August 20, 2007

Ethanol margins declining as gas demand winds down

A larger-than-expected US corn production estimate in August from the USDA is not expected to improve ethanol profit margins this fall, analysts said.

Corn production is expected to increase to 13.054 billion bushels in 2007, well above the 10.535 billion produced in 2006 as farmers responded to surging demand from the ethanol industry.

The larger corn production estimate on the surface should lead to higher to ethanol refining margins but other fundamental factors probably will limit any increase in those margins, said Dave Wilson, energy analyst at Morgan Stanley.

Earlier this summer, ethanol profit margins for refiners were near 80 cents per gallon when CBOT corn prices were trading above $4.25, as CBOT ethanol futures were also higher. Nearby ethanol futures were then trading well above $2.00. Ethanol margins have since declined to around the 35 cents per gallon level. On Friday, September ethanol rose 1.2 cents to $1.812 per gallon.

 Ethanol prices are very closely tied to gasoline prices and when gasoline prices decline, ethanol declines as well, pressuring margins, said Rich Asplund, director of research at Melvin & Company which tracks clean energy markets.

Gasoline prices in the cash market have declined by 45 cents over the last two months and ethanol pries have followed, Asplund said.

Another reason for the decline in profit margins is lower demand for automotive fuels. The summer driving season is winding down, gasoline demand is down and as a result, the demand for ethanol is lower, said Wilson.

Continued increase in ethanol production is also seen weighing on margins for now and into the near future, analysts said.

According to the Renewable Fuels Association,, there are currently 124 ethanol refineries operating with the capacity to produce 6.5 billion gallons of ethanol. An additional 83 construction projects coming up soon will add another 6.4 billion gallons of capacity.