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Credit Crunch and High Feedstock Costs Threaten U.S. Ethanol Industry
25 Jun 08
Unfavourable market conditions, compounded by bad weather, are threatening to derail the United States' great ethanol experiment—at least temporarily.
Global Insight Perspective | | Significance | A once-bright outlook for the ethanol industry in the United States has become significantly cloudier of late. | Implications | Ethanol production margins have been squeezed this year by a combination of rising corn and natural gas prices, and bad weather that has destroyed corn crops. The weaker U.S. economy and tighter credit conditions have made operating and financing new ethanol build much more expensive, and in many cases unprofitable, driving smaller players out of business. | Outlook | The situation effectively places at risk the mandates established by the U.S. federal government calling for much greater renewable fuel production, but the poor state of the industry potentially leaves it open to eventual consolidation as investors seek underpriced assets made cheaper still by the weak U.S. dollar. |
The U.S. ethanol industry is suffering under the weight of problems ranging from flooding to increasing feedstock and natural gas costs, even as tighter credit conditions make operations and new build more difficult. Reuters reports that floods two weeks ago destroyed significant volumes of corn yields across eight states in the U.S. Midwest, and this has pushed corn prices, which were already rising, even higher. The result has been that several smaller ethanol producers have seen their profits slashed, with negative margins threatening to send many into bankruptcy. Some estimates have suggested that prevailing market conditions could mean that up to 5 billion gallons of ethanol output are wiped out this year. The United States currently has around 154 ethanol refineries with an aggregate production capacity of 8.8 billion gallons per year (g/y). Actual production in 2007 stood at just under 6.5 billion g/y, according to the U.S. Energy Information Administration (EIA). Outlook and Implications These problems call into question the country's ability to meet the federal government mandates set out not just by the Energy Policy Act of 2005's Renewable Fuel Standard (RFS), but also by the Energy Independence and Security Act of 2007. The RFS programme calls for increasing renewable fuel output every year until 2012, by which point a minimum of 7.5 billion g/y should be being produced annually for use in gasoline (petrol) blending. The standard then requires production to continue growing in line with gasoline demand. The 2007 Act supplements these requirements by setting a further mandate boosting production of alternative fuels, such as ethanol, in the United States to a minimum of 36 billion g/y by 2022—around five times current output levels. Most current ethanol production comes from corn—itself an important food crop—and this factor has proved immensely problematic for ethanol producers as the costs of the feedstock have spiralled upwards. Over the last year, corn prices have more than doubled to over US$7.50 a bushel, and this, along with effective limits on how high ethanol can be priced, has meant that many smaller producers have been forced to cease production, either temporarily or permanently. Given that many ethanol plants are fired by natural gas, these businesses have also been exposed to further price risk on this front, where natural gas prices have themselves reached new records this year. For new ethanol plants under construction, these market fundamentals have coincided with a drying-up of credit, and a weakened U.S. economy, making it more expensive still to finance the projects, even as demand seems to be hitting a wall. Given these factors, the industry will eventually be seen as underpriced, potentially paving the way for consolidation and new investments. Foreign buyers are likely to feature quite widely thanks to the advantage conferred on them by the weak U.S. dollar. For many smaller producers however, these challenges will prove insurmountable, forcing them out of business.
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