When gas prices plummeted during the recession and at least half of US ethanol producers went bankrupt in the 2008-2009 ethanol crash, ethanol production continued to increase. But ethanol will crash again in the face of a summer drought, and this time the crash will be more definitive.
The difference this time around is that the ethanol will not crash because of product value, but because of under-supply of feedstock, like corn.
The US is now experiencing its worst drought in over half a century; the United Nations is warning of a food crisis and EIA is warning that exports will be significantly affected. In the meantime, corn-ethanol producers are struggling to defend a federal mandate that sets out ambitious ethanol requirements.
The US Energy Information Administration (EIA) says the drought is likely to hit exports but not cause any significant rise in ethanol-blended gasoline. However, we might take issue with this prediction as a longer-term loss of ethanol will surely affect the supply and price of the gasoline with which it is blended.
Corn crops are shriveling and corn prices have reached record levels, in turn boosting ethanol prices. According to the EIA, ethanol output should fall by 70,000 barrels per day for the second half of this year, but the main impact of will be reduced ethanol exports, rather than an increase in gas prices.
The push to produce corn-based ethanol has helped push corn prices up to more than $8 a bushel today, from just over $2 in 2006.
The obvious battle lines are drawn between livestock farmers who are being negatively affected by the high price of corn, and feedstock farmers, who are benefitting from the federal ethanol mandate. Politically, congressmen representing livestock states are calling on the Environmental Protection Agency (EPA) to remove the federal mandate for ethanol. The bulk of these calls are coming from Republicans, but there is some bipartisan support for such a move. Clearly the corn-producing states of Nebraska and Iowa would like to see the mandate remain in place.
How bad is the drought and how badly does the US need ethanol?
The drought is pretty bad, with over 60% of the country affected and another 16% dryer than normal. The worst cases are in the corn belt, meaning the Midwest and the High Plains, where the combination of no rain and severe heat are taking their toll on corn crops.
Some estimates say that the US will likely lose nearly 40% of its corn crop, and possibly more, which means that the price of corn will continue to rise. The price of feedstock will be too high to sustain ethanol production, especially now that it no longer enjoys a blending credit.
The federal mandate on ethanol stipulates that all gasoline purchased wholesale must be blended with ethanol. (The Renewable Fuel Standard requires blending 13.2 billion gallons of corn-based ethanol into motor fuels this year.)
To meet this federal mandate, ethanol must use some 40$ of the corn crop—a percentage that will be missing from this year’s harvest.
The answer is not to get rid of the federal mandate, but to pause it for the rest of this year as the corn harvest cannot sustain the necessary ethanol production. That corn will have to go to feed cattle, and this is a simple fact. The federal mandate for ethanol is a necessary one but in the face of drought we must be more flexible and rational.
Seeking Alpha makes an interesting point, and this is purely from a market perspective: “During most of the 2000's when global oil supply and global oil demand were near matched, the additional input from ethanol served to keep the balance better restored, and served to keep oil prices far more stable than they would have been without the then ~700,000 [bbl/d] of ethanol being pumped into the system.”
Getting rid of the federal mandate just like that would send ethanol refineries into bankruptcy and cost the country jobs it cannot afford to lose right now. The question is whether the refineries are going to face bankruptcy even with the federal mandate.
Ethanol producer East Kansas Agri-Energy LLC has announced it will halt production at its Garnett, Kansas plant in October due to the drought, which has rendered operations unprofitable. According to Bloomberg, Valero Energy Corp. (VLO), the third-biggest U.S. ethanol producer, is operating at about 50% of capacity.
No agriculture-based industry can survive for long without federal mandates or subsidies. This is a fact that history clearly demonstrates and that the public might as well just accept. The market is unkind to agriculture and the farmer. Mother Nature can also be rather fickle.
By. Jen Alic of Oilprice.com
Jen Alic is a geopolitical analyst, co-founder of ISA Intel in Sarajevo and Tel Aviv, and the former editor-in-chief of ISN Security Watch in Zurich.