Ethanol fortunes in limbo as E15 ruling looms

CHICAGO Thu Mar 18, 2010 4:35pm EDT

AgResource President Dan Basse speaks during the Reuters Food and Agriculture Summit in Chicago March 16, 2010. REUTERS/Jeff Haynes

AgResource President Dan Basse speaks during the Reuters Food and Agriculture Summit in Chicago March 16, 2010.

Credit: Reuters/Jeff Haynes

CHICAGO (Reuters) - The U.S. ethanol sector has been on the road to recovery since a calamitous 2008, but the once soaring industry appears to have hit a plateau amid a glut of supply and a murky demand picture, analysts said at the Reuters Food and Agriculture Summit in Chicago.

Producers are hoping that a government ruling expected this summer to increase ethanol blends will reignite the type of demand growth seen years ago when competing fuel additive MTBE was phased out due to environmental concerns.

But even if the Environmental Protection Agency allows the maximum blend of ethanol in U.S. gasoline to rise to 15 percent from the current 10 percent, legal challenges could delay full implementation for months or even years, analysts said.

Meanwhile, U.S. unemployment near 10 percent and questions about whether an economic recovery will gain traction has held down demand for fuel, leading to a glut of ethanol, they said.

"There's been some discussion that unless U.S. auto owners start driving more that we are kind of seeing a modest blend wall here. I hate to use the term blend wall but people are having difficulty getting rid of ethanol here today," said Dan Basse, president of Chicago-based consultancy AgResource Co.

A blend wall refers to a point where demand growth is stifled unless the blending rate is increased.

"In the last week we've seen ethanol prices collapse at the same time that crude oil prices have rallied and our ethanol clients are telling us that they're having difficulty getting rid of supply," he said, adding that current average ethanol producer margins are at minus 23 cents a gallon.

Michael Swanson, economist with Wells Fargo, was more optimistic about the ethanol sector's outlook this year.

"I don't think the ethanol industry is in that bad of shape and they are going to go where the gasoline goes. I see, with a stronger economy, driving miles starting to expand again and gasoline utilization starting to go back up. That's all very positive for the ethanol side," he said.

MODEST DEMAND GROWTH

U.S. law requires that 12 billion gallons of ethanol be blended into the U.S. fuel supply this year. Fuel blenders currently have little incentive to incrementally blend more than that, analysts said.

The law requires a gradual rise in corn-based ethanol use through 2015, but the year-over-year increases are minimal.

A 15 percent ethanol blend, known as E15, is therefore critical for continued growth of the ethanol industry and a crucial swing factor for corn demand.

"I see that as a looming bullish potential there," said Bill Lapp, president of Advanced Economic Solutions, a food consulting firm based in Omaha, Nebraska.

"If I'm correct that there are 700 million bushels of incremental (corn) demand potential there, that's equal to roughly a majority of the carry-out and equal to about 4 or 5 million acres of corn."

If E15 is not adopted, corn usage by ethanol producers would rise by just 130 million bushels a year through 2014, according to a U.S. Agriculture Department study. That compared with demand growth of 675 million bushels per year in 2008 and 2009.

Analysts are cautiously optimistic that the EPA will rule in favor of a higher ethanol blend, but it remains unclear how soon it could be fully implemented due to potential legal action.

"Once you get something like this caught up in the courts, it could be a yearly or multiyear-type of situation before it is implemented," Basse said.

Legal challenges could come from auto makers who fear that they would be held liable for damage done to older cars or from fuel retailers worried that they could face lawsuits for selling a product that may damage some engines.

In focus are the roughly 20 percent of U.S. cars on the road produced before 2000 and small engine machines such as motorboats, snowmobiles, or garden equipment.

"It may be implemented in spite of (legal challenges). The precedent would be the implementation of a split fuel blend such as we had in the 70s with leaded and unleaded (gasoline) so you'd have two different pumps," Lapp said.

(Reporting by Karl Plume; Editing by Richard Chang)

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