Is an Ethanol Glut Inevitable?

A year ago, ethanol industry talk centered on shortages. Now the hot topic is a possible surplus and what needs to be done to amplify demand as the ominous E10 wall approaches. On the other hand, there's a contingent who believes demand is picking up. However, without the proper infrastructure or a dedicated pipeline, will the renewable fuel be able to penetrate new markets?
By Nicholas Zeman | August 27, 2007
Ethanol has to be cheap to compete with gasoline as a transportation fuel. That's what economists at schools across the Midwest, like Iowa State University (ISU) in Ames, Creighton University (CU) in Omaha, Neb., and managers at the Chicago Board of Trade will tell you. As will Iowa Secretary of Agriculture Bill Northey. "E10 and E20 can be closer to the price of gasoline," Northey tells EPM. "But E85 has to be considerably less expensive to be competitive." Therefore, when the price of ethanol fell 43 percent in the past year making it cheaper than gasoline for the first time in two years, that might not have been a negative in terms of market longevity.

Market watchers are noting a gap between ethanol and gasoline prices. During the second week of July, for instance, Chicago gasoline rack numbers were seen as high as $2.75-per-gallon, while ethanol spots hovered just over the $2 mark. This ultimately means that ethanol is not going to be able to cling to unleaded prices, as was once thought. "They should move in tandem, but sometimes you see gasoline prices spike because of things like refinery problems or Hurricane Katrina, and ethanol just doesn't follow," says Ernie Goss, chair of the economics department at CU and head of the Creighton Economic Forecasting Group, which conducts a yearly survey of banks and businesses through the mid-American and Mountain states. In doing that survey, the group learns a lot about the impact of the ethanol industry. "A lot of these businesses and institutions are really tied to ethanol," Goss says. "So we have a pretty good idea of what's going on out there."

According to the research at CU, the actual boom is not over but it is starting to slow down. Smart investors aren't going to be rushing in or throwing money around to help build new plants in the Corn Belt, Goss says. It just isn't going to happen, but the Midwest is still outpacing the economic growth of the rest of the United States at a rate of nearly 50 percent, according to CU analysts. Farm income and income in the sectors it impacts, like transportation, are increasing in the Midwest largely because of ethanol production, Goss says. Also, the Midwest isn't as dependent on housing construction and real estate development—a sector experiencing a serious slow down—as the rest of the country.

The construction boom and the rate at which gallons are coming on line has led some analysts and the mainstream media to forecast a possible "glut" situation for the renewable fuel in the coming months and even years. Goss tells EPM, however, that this is a mistaken consensus. "I wouldn't say there is a glut of ethanol because the demand is out there," he says. "But there are transportation issues. That means large volumes of ethanol might sit for long periods of time because they just can't move it."

When Goss looks at ethanol as a potential investment he looks at the big picture. "From an investment standpoint, I'm more bullish on the ethanol industry in general than I am on the actual plants," Goss says. "In fact, I was doing some work for a venture capitalist who had invested in an ethanol plant and was wavering on the decision to remain a partner. When he had the chance for a buyout my advice was, 'Take the money, man.'"

New Opportunities
In terms of new markets, there is some good news on the horizon for ethanol marketers. California recently modified its emissions regulations to accommodate higher blends of ethanol. "One of the ways we are going to meet the goals in Gov. Arnold Schwarzenegger's Low Carbon Fuel Standard (LCFS) is to increase the amount of ethanol used in California," says Dimitri Stanich of the California Air Resources Board (CARB). Stanich tells EPM that changes have been made to California's predictive model, which is a set of mathematical equations used by oil companies to formulate lower emitting gasoline. Approving blend levels of up to 10 percent means the opening of a new 600 MMgy to 700 MMgy ethanol market in California. That's around 11 percent of the industry's current output capacity. "It hasn't been talked about a lot in Iowa, but I definitely think this could be very, very helpful," Northey says. "It could be as high as a billion gallons."

Although the news regarding California is good, the ethanol industry is going to need even more good news in the near future to keep up with potential supplies. Ethanol now makes up about 4.5 percent of the nation's gasoline mix, but once that number rises to 10 percent—the amount all cars now sold in the United States can use without modifications—it will hit the so-called E10 wall.

Some people are under the impression that until there is a nationwide system to move ethanol via pipeline, there will likely be an excess of product. That probably won't happen until more information is known about transporting ethanol through a pipeline. The House Energy and Commerce subcomittee recently approved a grant program requiring the secretaries of energy and transportation to conduct an ethanol pipeline feasibility study. "[Iowa] Senators [Tom] Harkin and [Chuck] Grassley have been indicating support of a [feasibility] study," Northey says. "But I think there are more questions than answers at this point." Because ethanol production plants aren't centrally located it's not known how the fuel could be transported efficiently to the pipeline, or if enough volume can be produced to push it over long distances through such a vein.

Northey expresses optimism though about operations and developments underway at the fuel terminal in Manly, Iowa, which claims to be the center of a virtual pipeline. "They are looking to collect unit trains there; once that happens I think we will be able to get into some new markets," he says. "If we are able to move ethanol more efficiently, producers need to find new sectors and locations to sell ethanol in, and not just fight to get deeper into ones that already exist. There are locations on the East Coast, and in rural areas throughout the country where E10 still isn't available."

Blenders, Exports
A simple solution to increase the infrastructure for renewable fuels might be the increased use of blender pumps. These pumps contain tanks of ethanol and gasoline and are essentially mixed on the spot by the consumer at a retail location. "This would allow ethanol producers to deliver directly to stations and avoid some of the handling costs by bypassing the petroleum fuel terminal," Northey says. However, consumers need to see a savings when they fill up with ethanol versus unleaded gasoline. Fuel alcohol has an energy equivalent to roughly two-thirds that of gasoline so the renewable fuel should reflect that in terms of pricing. "It's just more expensive than it ought to be," Northey says. Does that mean the 51-cent blenders' credit should be discontinued? "I think that would send the wrong message to investors," he says. "In the future, investors are going to want that in place if they're going to be involved in some high-risk ventures like building cellulosic ethanol plants."

Marketers could be more aggressive in terms of finding export opportunities for their product. Because ethanol doesn't benefit from tax incentives when it leaves American shores it has to compete more directly with gasoline. "I think it will go into the fuel mix [in other countries] more and more not only for its octane value, but also for its environmental benefits," Northey says.

In terms of demand, the surplus fears may well be overstated. In economics, the term "glut" refers to the situation where a product has been over-produced, consumers don't respond to the volume and the price plummets. This is not the situation with ethanol. "The problem is that there is supply in one place and demand in another, not that there is a lack of demand," Goss says. "China is growing. Europe is growing. The need for alternative fuels will be strong … some of these transportation and logistical issues will be solved. Goldman Sachs has also estimated that there is going to be oil shortages for the next 25 years, so there is not going to be a glut of ethanol."

Greater demand, however, doesn't always translate into higher profits. One reason is the high cost of corn. On a positive note, however, the USDA is predicting a record corn harvest this fall, so there could be some relief coming. "We're already starting to see prices come down around the $3 mark," Northey says. "A little over a year ago, corn was around $2 per bushel, but six months ago we were at $4, so things are getting better."

Nicholas Zeman is an Ethanol Producer Magazine staff writer. Reach him at [email protected] or (701) 746-8385.