May 18, 2009

Pressure on the beleaguered ethanol industry could intensify this year as producers chase a smaller US corn crop that is likely to drive up corn prices and push down profit margins.

 

How the situation plays out over the next few months will be closely watched from Wall Street to the Midwest Corn Belt and right down to the fuel pump. That's because almost all ethanol produced in the US uses corn as its basic ingredient, and corn accounts for 70 percent of ethanol production costs.

 

Following a string of bankruptcies in 2008 by some of the nation's major ethanol producers, 2009 is shaping up to be yet another "difficult year" for the industry, said Robert Sharp, an ethanol analyst at energy information provider Platts.

 

"Profit margins should remain weak, as any possible rise in ethanol prices will be offset by a rally in grain prices," Sharp added. Meanwhile, the ethanol industry is still grappling with excessive production capacity.

 

This year's corn planting season has been hampered by heavy rains in the Midwest and farmers - mindful of weak prices by the time last year's harvest rolled around - are expected to plant less corn.

 

Corn, recently trading at US$4.30 a bushel, could rise above US$5 within the next five months, analysts say.

 

According to the latest monthly report released Tuesday (May 12) by the US Department of Agriculture, farmers are expected to plant 85 million acres of corn this year, 1 million less than a year ago.

 

As a result, corn production for the new season is projected at 12.1 billion bushels, down 11 million bushels from the last season.

 

Meanwhile, Ethanol use is expected to reach 4.1 billion bushels, or about one-third of the total production, up from last year's 3.75 billion bushels.

 

Corn use for ethanol production is rising. The federal government mandated gasoline refineries to blend 10.5 billion gallons of ethanol in 2009, up from last year's 9 billion gallon.

 

The "federal biofuels mandate and improved blending incentives" together pushed up corn use for ethanol production, the USDA said in the monthly report, the World Agricultural Supply and Demand Estimates. "Ethanol producer returns, however, will remain under pressure as excess production capacity weighs on producer margins," it added.

 

As a result of rising demand and falling production, corn year-end stocks for the new season are projected to be down 28% to 1.1 billion bushels.

 

Hussein Allidina, an analyst at Morgan Stanley, said the USDA's new report is "bullish" for corn prices, owing to lower year-end inventories.

 

"The economics for planting corn remain less attractive relative to soy," Allidina wrote in a research note. "Lower fertilizer application, coupled with poor economics and unfavourable weather, are poised to send corn production lower" this year.

 

Meanwhile, heavy rains and flooding in the Midwest are delaying this year's corn planting.

 

As of May 10, farmers had planted 48 percent of their intended corn acres, severely lagging the five-year average of 71 percent. The planting level was little changed from the same period a year ago, when the Midwest was hit by massive flooding.

 

"Planting progress is way behind schedule in big corn states," said John Sanow, commodity market analyst at commodities information provider DTN. "New-crop futures could test US$4.70, and if the planting delays continue could test US$5.25."

 

Front-month corn futures ended at US$4.265 a bushel Wednesday, more than 40 percent higher than their December low near $3 a bushel.

 

For refineries, profit margin for blending ethanol is closely linked to the price of oil.

 

Today ethanol is trading at a premium to gasoline. If gasoline prices rise faster then ethanol prices, this premium could shrink or could be reversed, which would give refineries incentives to blend more ethanol into gasoline.

 

Last year, with oil prices briefly rising to a record high near US$150 a barrel, refineries blended about 9.5 billion gallons of ethanol, more than that year's mandate, according to Platts' Sharp.

 

Oil prices have slowly climbed back from their four-year low below US$34 a barrel in December. They topped $60 a barrel Tuesday and have risen more than 30% in the year to date.

 

Rising oil and corn prices could invite a renewed debate over corn-based ethanol production.

 

"A pick-up in global oil demand next year could again drag millions of tonnes of corn, sugar and wheat out of the food pool into the fuel pool," the Merrill Lynch analysts wrote in a recent report.

 

"A second round of food and fuel competition could happen as soon as next year," they added.