Exploring Hydrocarbon Depletion
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Page added on July 17, 2012
I have long felt that one of the biggest threats to the U.S. ethanol industry is a major drought/crop failure in the heart of corn country. This year we may be experiencing such an event. Recent reports indicate that what had been expected to be a record crop of corn has been downgraded such that only 40% of the corn crop is being classified as in good or excellent condition. This is down 48% versus last week and 69% versus a year ago.
Corn prices are naturally surging in response; current corn prices are 21% higher than they were a year ago. Because so much of the corn crop is devoted to meeting ethanol mandates, there is a potential supply conflict being set up between food producers and ethanol producers.
This was always the risk in my mind; that a major drought could reduce the corn crop and result in surging fuel and food prices at the same time. This creates a situation that politicians who are not friendly to the ethanol industry will likely exploit. It won’t likely lead to an end to the mandates, but support for a 15% ethanol mandate (E15) — something the industry desperately wants — will likely erode in the face of the weak corn crop.
As you might expect, ethanol prices are moving higher, but I don’t think the price fully reflects the situation with the corn crop. It has been clear for at least two weeks that ethanol prices should move up in response, but the response has been slow and is just now gaining momentum. Normally, one would expect demand to fall in response to higher prices, and for that to mitigate the price rise, but gasoline blenders do not have the option of reducing their ethanol usage because of the mandate in place.
Thus, it appears that there is a short term opportunity in the ethanol market brought about by the corn shortfall. Longer term, there is a distinct risk for the growth of the industry as E85 prices become less competitive, and gasoline prices potentially rise because blenders are being forced to blend higher-priced ethanol. The MPG adjusted fuel price for E85 has now risen to above $4.00 a gallon, which is 50 cents higher than the price of midgrade gasoline.
The bottom line is that the short-term market for ethanol futures is bullish, but the longer-term market may become extremely bearish if politicians are successful in using the current situation to soften future support for ethanol.
(EDIT: As we go to press, the U.S. Dept. of Agriculture (USDA) confirmed this report by lowering their projected corn yield by 20 million bushels, a 12% reduction.)