Economists: Rising ethanol prices allow even higher corn prices

By Susanne Retka Schill | July 27, 2012

With ethanol prices rising to follow the drought-driven rise in corn prices, there is still room for ethanol producers to bid those prices higher, according to a recent analysis by ag economists at the University of Illinois, Urbana-Champaign.

After seeing lows around $2 per gallon just a few weeks ago, ethanol prices have followed the sharp, drought-driven rally in corn prices, increasing by 32 percent compared to corn price increases of 27 percent since June 15.

Scott Irwin, Laurence J. Norton Chair of Agricultural Marketing at the University of Illinois, and colleagues have developed an analysis to determine the shutdown corn price for ethanol plants, based on a model 100 MMgy ethanol plant in Iowa. The model factors in typical fixed costs and allows variable cost adjustments for different scenarios for what could be considered an average plant constructed in the last five years. The shutdown point is the level when revenue no longer covers the variable cost of production. Prices used in the model are Iowa-based, cash prices from USDA reports.

Corn is the single largest cost of ethanol production, recently figuring at about 80 percent of total cost. Ethanol profitability, however, depends upon the cost of corn relative to the price of ethanol. The shutdown price of corn moved in a narrow range between $6.50 and $7 per bushel corn for the first half of 2012, but in recent weeks has skyrocketed, increasing by over $2 per bushel. On July 20, this model ethanol producer could go as high as $9 a bushel for corn and cover variable costs, according to the analysis. The model, of course, isn’t an actual plant and doesn’t reflect the wide variability in production efficiencies and local market conditions across the ethanol industry. “It’s meant to represent an average or typical plant without incorporating detailed aspects like a risk management strategy,” Irwin said. “It’s a simplification, but not so simplified that it doesn’t capture the essence of the technical and economic relationships.”

Earlier, Irwin and his colleague ag economist Darrel Good took a look at the deteriorating corn crop and ran multiple yield scenarios asking the question: at what yield/corn price will rationing occur? They discussed multiple factors, including feed use and ethanol use and the impact of the renewable fuels standard and the availability of excess renewable identification numbers (RINs). It is estimated that blenders hold approximately 2 billion gallons of RINs that could be used to meet the RFS. 

On July 13, when they published their report in the FarmDocDaily newsletter, the authors concluded that substantially more rationing will need to take place at a 135 bushel per acre national average yield and corn prices would need to move higher. “Prices have probably not yet gone high enough to accomplish the necessary rationing if the average yield is below 135 bushels.”

The authors add a cautionary note: “It is important to emphasize that our analysis should be viewed for what it is—a simple, first take on what might happen under alternative corn yield scenarios. How actual market dynamics will be worked out is fraught with complexities. In particular, we are in uncharted territory regarding the interaction of the corn, ethanol and gasoline markets in a major drought. This adds even more uncertainty to what is already an extremely volatile market situation.”