Strong Ethanol Production Hurts Margins

Ethanol Production Hurts Margins

Todd Neeley
By  Todd Neeley , DTN Staff Reporter
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Ethanol prices dropped to long-term lows this week, causing profit margins to fall at DTN's hypothetical ethanol plant. (DTN file photo)

OMAHA (DTN) -- Profit margins at DTN's Neeley Biofuels hypothetical ethanol plant have deteriorated significantly in the past month, as ethanol production in the United States has ramped up and ethanol prices hit long-term lows.

Since our last update of the hypothetical 50-million-gallon plant in South Dakota, the net margin without debt service has fallen dramatically from 20 cents per gallon on Aug. 13, to just 8 cents on Wednesday. Margins including debt service came in at a net loss of 23.4 cents, compared to a net loss of 11.7 cents on Aug. 13. Most ethanol plants are not paying debt service.

DTN Analyst Rick Kment said margins have weakened because of strong ethanol production and price pressure in corn markets.

"The focus on continued strong ethanol production as well as price pressure that has developed in corn markets is likely to limit any significant additional support through the ethanol market in the near future," he said. "The lack of support in ethanol markets is likely to continue to keep margins weak over the near future."

With a large corn crop expected through the fall, he said, additional short-term pressure is likely to develop in corn and ethanol prices.

Ethanol futures are already at long-term lows with ethanol trading at $1.25 per gallon on Wednesday. That was a dramatic drop from our August update when the ethanol price received by the hypothetical plant was $1.53.

Pavel Molchanov, senior vice president and equity research analyst at Raymond James and Associates, said the price spread between ethanol and gasoline, which traded at $2 per gallon on Wednesday, is something not often seen in the market.

"Fundamentally, the problem is with depressed ethanol pricing," he said.

"This level of discount is virtually unheard of. What this indicates is that the market is seriously oversupplied. As you know, the Renewable Fuels Standard sets a floor for domestic ethanol consumption, but the industry is producing well in excess of that. Most of the surplus goes for export, but because of the various trade conflicts -- especially, but not solely, with China -- export volumes have faced pressure. That's really the issue here."

In August, ethanol margins at Neeley Biofuels received a bump from USDA's hike in corn yields and production.

The dip in margins in our latest update came despite a drop in the corn price paid by the hypothetical plant, from $3.57 per bushel to $3.45. In addition, margins were hit when the price received for dried distillers grains at Neeley Biofuels dropped from $130 per ton to $125.

The market for DDG exports to China remains largely closed off to producers in the United States after the Chinese slapped anti-dumping duties and tariffs on American ethanol producers.

DTN's hypothetical ethanol plant turned in a solid performance in June with some of its highest margins of 2018, with losses in the corn market.

DTN established Neeley Biofuels in DTN's ProphetX Ethanol Edition as a way of tracking ethanol industry profitability. Using the real-time, commodity price data that flows into the "corn crush" in ProphetX and some industry-average figures for interest costs, labor and overhead, DTN is able to track current profits. It also tracks how much Neeley Biofuels would make or lose under an infinite number of "what-if" scenarios.

DTN uses industry-average figures from Iowa State University economist David Swenson. Included in the figures are annual labor and management costs, transportation costs, debt-servicing costs, depreciation and maintenance costs. Even though Neeley Biofuels is paying debt-service and depreciation costs on its plant, many real plants are not in debt.

Also, it should be noted the calculations include all other costs such as chemicals and yeasts, electricity, denaturant and water. While DTN uses natural gas spot prices for these updates, many ethanol plants lock in prices on the futures market, so they are not as vulnerable to natural gas market volatility.

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Todd Neeley