INSIGHT: US drought erodes ethanol margins, drives up prices

15 August 2012 12:49  [Source: ICIS news]

By Samuel Weatherlake and Sarah Trinder

LONDON (ICIS)--The effects of a drought in the US farm belt have rippled across the globe, with crop devastation elevating food prices and prompting an outcry from livestock farmers.

According to a crop production report from the US Department of Agriculture (USDA) released on 10 August, corn production in 2012 is forecast to be 13% lower than in 2011.

Dwindling harvests have sent corn costs rocketing, which have in turn dragged up European wheat prices, resulting in higher fuel ethanol values in Europe.

European T2 fuel ethanol prices are at their highest level since records began in December 2005 at €730-740/cubic metre (cbm) ($901-914/cbm) FOB (free on board) Rotterdam, according to ICIS data.

One trader said that although wheat costs have increased, exerting pressure on margins, the outlook for European producers has improved.

“The picture for European producers is looking better. The removal of the US ethanol subsidy in 2011 and the closure of import loopholes in Europe mean there is a more level playing field for European producers,” he said.

“Although European feedstock costs are increasing as a result of the drought, at least their US counterparts are experiencing the same conditions,” the trader added.

The source also noted that European margins have improved, as the value of the animal feed by-product of fuel ethanol production has increased because of the drought.

However, soaring ethanol and corn prices are not so popular in the US, where fuel ethanol values are at the high level of $765-785/cbm FOB Rotterdam.

A number of US meat and poultry groups have called for the ethanol blending mandate to be waived to reduce pressure on corn supplies.

There have also been calls from the UN and the International Food Policy Research Institute (IFPRI) to cut blending mandates in the US, to quell increases in global food prices.

Calls to reduce the blending mandates have, unsurprisingly, been met with opposition in the ethanol industry.

“It’s election year, so I do not think the US government will waive the mandate. They’ll let the market decide. If the mandate was reduced, it would be a bad precedent to make for the future of the US biofuel industry,” one source said.

It is also thought US ethanol producers will be forced to lower operation rates to protect their margins if corn costs continue to soar.

However, some said it is likely that producers will try to achieve higher prices before they think about cutting production rates.

The impact on sentiment in the European traditional ethanol market has also been significant, although the quarterly contract pricing system that dominates this segment means that many players will not be able to renegotiate their prices until late September.

So far, 2012 has not been a good year in terms of demand for 96% beverage grade and 99% industrial grade ethanol.

While macroeconomic concerns have undermined consumer demand across the spectrum, consumption of beverage grade ethanol has taken the hardest hit.

Buyers responded to poor end-user demand by trying to keep their stocks down, adopting a hand-to-mouth purchasing strategy which has persisted into August.

The decline in offtake and consequent improved supply resulted in third-quarter contract prices being settled at average decreases of €2–3/hl (hectolitre).

The market for 99% industrial grade ethanol is typically less seasonal, but it has not escaped the effects of lower consumer spending this year.

An additional factor in this market has been competition for market share between producers of fermented and synthetic ethanol, which has been particularly intense since the fourth quarter of 2011.

Producers of this grade are divided between those reliant on the sugar fermentation process and those that take ethylene as their principal feedstock, using it to produce “synthetic” ethanol.

“I have a big fight with synthetic ethanol”, said one producer of fermented ethanol.

The competitiveness of synthetic ethanol is determined chiefly by the cost of ethylene, which has been extremely volatile this year.

Successive increases in ethylene costs totalled €225/tonne in the first four months of 2012; the upward trend was then reversed, with prices plunging by a total of €310/tonne over the April-July period. This was followed by a €140/tonne hike in August.

As buyers attempted to maintain their inventories at minimal levels, European sellers had to become ever more aggressive in their efforts to protect their share of the market.

The outcome of this was that third-quarter contract prices for 99% industrial grade were concluded at average decreases of €2–3/hl, with price cuts of €4–5/hl for some large accounts.

Even as the last third-quarter contracts were being concluded, sentiment was beginning to harden in response to the sharp rise in fuel ethanol prices, which one producer described as the “driving factor” in the market.

Producers said the downward adjustment on third-quarter contract prices for traditional ethanol might have been an overreaction to the previous bearish indicators.

As wheat and corn prices continued to rise through July before stabilising towards the end of the month, producers began to divert material away from traditional applications into the more remunerative fuel ethanol market.

By August, sellers were complaining that prices for traditional ethanol had fallen well below replacement costs.

“Things are in total disorder”, was how one reseller described the situation, adding that “everyone is aware that something has to happen rather soon.”

However, market participants acknowledged that August is not a good time to seek price increases, with the reseller observing that “August is the lowest of the low seasons.”

Market attention has therefore turned to September, with producers adamant that fourth-quarter contract prices will have to rise.

One producer of fermented 99% industrial grade ethanol said it would operate its plant at below normal capacity because poor margins did not justify full production rates this month.

However, the producer emphasised that, following the abrupt change in sentiment around the time of the third-quarter contract settlements, it would avoid settling its fourth-quarter prices too early.

“If you start too early, you will have a good possibility to burn money”, the producer warned.

($1 = €0.81)

By: Samuel Weatherlake
+44 20 8652 3214

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