Ethanol

Patrick Millar analyzes the U.S. ethanol industry’s market trends and pricing and provides advice for lenders based on the short- and long-term outlook.

Current Trends

• 2021 was the ethanol industry’s second-most profitable year in its history as surging gasoline demand returned to near pre-pandemic levels in July.
• Higher ethanol prices, stable corn prices and higher by-product prices generated near-record operating margins for ethanol producers from September to December 2021.
• The U.S. produced 15 billion gallons of ethanol in 2021, up 7.8% from 13.9 billion gallons in 2020.
• Ethanol exports declined for the third straight year falling 6.8% in 2021.
• Canada, India and Korea accounted for over 50% of exports in 2021, and Canada was U.S. ethanol’s leading destination for the second year in a row.

Market Outlook

Ethanol margins have been under pressure since early 2022 with lower ethanol prices, near-record corn prices from a late planting season in the U.S. and strong corn demand from ethanol producers.

The Biden administration set new federal requirements in June 2022 increasing the amount of ethanol that must be blended into gasoline to improve domestic fuel supplies, but suppliers’ year-end margins remain uncertain.

A Profitable Year

2021 was the ethanol industry’s second-most profitable year in its history despite early expectations for a dismal performance. Ethanol producers barely broke even in early 2021 with low ethanol prices and relatively high corn prices.

In January 2021, the average daily price of ethanol was $1.44.[1] By April, the average daily price of a bushel of corn was over $5.[2] Gasoline consumption jumped midyear to approximately 98% of pre-pandemic levels, driving ethanol demand at a time when ethanol stocks were relatively low and increasing ethanol prices from September through November.

Ethanol producers benefited from a spike in ethanol prices and lower corn prices driven by a strong harvest in late 2021. The U.S. produced 15.1 billion bushels of corn in 2021, up 7% from 2020.[3] Corn prices stabilized in the last four months of 2021 and this, combined with unusually high ethanol prices, generated record margins for ethanol producers in the fourth quarter, which has not happened since early 2014. Additionally, ethanol producers benefited from higher by-product prices in 2021, particularly for corn oil used for biodiesel, renewable diesel and poultry feed.

U.S. ethanol production increased by 1.1 billion gallons, or 7.8%, to 15 billion gallons, or 85%, of the industry’s 17.7 billion gallon capacity in 2021.[4] Ethanol exports declined for a third straight year in 2021, falling 5% from 2020 to just over 1.2 billion gallons primarily because of protectionist trade policies abroad and reduced demand from Brazil.[5] Canada, India, Brazil and the Netherlands are leading destinations for U.S. ethanol and collectively accounted for 55% of exports in 2021.[6]

U.S. Corn Production and Portion Used for Fuel Ethanol

Ethanol prices retreated in January and February 2022 to just over $2 per gallon before rebounding to approximately $2.70 in May. Corn prices increased approximately $2 to $8 per bushel over the same period, marking the highest price since fall 2012. Several factors contributed to the increase, including potential supply issues in Brazil, a delayed planting season in the U.S. and the Russia-Ukraine war, which affects one of the world’s largest grain production regions. Ethanol margins, which have been under pressure since early 2022, have retreated to near break-even levels as corn prices increase.

Crush Spread an Indicator of Financial Health

The crush spread is a financial metric ethanol producers routinely use to monitor their financial health and gauge the relative costs of production. The crush spread is the difference between the combined sales value of the ethanol and co-products that can be extracted from a bushel of corn and other operating costs.

When the margin exceeds processing costs, ethanol producers tend to process more corn into ethanol. When the margin falls below processing costs, ethanol producers tend to scale back their operations and idle plants. A narrowing corn crush spread occurs when the price of corn rises relative to the selling price of ethanol, corn oil and distiller’s dried grains with solubles (DDGS). When this occurs, the spread becomes less positive. A widening corn crush spread occurs when the selling price of ethanol, corn oil and DDGS rises relative to the price of corn. When this happens, the spread becomes more positive.

Ethanol crush margins increased sharply in fall 2021 driven by surging gasoline demand, higher ethanol prices and lower corn prices. While the last four months of 2021 generated some of ethanol producers’ highest margins in a decade, lower ethanol prices and exceptionally high corn prices have dampened profitability in 2022.

Ethanol Crush Margin

Source: USDA

Valuation Considerations

Since the early 2000s, the ethanol industry has encountered several periods of challenging economic conditions because of rapid growth, oversupply, high corn prices and unfavorable trade policies.

Additionally, opponents and proponents of the Renewable Fuel Standard (RFS) program, which aims to reduce greenhouse gas emissions and expand the U.S. renewable fuels sector while reducing reliance on imported oil, continue to critique the government’s handling of the program. The RFS requires renewable fuel to be blended into transportation fuel in increasing amounts each year, which has risen to 36 billion gallons in 2022. Each renewable fuel category in the RFS program must emit lower levels of greenhouse gases relative to the petroleum fuel it replaces.[7] Annual compliance costs for refineries increase in tandem with blending volumes. Costs include the buying and blending of biofuel as well as the purchase of regulatory credits to prove compliance to the EPA.[8]

The recent rise in corn prices, record-high gasoline prices and the potentially adverse effect the growing movement toward electric vehicles could have on ethanol demand is challenging the current environment. To boost domestic fuel supplies, the Biden administration set new requirements in June 2022 increasing the amount of ethanol that must be blended into domestic gasoline supply.[9] For lenders with ethanol suppliers or end users in their portfolios, monitoring economic and regulatory factors and the availability of government stimulus to ethanol producers is critical.

Pricing may affect inventory appraisal values for ethanol but should remain stable on a mark-to-market basis. Current fuel price levels will somewhat impair equipment assets. Lenders who have not recently updated the asset values in their portfolios may want to consider a new appraisal that reflects the adjustment in market conditions.

Complex Nature of Equipment Requires Special Valuation Approach

Given the increased uncertainty in the market and the growing importance of revenue-enhancing and cost-saving technologies in ethanol production, a business overlay approach considers a company’s overall cash flows and value, which is critical for capturing the full income-generating value of ethanol facilities and equipment.

An income or cash-flow approach is another common method for valuing companies in which the known value of company assets, such as working capital and real estate, are subtracted from the company’s total value to calculate the remaining asset value. This residual value essentially determines whether the production assets provide an adequate return for the company.

In deriving the residual value or available return on the remaining assets, Gordon Brothers considers all available information concerning the company, its assets and industry trends affecting the company’s cash-generation ability. Generally, a company’s earnings capacity supports the continued use of fair market value.

[1] https://www.card.iastate.edu/

[2] https://ycharts.com/indicators/us_corn_price

[3] https://www.nass.usda.gov/Newsroom/2022/01-12-2022.php#:~:text=U.S.
%20corn%20growers%20produced%2015.1,of%20171.4%20bushels%20per%20acre.

[4] https://www.eia.gov/energyexplained/biofuels/ethanol-supply.php

[5] https://ethanolrfa.org/media-and-news/category/news-releases/article/2022/02/new-rfa-reports-summarize-2021-ethanol-distillers-grains-trade-

[6] IBISWorld: Ethanol Fuel Production, Sean Egan, 2021

[7] https://afdc.energy.gov/laws/RFS#:~:text=The%20Renewable%20Fuel%20Standard%20(RFS,
Act%20of%202007%20(EISA).

[8] https://www.afpm.org/newsroom/blog/supreme-court-reviews-rfs-small-refinery-relief-program

[9] https://www.wsj.com/amp/articles/epa-trims-ethanol-fuel-mandate-for-2020-21-but-raises-it-for-2022-11654283272?mod=latest_headlines