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Schork Report: Ethanol—the Rodney Dangerfield of the Energy Complex

According to the latest EIA Petroleum Supply Monthly, net fuel ethanol production finished 2009 at a record pace, just as extreme winter weather hindered demand from the transportation sector. Daily production jumped by 3½ per cent to a record 787.9 Mbbl/d. Thanks to the addition of an extra calendar day, cumulative output hit a record in December as well, 24.4 MMbbls. It was the third month-on-month increase in production in a row.

Moreover, monthly output was 20 per cent greater than December 2008 and 152 per cent above the 2003-07 average timestep. For 2009 as a whole, production averaged 697.4 Mbbl/d or 100.3 Mbbl/d (16.7%) above 2008. In fact, over the last six years daily production has increased to a record 53 times, i.e. 5 out of 7 months, despite poor distillation margins (high variable costs, primarily corn, but natural gas too).

Thanks in large part to weather related demand destruction, ethanol supplies outpaced production in December. Supplies topped out at a record 16.71 MMbbls. Poor road conditions in January and February likely retarded demand at the start of this year as well. Be that as it may, government mandated demand is set to increase this year… whether we like it or not, kind of like health care reform. (More on this topic: Schork Oil Outlook: Ayn Rand & California)

According to the EIA, fuel ethanol demand from the transportation sector rose 12.4% per cent in 2009 to 258.6 MMbbls (9.15×1014 Btus). Keep in mind, daily production in December was 787.9 Mbbl/d or 287.6 MMbbls on an annualized basis. Projections from the EIA spot transportation sector demand for ethanol in 2010 up 15.8% to 299.5 MMbbls, thereby creating a potential deficit this year of 11.95 MMbbls of ethanol.

Furthermore, discretionary gasoline blending is averaging 4.37 MMbbl/d over the last four DOE reports, thereby accounting for half of the entire gasoline pool. In other words, demand from the energy complex is stout.

Thus, in this backdrop, analysts at The Schork Reportdeem it reasonable to ask why ethanol is not commanding more respect. Per the EIA, fuel ethanol distillation margins peaked in mid-November at 68 cents per gallon, the highest level in more than two years, but they then slumped sharply to about 30 cents per gallon as ethanol prices fell in the last three weeks of the year, possibly as a result of the restart of some of the shutdown plants and a seasonal drop-off in gasoline (and thus ethanol) demand.

What’s more, last week the CBOT corn-ethanol (crush) margin for May delivery averaged $0.736. That is much better than year ago when the margin was around $0.52 and around par to 2008 when the margin with corn was around $1.30, but was really closer to $0.80 after you factored in +$9 natural gas. Therefore, margins have improved relative to the last two springs, but values are still a fraction of what they were in 2007 and 2006.

However, the recent improvement in ethanol distillation margins is likely derivative of bearish supply fundamentals for corn, rather than bullish demand fundamentals for ethanol.

According to the latest Feed Outlook from the USDA, forecast prices for corn were lowered as export prospects declined with plentiful world supplies. In particular, corn exports were lowered because of larger Southern Hemisphere crops. Increased global corn production is boosting projected ending stocks, especially in major corn-exporting countries. Specifically, recent export prices indicate that Argentine corn is being sold at enough of a discount to U.S. corn to make significant inroads in key markets such as South Korea and Japan. Additional U.S. export sales for 2009/10 are expected to be reduced by the big crop in Argentina.

In this vein, as of last Friday sugar futures in New York were the worst performing market on the S&P GSCI Index, down 28.9% year to date, the second worst performer was natural gas, down 25.1%, with corn in Chicago not far behind, i.e. down 12.1%.

Therefore, the future is now for ethanol producers; feed stock costs are depressed and demand from the transportation sector is about to increase, albeit, by government fiat.

What’s more, with domestic supplies of ethanol at record levels, imports in December were virtually nonexistent. Outside of 12 MMbbls coming down from Canada, no other imports came ashore, be they from usually dependable sources in the Caribbean (CBI) or the proverbial 800-pound gorilla that is Brazil.

With regard to Brazil, sugar futures, as previously noted, are currently circling the bowl, as it were, thereby implying cheaper import values for sugarcane based fuel, but fortunately for U.S. motorists, we tax foreign born efficiencies.

Nevertheless, the U.S. renewable fuels mandate increases this year. More importantly, California which accounts for one ninth of U.S. gasoline demand, recently boosted ethanol gasoline blends from 6 to 10 per cent. As such, analysts at The Schork Reportare noting that for the first time in about three U.S. driving seasons it might not stink to be an ethanol distiller.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.