Falling Crude Prices Force Ethanol Makers to Take It on the Chin

Source: By  JACOB BUNGE and  JESSE NEWMAN, Wall Street Journal • Posted: Monday, January 5, 2015

Though Oil’s Slide May Hurt the Ethanol Industry, It Could Boost Other Corners of U.S. Agriculture

Falling profit margins for the $40 billion U.S. ethanol industry may cause some companies to scale back production in 2015.

Falling profit margins for the $40 billion U.S. ethanol industry may cause some companies to scale back production in 2015. BLOOMBERG NEWS

Ethanol makers are bracing for a drop in earnings as cheap crude pushes down the prices they fetch from refiners to blend the corn-based fuel additive into gasoline. Ethanol producers also face a recent jump in the price of corn, their main raw material.

Falling profit margins for the $40 billion U.S. ethanol industry may cause some companies to scale back production in 2015, analysts and industry executives say. Still, many observers think ethanol demand may remain steady or even rise if cheap gasoline spurs U.S. motorists to drive more, tempering the hit to ethanol earnings.

Crude-oil prices slid 20% in December to about $53 a barrel and fell 46% in 2014. That helped trigger a 25% decline in ethanol futures prices during the month of December and pushed down stock prices for ethanol makers. Shares of Green Plains Inc., one of the largest U.S. ethanol producers, were down 17%, while Pacific Ethanol Inc., a smaller producer, fell 11%.

The headwinds come after the sector enjoyed one of the most-profitable years in its history in 2014, buoyed by strong export demand and the lowest corn prices in about four years.

Ethanol-industry profit margins reached an all-time high of $2.04 a gallon in April, according to Iowa State University’s Center for Agricultural and Rural Development. But margins dropped to 58 cents a gallon on Dec. 19, the center estimates, from $1.12 a gallon on Dec. 3.

Lower oil prices have made for an unusual scenario in which gasoline prices currently trade at a discount to ethanol, making blending of the biofuel—which has been required by federal law since the 2000s—a pricier proposition for fuel companies. Most U.S. gas contains as much as 10% ethanol as a result of the federal rules, but fuel companies also can meet ethanol-blending requirements by using credits stored up from surplus use.

The shift in the sector’s profit outlook means some ethanol makers may have to ratchet down production from the record levels experienced in recent weeks. “I don’t think we’ll be able to maintain these production rates as an industry,” said Green Plains Chief Executive Todd Becker.

Though oil’s slide may hurt the ethanol industry, it could boost other corners of the U.S. agricultural sector. Meat industry executives expect consumers to spend some of their projected $100 billion in 2015 gas-pump savings at restaurants, increasing beef and chicken sales. Meanwhile, cheaper gasoline will provide some cost relief to farmers as they run tractors on fields and transport grain and other crops.

An almost 43% decline in corn prices in the past two years—the result of back-to-back bumper U.S. crops—has been a boon to the ethanol sector, which consumes about one-third of the U.S. corn crop each year. The lower production cost made U.S. corn ethanol more competitive in export markets with the sugar-derived ethanol produced by Brazil, the U.S.’s main global rival. U.S. exports of the biofuel jumped more than 46% to nearly 681 million gallons in the first 10 months of 2014, from 465 million a year earlier, according to federal data.

The U.S. ethanol industry reaped about $8.6 billion to $10 billion in profits in 2014, among its most profitable years, according to an estimate from the Renewable Fuels Association, a trade group.

Since Sept. 30, U.S. corn futures prices have surged 23%, due in part to farmers storing more of their freshly harvested supplies rather than selling. Meanwhile, gasoline futures dropped 21% in December, after the Organization of the Petroleum Exporting Countries, or OPEC, on Nov. 27 said its members would continue producing crude oil at their planned rate, despite rising supplies in the U.S.

“I think we’re facing a period of dim ethanol prices and profitability,” said Scott Irwin, professor of agricultural economics at the University of Illinois. “At $1.50 [per gallon for the] wholesale price for gasoline, ethanol producers can’t pay $3.75 per bushel of corn and make money. It doesn’t work.”

For now, domestic plants are still pumping out ethanol at a fast rate because profit margins remain adequate, said Hal Reed, chief operating officer for the Andersons Inc. The publicly traded agricultural company is an investor in four ethanol plants capable of making 330 million gallons a year.

“We’ve been operating our plants at full capacity,” Mr. Reed said. “Margins are still positive, so it certainly pays to produce all you can.”

U.S. oil refiners are expected in 2015 to continue mixing gasoline with roughly 10% ethanol to meet annual requirements for the biofuel, ensuring a minimum level of demand for the additive, analysts said. Under a 2007 law intended to spur greater use of renewable fuels, refiners have been required to blend more ethanol into gasoline each year. Though the U.S. Environmental Protection Agency in November deferred announcement of its 2014 blending requirement until next year, refiners have continued to use ethanol due to its typically low cost compared with other octane-boosting additives, industry executives said.

While some market watchers anticipate smaller ethanol companies may scale back production from current rates, few expect the industry to suffer as it did in 2008, when surging corn prices spurred bankruptcies.

“There’s a lot of very strong balance sheets in the industry,” said Rick Schwarck, CEO of Absolute Energy LLC, an ethanol plant in St. Ansgar, Iowa. He added that significant cash reserves will allow producers to slow, and perhaps halt, production if margins turn negative, biding their time until it becomes profitable again.

One wild card for the industry in 2015 may be exports. Demand from some overseas buyers may ease if cheap oil and gas prices reduce the incentive to add ethanol to fuel supplies.

Export markets are the “ultimate swing factor,” said the University of Illinois’s Mr. Irwin, noting that sales of the biofuel to places like the United Arab Emirates have been the driving force behind recent strength in ethanol prices. “If the market incentive is removed, that process is reversed.”