INDUSTRY ANALYST SAYS LONG TERM OUTLOOK FOR ETHANOL STILL BRIGHT
Jun. 6, 2014
Illinois Agri-News reports:
Strong exports and domestic demand sets the stage for a bullish long-term ethanol market outlook after a contraction later this year.
"I am bullish on biofuels longer term. I think this is a market that continues to grow and continues to have value to the U.S. economy," said Craig Irwin, Wedbush Securities equity analyst, in a May 27 webinar hosted by Allendale Inc.
"In the short term, I am a little bit cautious that we may see some continued weakness or profit contraction for ethanol producers, but that will most likely start resolving itself at the end of the year."
Irwin said analysts are focused on the upcoming U.S. Environmental Protection Agency's final ruling on the Renewable Volume Obligation for the Renewable Fuels Standard, Brazilian sugar cane-to-ethanol production and policies and a potential transportation ruling affecting rural tanker cars.
"The EPA is usually a somewhat predictable agency, and the August 2013 U-turn on RVOs took us by surprise," Irwin said.
That is when the EPA proposed cutting the ethanol requirement in the RFS from 14.4 billion gallons down to 13 billion, a plan that was included in a leaked document in mid-August two weeks after the EPA had released a positive view of the ethanol industry.
"Our understanding is, in the final regulatory review, usually the Office of Management and Budget in the White House is the one that basically drives the bus while the Council of Economic Advisers closely monitors RVO developments, but in August 2013 the Council of Economic Advisers was in control," Irwin said.
"We hear from executives in industry that the EPA is admitting they omitted analysis of carry-forward compliance credits that were available from last year to this year, and they omitted both exports and imports from their analysis. Those are very big omissions and not something they've done historically."
High Renewable Identification Number prices also are part of the mix. RIN is a serial number assigned to a batch of biofuel for the purpose of tracking its production, use and trading as required by the U.S. EPA's Renewable Fuel Standard.
"The political consequences of high RIN prices are difficult for any administration to swallow," Irwin said.
"Basically, it makes it easy for 'big oil' to take shots at the political priorities and to misrepresent what's being done for consumers, so I think that is probably the primary driver for an RVO below trend."
Despite the proposed RFS cutback, EPA Administrator Gina McCarthy has made multiple statements in support of biofuels.
Turning to the ethanol export environment, Irwin said Brazil is the key. U.S. ethanol exports in 2014 have benefited largely from the drought in Brazil - sugar cane production is projected downward 5.2 percent this year - and high sugar prices.
"It has really created a great opportunity for corn-based sugar versus cane-based sugar," Irwin said.
Brazil also is considering increasing the ethanol blend rate from its current 25 percent to 27.5 percent. The country's political leaders are weighing the possibility of ending gasoline price controls, as well.
"A lot of the fund managers I talk to here are really pretty excited about that potential (for a blend increase), but when I talk to the Brazilians they're much more constructive on the price controls," Irwin said.
"Their explanation is that this would cause economic switching over from gasoline to ethanol and that that would have a much more material impact on their local market and then as a consequence that would create a much more accommodative export environment for the U.S."
Tank Car Rules
One concern that could throw a monkey-wrench into the forecast is a pending tanker rail car rule change that would take cars out of service for 30 to 60 days. About 70 percent of ethanol is transported by rail.
The U.S. Department of Transportation is expected to submit a package of regulatory changes for rail shippers, including retrofitting with thicker hulls or phasing out the DOT-111 cars commonly used for shipping crude oil and ethanol after several fiery derailments the past year. Canadian officials recently unveiled similar plans.
"The Polar Vortex that we experienced the beginning of the year and the shut-in of some of the ethanol production had a pretty significant impact on profitability. I could see the same thing happening if the tanker fleet shrinks in the short term," Irwin said.
The analyst sees a continued bright future for ethanol production profitability, driven by exports and domestic demand.
"We had a really amazing run the last several months. 2013 U.S. ethanol exports were strong, but started 2014 stronger," he said. "Growth in gasoline demand right now, if nothing changes, I think actually gives us much better visibility on profitability in 2016 than it does in 2015.
"So another 300, 400, 500 million gallons of ethanol demand in 2016 driven by gasoline demand growth should be more than enough to sop up the increase in ethanol plants we're going to see come on line.
"Absent any changes, I think we're probably going to be not as profitable in 2015, but 2016 could again be another exciting year."
Demand For Corn
This also translates into strong demand for corn by the ethanol industry over the next couple of years.
"If we are able to get a more robust export market together by the price controls coming off in Brazil and maybe a higher blend rate in Brazil, clearly that is supportive of some pretty strong demand for corn from the ethanol industry," Irwin said.
"Now there are some potential huge pluses out there. Everybody loves to talk about China. Personally, I think the reality of price de jour, which is how they deal with cargos that they don't like, makes that a much more complicated long-term phenomenon.
"But I think that you'll continue to see incremental gains in the demand from the ethanol industry for corn to support production.
"On the biodiesel side, the outlook for an RVO adjustment and the probability of the blenders' credit being reinstated both are pretty strongly supportive of a nice earnings recovery in this industry. The question is not if. The question is when."