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February 2, 2007 Special Message From Our Author Is corn demand for fuel going to increase? Today's Featured Article
ETHANOL THE FUEL OF THE FUTURE(S)? Ethanol or just plain alcohol has been around since man first learned the art of fermentation. It is an odorless, clear, flammable, somewhat toxic liquid. It has been said that at one time seventy percent of the vodka distilled in this country, could well have been ethanol if the margins were better. As a fuel ethanol is a high octane, clean burning energy source derived from renewable sources: which in the United States is primarily corn, in Brazil it is primarily sugar. But ethanol can also be produced from wheat, barley, sorghum, certain trees and certain grasses. Using today's technology there is about 345 gallons of ethanol produced per acre of corn, and about 600 gallons per acre of sugar in Brazil. WHY THE SUDDEN INTEREST? It is not as sudden as the recent surge might suggest. It really started in about 1990 when the Clear Air Act Amendments mandated the use of oxygenated fuels in areas of the country where the air quality was compromised. The demand for ethanol then took a quantum leap when the Energy Policy Act of 2005 contained a Renewable Fuels Standard that required a percentage of motor fuels in the United States be obtained from renewable sources. It should be obvious that the Renewable Fuels Standard is the foundation upon which the ethanol demand stands.
WHAT HAS THE IMPACT BEEN? In 2006, seventy-two new ethanol plants were built or under construction, with a fair number of the existing one hundred and sixteen plants expanding capacity. Just under half of the new capacity started production in the year since the enactment of the energy bill. Production has expanded from 3.4 billion gallons in 2004, to about 5.0 billion gallons in 2005, and about 6.0 billion gallons in 2006. Taking the new and planned facilities into consideration there are projections that put the U.S. ethanol production at 18 billion gallons level within the next eighteen months. During the first part of January 2007 a major U.S. producer announced the intention to build four new 100 million gallon facilities. Many hold the belief that the majority of production and new construction is in the hands of the major corporations. Fact is that today nearly half of the production facilities are farmer owned. PROPORTED NEGATIVES From the onset of ethanol production there have been vocal critics. An area that receives critical review centers on the 51 cents federal tax credit. Critics point out without tax credits and tax breaks ethanol would not even be on the radar screen. While this may be true taken by itself, critics never factor in cost of crop support payments if farm prices fall below prescribed levels and achieve an actual net cost figure. To me the choice is clear, as a nation we can support ethanol and reduce our dependence on imported oil, or pay farmers crop support prices and increase our use of imported oil. A second area receiving criticism is the belief that takes more energy to produce ethanol than the energy produced. Recent studies show that with the improvement in engineering that is no longer true. These studies show that there is a positive energy return ranging from twenty-five to fifty percent. There are those that will argue that once the energy used to plant in the crop, then fertilize the crop, then harvest the crop, and finally deliver the crop is taken into consideration, the energy return remains negative. What is not mentioned in that analysis is the production energy is spent regardless of the end use. ETHANOL PRODUCTS AND USAGE Ethanol is used as an additive or extender, if you will, when blended with unleaded gasoline. It is kind of like "Hamburger Helper" for the gas tank. In 2005, ethanol was blended into slightly less than half the gasoline consumed in the U.S., which is equivalent to slightly more than 3% of the total U.S. gasoline consumption. The two basic products are a 10% blend or E10, and an 85% blend or E85 used in Flexible Fuel Vehicles. The E10 blend is widely available and can be used in any vehicle, while the E85 is not as easily found with fewer than 1200 locations in the country. The Flex Fuel Vehicles can operate on straight gasoline, or any blend up to 85%.
IMPACT ON COMMODITIES The most obvious commodities impacted are corn in the U.S. and sugar which is used in Brazil. Consider that with Brazil's aggressive policy mandating the movement towards renewable fuels, it has been able to release itself from the clutches of imported oil. Be aware that the production of ethanol from sugarcane is significantly more efficient than from corn. Jim Rogers in his book, "Hot Commodities" (recommended reading), builds a long term bullish case for sugar as Brazil uses an increasing amount of sugar for ethanol production. As an interesting extension, Mr. Rogers goes on to suggest as this happens, it will have a long term bullish impact on coffee as the Brazilians reduce coffee acreage to increase sugar production. In the U.S. the major impact of ethanol production will be felt initially in the corn market. The USDA projects use by distillers to be about sixty million tons by 2008. I think they are so far off in left field they are past the bleachers and over the fence. I believe the reason for their error (if I am correct) lies in the inadequate information as to new ethanol plant construction. Presently, the government is projecting just over two billion bushels of corn for ethanol production or the equivalent of just over thirteen million acres at 150 bushels to an acre. It is my belief that the new plants on average are larger than the older plants, producing somewhere between 50 million to 100 million gallons of ethanol annually. If I am correct, I believe corn used for ethanol production could almost double to something around the 3.8 billion bushel level. What does that mean? Just consider the following ratio, a million bushels of corn at 150 bushels an acre is equivalent to about 6,700 acres of corn. Take that a step further, five million bushels at 150 bushels an acre is equivalent to about 33,000 acres. 1.8 billion bushels of corn at 150 bushels to the acre is equivalent to about twelve million acres of corn. I do believe that the twelve million acre figure will be reduced to some extent as users of corn switch to other more economical inputs. Even so we will have to add significant acres none the less. Given the demand fundamentals and current realities, I believe we will see a yearly struggle by soybeans, wheat, and corn to attract sufficient acres to meet demand. In my opinion, nothing in my 32 years in this business has had the potentially dynamic impact on grain and oilseed prices as does the demand for alternative renewable fuels. Understand, for more years than I have been in the business Iowa has been a corn surplus state. But in the near future, Iowa could become a corn deficit state. That is significant, whoever heard of corn being shipped westward INTO Iowa. It is my opinion that the growth in ethanol facilities has and will forever change the fundamental realities of the grain and oil seed markets. CONCLUSION As more ethanol plants come on line, demand for corn will increase not because it makes complete economic sense, but because it is mandated by the law. I think it is necessary to understand that as an industry ethanol is only in its infancy. I believe over time with better science and engineering our facilities will become more flexible and efficient in both the source of energy used in the production of ethanol and the amount of energy produced. Until then I believe we will be witnessing an increased competition between the various grains and oilseeds in an effort to attract acres. I do need to point out that the government may eventually release acres from the Conservation Reserve Program. That process may take as long as a year to take effect but will have a negative impact on prices when and if it happens. Jim Rogers in his book, "Hot Commodities", speaks of a fifteen year to seventeen-year bull market in commodities. If true, I believe that ethanol will be one of the major engines in this potential bull market. There is a risk of loss in trading futures and options. The futures markets very quickly factor in well-known public events, thus removing any obvious opportunity for profit. About the Author Lee Gaus is a 54 year old industry veteran of twenty-six years. Lee began his career in the livestock feed business before becoming a grain merchandising/commodity trader with a leading international company. Special Message From Our Author Is corn demand for fuel going to increase? |
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Disclaimer:The Commodity Futures Trading Commission has asked us to also advise you that trading futures is not without risk. While there is opportunity for incredible wealth building, there is also the risk of losing even more than you invested. Of course, that's not unlike most other businesses. But informed traders are the best traders! Opinions expressed by Fast Break authors are not those of FutureSource. |