Ethanol has outgrown the Renewable Fuel Standard

Everybody knows that investing in ethanol right now is a bad bet. The logic is simple: The national average price for a gallon of regular gasoline was $2.45 on Thursday, down about 30 percent from this time last year. Ethanol prices have dropped as well.

On top of that, you have the uncertainty of whether the EPA will ever issue a Renewable Fuel Standard for 2014, let alone 2015. Marin Katusa, chief energy investment strategist for Casey Research, is warning investors:

[Warren] Buffett would tell you, if you asked him, that an investor should absolutely avoid the ethanol market in the current market. Why? Because of his two rules:
1. Don’t lose money.
2. Don’t forget rule #1.

Yet if the ethanol effort is about to run out of gas, how do you account for stories like this:

Ethanol industry pretax profit estimated at $7.8 B for 2014 (Ethanol Producer magazine)

The U.S. ethanol industry came off its best streak of profitability in January, one that ran 95 consecutive weeks without a loss for the model Iowa plant used to estimate and track industry profitability. … University of Illinois economist Scott Irwin presented his analysis of ethanol profitability in a recent FarmDocDaily post, “2014 really was an amazing year for ethanol.”

Ethanol plant stays profitable in challenging times (Farm and Ranch Guide)

Changing over from powering Red Trail Energy LLC with coal to using natural gas is a major step forward for this ethanol plant in southwestern North Dakota. With the changeover from coal to natural gas in March, the plant will be able to produce more ethanol, according to Gerald Bachmeier, CEO of Red Trail Energy LLC. … “We’re excited about the change and the opportunity to reduce our carbon footprint,” he said.

Pacific Ethanol reports 2014 was a record year (Ethanol Producer)

Pacific Ethanol Inc. has released 2014 financial results, reporting record net sales, gross profit, operating income, adjusted EBITDA and gallons sold. Neil Koehler, CEO of Pacific Ethanol, called 2014 a pivotal year and stressed that the company met and exceeded all of its goals for 2014. Shares of Pacific Ethanol were up 23.4 percent at $11.51 Thursday afternoon.

Something is going on in the ethanol industry that commentators haven’t quite grasped. I would put it this way: The industry has matured to the point where it doesn’t much matter how much ethanol the government says we have to consume. The industry has outgrown the Renewable Fuel Standard.

Here’s another headline that indicates what’s going on:

Louis Dreyfus ships big U.S. ethanol cargo to Middle East traders (Reuters)

Louis Dreyfus Commodities has shipped a large cargo of U.S. ethanol worth $17 million to the Middle East traders said, stoking hopes among U.S. producers of renewed appetite from some buyers overseas. Dreyfus, one of the world’s largest commodities merchants and a major ethanol player, is sending 280,000 barrels of ethanol from the Port of New York to Jebel Ali in the United Arab Emirates, where it will be blended into gasoline for Iraq, according to four traders familiar with the move.

This followed on a February 27 report that Dreyfus had also shipped 3.56 million gallons by tanker to Brazil, which is the world’s leading consumer of biofuel.

“Consumption was surprisingly high last year and now mills must refill inventories,” Mauricio Muruci, an analyst with Porto Alegre, Brazil-based research firm Safras & Mercado, told Bloomberg. Brazilian ethanol demand jumped 15 percent to 5.41 billion gallons last year, the highest level since 2010, data from Sao Paulo-based sugarcane group Unica show. Ethanol, produced from corn in the U.S. and sugarcane in Brazil, is used as a transportation fuel undiluted or in a blend of 25 percent of the biofuel and 75 percent gasoline in the Latin American country.

So American ethanol is filling gas tanks in Iraq. It is replenishing inventories in Brazil, which uses more ethanol than any other country. Is there any doubt that there is a world market for this product?

The opening of world markets comes just at the time when the impracticality of the Renewable Fuel Standard is becoming too difficult to ignore. Senators Diane Feinstein (Democrat of California) and Pat Toomey (Republican of Pennsylvania), a kind of east-west alliance, have introduced a bill ending the Renewable Fuel Standard altogether.

This past weekend at the annual Iowa Ag Summit, a passel of Republican presidential hopefuls addressed the ethanol issue, and none of them was very enthusiastic. This contrasted starkly with the usual kowtowing to Iowa farm interests that characterizes the run-up to the Iowa caucuses, the first official event of the primary season. In 2012, both Newt Gingrich and Mitt Romney, who had publicly opposed ethanol subsidies, buckled under pressure and supported ethanol. That may not happen this time around. With several candidates opposing the RFS — and with Iowa mattering less and less to Republican Presidential hopefuls — the group may get up the courage to defy the state on the issue.

And the question must be asked: “Does it really matter?” Corn-bred ethanol seems to be doing very well despite the falling price of gas. And there is this report out of the University of Illinois:

A recent study simulated a side-by-side comparison of the yields and costs of producing ethanol using miscanthus, switchgrass, and corn stover. The fast-growing energy grass miscanthus was the clear winner. Models predict that miscanthus will have higher yield and profit, particularly when grown in poor-quality soil. It also outperformed corn stover and switchgrass in its ability to reduce greenhouse gas emissions.

It’s obvious the industry is still maturing. Iowa farmers may be much better off growing miscanthus on marginal land while sticking to their normal rotation of corn and soybeans. And as long as there are cars on the road, there will always be a market to buy it.

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[Disclosure: On the basis of research for a previous Fuel Freedom article, the author recently purchased a small holding of Pacific Ethanol stock. So far he is happy with the investment.]