ethanol plant in corn fields Jim Parkin iStock

Increase in ethanol production likely to outpace near-term demand

CoBank report finds ethanol market will soon face worsening slim-to-negative profit margins, forcing further industry consolidation.

According to a new report from CoBank's Knowledge Exchange Division, the ethanol market will soon face worsening slim-to-negative profit margins, which could potentially push the industry toward consolidation. However, producers that are well capitalized with strong balance sheets and cash reserves will be in the best position to weather the softening market.

The report, "Ethanol's Growth Path: Output & Export Uncertainties Both Rising," outlines how an ethanol market fueled by corn prices that are at multiyear lows, coupled with reinvestment into production capacity, will push supply past demand growth.

"Forecasts indicate that total ethanol production by 2020 will have increased by approximately 850-900 million gal. compared to 2017 levels," CoBank senior economist Tanner Ehmke said. "Without a substantial increase in domestic demand or exports to clear excess supplies, ethanol producers are facing a downturn over the medium term. Those who have access to multiple transportation markets and have invested in new technology will be leaner and more cost efficient, enabling greater flexibility to endure prolonged periods of low prices."

Demand picture
Domestic demand for gasoline blended with ethanol has been strong over the last 18 months, as low fuel prices resulted in consumers driving more. A second bright spot for ethanol has been continually rising ethanol blend rates at the pump. While E10 (gas containing 10% ethanol) remains the dominant fuel blend, consumers are increasingly buying higher blends like E15 (15% ethanol).

However, the longer-term picture for ethanol in gasoline is less optimistic. In 2017, export weakness and lower dried distillers grains prices have hurt margins.

Exports of ethanol, particularly to Brazil and China, have been strong over the last year, but that picture has changed significantly, and the outlook for future ethanol exports suggests a continued decrease over the foreseeable future.

China has effectively ceased imports of ethanol from the U.S. following its implementation of a 30% tariff on U.S ethanol. Exports to Brazil are also expected to erode as Brazilian sugar refiners come back on line following a sugar crop failure in 2016 that led to the country's heavy reliance on ethanol imported from the U.S.

U.S. export growth is possible to new markets such as India, Mexico and Indonesia, where governments are seeking to improve air quality, but this will likely take time to fully materialize.

Weathering the storm
While a market correction is anticipated over the next two years, it is not expected to be as severe as prior corrections. Tight margins, limited profitability and consolidations are anticipated for the ethanol industry in the near future. However, ethanol producers that survived the last market correction have become wiser about the vagaries in the market and hedge their inputs and products -- corn and ethanol -- via the futures markets.

"More idling of production is expected in the next 18-24 months, and aging facilities could be retired," Ehmke said. "Financially weak and less efficient producers who have limited access to dependable corn supplies and transportation risk being consolidated, but given the recent profitability, those producers with favorable cash positions and technology-driven efficiencies will have greater flexibility to endure prolonged periods of low prices or higher production costs."

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