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Page added on September 26, 2010

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Robert Rapier: The Lesson from Rising Ethanol Prices

Alternative Energy

I thought it was a bit humorous recently — when corn ethanol prices dipped and were cheaper than both sugarcane ethanol and gasoline (even when adjusted for lower energy content)  — that some corn ethanol proponents pointed to this as a watershed event. Their underlying message, which was repeated almost daily in the comments on my blog, was that corn ethanol had now reached the point of permanent price competitiveness with gasoline. But I have repeatedly warned about price volatility in the energy business; that nothing is permanent. Today natural gas is $4 per million BTUs, but a few years ago it was $15. Oil has traded between $10 and $150 over the past decade. And corn — upon which corn ethanol is dependent — is not only strongly influenced by energy prices, it is a commodity in its own right and has volatility that can be influenced by crop failures around the globe.

Those who highlighted corn ethanol’s competitiveness in the summer have been pretty silent on the topic lately. The reason is that ethanol prices are sharply on the rise:

Schork Oil Outlook: Ethanol’s Late Season Surge

Since the end of June, spot ethanol CBOT futures for October delivery have surged 43% on the back of a strong export market along with substantial spikes in corn and sugar feedstocks. Strength in this market is motivated by new estimates from the USDA. In short, the crop yield forecast has been lowered and the volume dedicated to ethanol output has been raised.

So back in June, ethanol was briefly cheaper than gasoline. Today, ethanol on the spot market trades for $26.84 per million BTUs ($2.04 per gallon) and gasoline trades for $16.87 per million BTUs ($1.94 per gallon). (Sources, CBOT, EIA). But the point here is not to simply highlight that ethanol is now 60% more expensive than gasoline. After all, in the long run we may pay $50 per million BTUs of liquid fuel and be happy that the supplies are available. The lesson here is that energy prices, whether current as in this case with corn ethanol — or future speculations based on cellulosic ethanol or algae — are going to be subject to great volatility. In this context, a future projection of $2/gallon for cellulosic ethanol is meaningless.

A year from now, ethanol may once again be competitive with gasoline, or the situation could be even worse than it is now. I think one of the biggest risks hanging over the corn ethanol industry is that of a major crop failure in the Midwest. Imagine a terrible drought in Iowa that causes corn crops to fail. A corn ethanol industry that is heavily dependent on Iowa corn is going to need to scramble for supplies, and prices will be driven much higher. That would shed a spotlight on the industry that they would rather avoid; that is that ethanol could be subject to extreme volatility due to a crop failure OR to volatility in the energy markets. Public support for corn ethanol would probably vanish in such an event. People would be dealing with higher food prices as well if crops failed, once again focusing attention on the food versus fuel debate.

This scenario is certainly not out of the question. Energy cycles take place over many years, and most of the corn ethanol industry is less than a decade old. Whether the industry survives in the long run will be highly dependent on the crops coming in reliably year after year to keep price volatility to a minimum. The lessons people should take from rising ethanol prices are that energy prices are volatile, and nothing is permanent.

R Squared Blog

One Comment on "Robert Rapier: The Lesson from Rising Ethanol Prices"

  1. KenZ300 on Mon, 27th Sep 2010 12:48 am 

    Ethanol producers need to fuel their plants with renewable energy and continue to drive down the cost of production.

    They also need to look at deriving their inputs from several sources so that as prices rise for one source of inputs (like corn) they can use other sources like biomass to offset and balance the cost.

    Don’t put all your eggs — Oh I mean corn in one basket.

    We need to diversify our energy and supply more of it close to home. WE need to provide local jobs producing local energy and stop sending money to countries that want to do us harm.

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