May 26, 2008

Backlash by US presidential hopefuls puts status of ethanol in doubt

Election year politics has elevated criticism of ethanol as political pressure heats up around the fuel additive.

All three remaining presidential candidates have voiced concern about ethanol's role in rising food prices, and the governors of both Connecticut and Texas have filed waivers seeking exemptions from the federal renewable fuels mandate.

Several Republican senators - including presidential hopeful John McCain of Arizona have also filed a bill to freeze the recently enacted biofuels mandate at current levels.

On the other hand, this had the effect of preventing record-high energy prices and held back the rise in CBOT prices due to late crop plantings.

Responding to the onslaught by politicians, Agriculture Secretary Ed Schafer came to ethanol's defense Tuesday, saying it was having only a small effect on food prices.

The comments revived ethanol's  fortunes and prompted a brief rally in corn prices Tuesday.

Analysts and traders agree the ethanol backlash has become a drag on the corn market as traders anticipate, at some point, reduced corn demand for ethanol.

The USDA says 3.1 billion bushels of corn from the 2007-08 marketing year will be used in ethanol production. The federal ethanol mandate calls for 9 billion gallons in 2008.

Because ethanol affects corn prices across the board, analysts say it is hard to pinpoint an exact impact on prices. One analyst's "wild guess" was that corn is 30-50 cents lower due to the backlash.

Even without a policy change, there has been a mindset change, and ethanol is no longer the darling of the futures set, an analyst said. Instead, it is a "legislative question mark."

"It was the poster child of energy, and it moved to the stepchild," said Don Roose, president of US Commodities in Des Moines. "And now it's the red-headed stepchild."

Traders and analysts agree policy changes are likely, but probably not until next year, after federal elections. Any reduction of the ethanol mandate would be met with fierce opposition in corn belt states that could be important in the presidential race, analysts note.

Unless there are major weather problems in the summer, it's unlikely there will be any change (this year)," said Bill Nelson, a market analyst for Wachovia Securities.

Shawn McCambridge, a senior grains analyst for Prudential-Bache, said the effect of the backlash is limited because any changes are too far away to reliably forecast.

Ultimately, he expects a compromise between the end user, who wants no ethanol, and farmers who want to keep the country's ethanol policy on the same track.

Complicating any change is that ethanol has become well established.

Roose said the country will have 13 billion gallons of production capacity by next year. Ethanol will soon make up about 10 percent of gasoline. Without ethanol, the price of gas could rise as much as 50 cents per gallon, he said.

Credit Suisse said in a report earlier this month that the US government may decide to slow the growth, but it is highly unlikely that it would be eliminated because gasoline prices would skyrocket. The economics of ethanol will likely remain favorable, the report said.

The report said that the current 8.5 billion gallons of capacity is unlikely to go away soon. Although ethanol producers lose money when ethanol is at US$2.45 per gallon and corn is at US$6 per bushel, they make money at US$2.90 per gallon, the report said.