Ethanol Fuel Production & Demand
COVID-19 INDUSTRY BRIEF
EFFECTS OF THE CORONAVIRUS ON THE Ethanol INDUSTRY Updated March 30, 2020
- Market Sentiment: The U.S. ethanol industry, which was facing challenges before COVID-19, has been reeling since the outbreak of the coronavirus and the total destruction of gasoline demand that followed as California and other states adopted shelter-in-place orders.
- Production Cuts: Despite being classified as an essential industry, several dozen facilities have idled production since March 2020. It is estimated that two to three billion gallons of ethanol production have already come off line with more to follow. Many of the producers that are still operating are expected to idle production once their feedstock inventories are exhausted.
- Stimulus Impacts: While smaller producers are expected to receive aid under the U.S. government stimulus package, larger producers may not. Consequently, the industry is looking to the next round of stimulus for more focused aid for the sector. Even with the stimulus aid, the consensus is that a large number of ethanol producers will need grants to stay in business over the long run.
- Valuation Outlook: Inventory appraisal values for ethanol will be impacted from a pricing perspective but should remain stable on a market-to-market basis. Equipment assets will be materially impaired at current fuel price levels.
Date April 2021
- The U.S. ethanol industry produced 13.9 billion gallons of ethanol in 2020, down 11.7% from 15.8 billion gallons in 2019.
- Several factors contributed to the drop in production, most notably reduced demand for gasoline because of the pandemic, small refinery exemptions and lower exports due to unfavorable and protectionist trade policies.
- Ethanol exports declined for the second straight year, falling 8.5% in 2020.
- Despite the pandemic, the U.S. ethanol industry turned a profit in 2020 due to higher prices for the industry’s two principal by-products.
- As of April 2021, ethanol production has recovered to approximately 90% of pre-pandemic levels or 950,000 barrels per day but the near-term outlook for the industry is uncertain due to questions regarding final ethanol blending requirements for 2021 and future trade policies and small refinery exemptions.
A most peculiar year: What was expected to be a challenging year for
the U.S. ethanol industry in 2020 turned out to be one of the most trying
years for the industry since 2012, when a drought that wiped out large
portions of the nation’s corn crop sent corn prices soaring. In March 2020,
the COVID-19 pandemic and the related safer-at-home orders covering
much of the nation decimated gasoline and ethanol demand, leaving
ethanol producers with nowhere to sell their products. In addition, on
March 8, 2020, Saudi Arabia initiated an oil price war with Russia over
Russia’s failure to agree to cut oil production in response to falling global
oil demand. The price war triggered a major drop in global oil prices
followed by lower gasoline and ethanol prices.
In response to these events, many ethanol producers idled their plants
while others reduced output. Approximately 70 ethanol plants with output
of 6.0 billion gallons were idled as the pandemic spread. Another 64 plants
followed, reducing output and taking more than 1.7 billion gallons of
ethanol out of production. In total, approximately two-thirds of the nation’s
204 ethanol plants were either idled or were operating below capacity in
2020. This compares to approximately 10 plants idled in a normal year.
By the end of April 2020, daily ethanol production had declined
approximately 50% to 537,000 barrels per day from approximately 1.05
million barrels per day in January. To reduce losses, many plants that
remained open during the pandemic started producing industrial grade
ethanol for use in the production of hand sanitizer after the federal
government relaxed alcohol requirements for the product.
In the late spring and early summer of 2020, ethanol demand began to
recover, as the initial shock of the pandemic subsided. By the end of June,
industry production had climbed to over 900,000 barrels per day. At the
same time, prices for the ethanol industry’s primary by-products, distiller’s
dried grains with solubles (DDGS), the nutrient-rich co-product of drymilled
ethanol production, and corn oil, increased sharply, helping many
ethanol producers return to profitability. Aided by higher prices for DDGS
and corn oil throughout the second half of the year, the ethanol industry
managed to report a profit in 2020, something that seemed impossible at
the height of the pandemic.
Ethanol production declined to 13.93 billion gallons in 2020, a drop of
11.7% and the lowest level of output since 2013. Additionally, exports
declined for the second straight year in 2020, falling 8.5% to 1.34 billion
gallons, as compared to 1.48 billion gallons in 2019 and 1.72 billion gallons
in 2018. Due to the sharp drop in domestic demand, exports increased to
9.6% of total demand in 2020 from 9.2% in 2019. Three countries, Canada,
Brazil and India, accounted for over 53% of exports in 2020 with Canada
surpassing Brazil as the leading destination for U.S. ethanol for the first
time since 2017.
TRADE POLICY ADVERSELY AFFECTS INDUSTRY: Heading into 2020,
ethanol producers expected to contend with a challenging market due
to the Trump Administration’s handling of the Renewable Fuel Program
(RFP) and trade policies. The RFP mandates that refiners blend ethanol
into gasoline at a mixture of 10% ethanol and 90% gasoline. Since 2015,
the Environmental Protection Agency (EPA) has generally adopted final volume requirements for the upcoming year in November or December.
