Corn is a major feedstock for domestic ethanol production, when corn prices move, expect ethanol to follow closely behind.
Roughly a third of domestic corn is used to produce ethanol, and with harvests starting earlier and ending later, that number is only projected to rise.
However, the relationship between corn and ethanol isn’t that simple. In the event of a corn surplus, ramped-up ethanol production alone can’t entirely stem the overflow from corn inventories, but it will assist in limiting the price fallout from the build-up.
Aside from a corn surplus or deficit, the $44 billion ethanol industry’s prices are subject to lessened demand for gasoline stemming from drivers seeking greener ways to get around and ethanol reaching its blend limit in gasoline.
American ethanol producers have arrived at the blend wall, a term that refers to a point where the mandated 10% blend of ethanol with gasoline will reach its limit and ethanol demand will be severely reduced.
A high amount of corn being rated as in good or excellent condition for harvesting can also lead to a surplus. This will lower corn prices and take ethanol down with it. In markets such as these, overperformance is met with reduced profits.
A positive rating can generally be traced back to ideal weather conditions, particularly in the Corn Belt of the U.S., led by states such as Iowa and Illinois.
Expect the trend of cooperative weather to remain a factor as changing climate conditions produce larger harvests, at least within the next couple decades.
As for the future of corn, producers need to start planning as soon as possible for much lower crop prices in the next ten years. This begins with corn that has been withheld from the market which will be subject to more favorable corn prices in the future.
The USDA is projecting a sharp decline in average corn prices for the coming years, well below current break-even levels for many producers. Estimates for on-farm corn prices for the next decade average near $3.75 per bushel. Naturally, this will bring the price of ethanol down with it.
Major independent refiners that produce ethanol-blended gasoline, like Valero Energy Corp. (NYSE: VLO) and Tesoro Corp. (NYSE: TSO), generally prefer the low price of ethanol, which recently dropped below $1.60 a gallon — less than half the price of ethanol at its summer peak.
The Environmental Protection Agency (EPA) is considering a proposal that would lower the required 14.4 billion gallons of corn ethanol that is mixed into our nation’s fuel mix annually to 13 billion based on weak demand for the blends containing higher amounts of ethanol.
The future of ethanol demand hinges on proposed changes to the Renewable Fuel Standard (RFS) and the likely modifications to the ethanol Blend Wall limit.
As it is, decreases in gasoline consumption will precede decreases in ethanol demand unless the industry can create new avenues of growth.