Upside down ethanol-gas ratio appears to be new normal

By Susanne Retka Schill | January 18, 2016

After a decade of ethanol mostly being priced lower than gasoline, the ethanol/gasoline price ratio has been above 1.0 for the past four months. “The hefty premium of ethanol to gasoline threatens the position of ethanol as a cheap source of octane,” write University of Illinois economists Scott Irwin and Darrel Good in their most recent FarmDocDaily post examining the ethanol industry.

In “The New Upside-Down Relationship of Ethanol and Gasoline Prices,” the economists note that since 2011, the ethanol/gasoline ratio has averaged 0.86 until the past few months. The November peak was 1.46 and the mid-January ratio is 1.28. They argue that the current upside down ratio is a result of new circumstances that are truly different and likely to continue for the foreseeable future. In their analysis they review the safety net role of the renewable fuel standard (RFS), as well as conceptual models of the ethanol supply and demand curves under different scenarios.

In considering the impact of the mandate, they write, “the ethanol quantity floor provided by the RFS mandate also effectively puts a floor under ethanol prices.” At current corn, distillers grains, corn oil and other inputs costs, they add “we estimate the shutdown price at Iowa plants to be $1.11 per gallon.”  Adding there is a range of production costs, and some will be higher or lower, “Ethanol prices cannot be driven down below the (average) floor price to the level implied by the historical average ethanol/gasoline price ratio because this would force much of the ethanol industry to shut down production, which cannot occur and also have the ethanol mandate met. This is why ethanol prices have been supported above the price of gasoline in the face of plummeting crude oil and gasoline prices and why we believe this is the ‘new normal’ going forward.”

Wholesale gasoline, they note, has been trading at about $1 per gallon and if the historical average ethanol/gasoline ratio was in effect, ethanol would be just 86 cents per gallon. Crude oil prices, they add, have taken off 30 percent since Dec. 1, while corn is only down by about 5 percent.