5 cents a gallon or less, compared with 56 cents a gallon at the end of December, S. Eugene Edwards, Valero’s chief development officer, said during a call with investors.

The weak margins have some producers shutting capacity rather than losing money. Besides Green Plains Renewable Energy, several small producers have announced cutbacks recently. In addition, ADM said it would close down a small plant in North Dakota.

Still, producers aren’t slowing down. Even with the closure, ADM says it will continue to operate at its full capacity of 1.72 billion gallons.

ADM’s Chief Operating Officer Juan Luciano was subdued about the industry in a recent earnings conference call, saying spot ethanol margins would remain “poor” until supply and demand rebalance, but that the company should see “a little bit of a pickup in the ethanol margin” by the end of the current quarter on March 31.