For 2017 through 2019, final ethanol volume requirements were set at 15
billion gallons. In December 2019, the EPA adopted its final ethanol volume
requirement for 2020 at 15 billion gallons; however, the final volume
requirement for 2021 has been delayed due to the pandemic.
The Trump Administration’s management of the RFP adversely affected
industry demand in 2019 and was expected to do the same in 2020. During
the Trump Administration, the EPA granted approximately 90 hardship
waivers to small refiners exempting them from the mandated blending
requirements. Researchers at the University of Illinois estimated that the
hardship waivers granted to small refiners by the EPA reduced domestic
demand for biofuels by 1.6 billion gallons, of which ethanol was estimated
to account for 1.2 billion gallons.
In addition to the waivers, the Trump Administration’s protectionist trade
policies had a dampening effect on exports. For example, China was the
third-largest importer of U.S. ethanol in 2016, accounting for 17% of
exports. However, when the trade war erupted, China imposed a series of
retaliatory tariffs on U.S. ethanol that, by April 2018, amounted to a tariff
of 70% and all but closed off the China market to U.S. ethanol producers
by 2019. In 2020, the U.S. exported a 21.3 million gallons of ethanol China,
a fraction of the amount exported in 2016. In addition to the demise of the
China market, exports to Brazil, the largest importer of U.S. ethanol from
2017 through 2019, declined approximately 34% in 2019 and 40% in 2020
due to trade policies.
CRUSH SPREAD AN INDICATOR OF FINANCIAL HEALTH: The crush spread
is a financial metric that ethanol producers routinely use to monitor their
financial health. The crush spread is the difference between the combined
sales value of the ethanol and the co-products that can be extracted from a
bushel of corn and the cost of the bushel of corn and other operating costs.
The crush spread is used to gauge the relative costs of production. 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 price of ethanol, corn oil and DDGS. When this occurs, the spread
becomes less positive, or more negative. A widening corn crush spread
occurs when the 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 declined sharply in the spring of 2020 due to the
demise of gasoline demand and lower prices for ethanol. In the second half
of the year, higher prices for the industry’s by-products reduced the net
cost of corn and enabled the industry to return to profitability. Beginning
in December 2020, the industry was challenged by a spike in corn prices;
however, since the end of January 2021, the industry has benefited from
rising ethanol prices.
INDUSTRY AND VALUATION OUTLOOK:For the week ended April 9, 2021, domestic ethanol production was 941,000 gallons per day, representing approximately 90% of pre-pandemic levels. Despite the increased level of production, most industry participants do not believe the industry will return to pre-pandemic production levels until 2022, while others believe industry demand will never recover to pre-pandemic levels.
Despite differing viewpoints, most industry analysts agree that the
industry’s near-term outlook is uncertain due to questions regarding how
the Biden Administration will administer the Renewable Fuel Program
and small refiner exemption program. For lenders with ethanol suppliers
or end users in their portfolios, it will be critical to monitor economic and
regulatory factors and the availability of government stimulus to ethanol
Inventory appraisal values for ethanol will be impacted from a pricing
perspective but should remain stable on a mark-to-market basis. Equipment
assets will be somewhat impaired at current fuel price levels.
Complex Nature of Equipment Necessitates Special Valuation Approach: Given the increased level of uncertainty in the market and growing importance of revenue-enhancing and cost-saving technologies in ethanol production, a “business overlay” approach is critical when valuing ethanol facilities to capture the full income-generating value of the equipment. This methodology considers the overall cash flows and value of a company as a whole.
An income approach, or cash flow approach, is a common method to value entire companies. The known value of company assets, such as working capital and real estate, are subtracted from the company’s total value to derive a value for the remaining assets. This residual value essentially determines whether the production assets are providing an adequate return for the company. If they are not, economic obsolescence exists.
In general, a fair market value in continued use needs to be supported by the going concern earnings capacity of the business that the machinery and equipment supports. In deriving the residual value or available return on the remaining assets, Gordon Brothers’ appraisers will consider all information available concerning the company, its assets, and industry trends affecting the company’s cash-generation ability.
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Reference sources: U.S. ENERGY INFORMATION ADMINISTRATION, ENVIRONMENTAL PROTECTION
AGENCY, U.S. DEPARTMENT OF AGRICULTURE, RENEWABLE FUELS ASSOCIATION, IOWA STATE
UNIVERSITY, CENTER FOR AGRICULTURAL AND RURAL DEVELOPMENT AND AGRICULTURAL MARKETING
RESOURCE CENTER, UNIVERSITY OF ILLINOIS AT URBANA-CHAMPAIGN, STAR TRIBUNE, NEWS BREAK,
FEED & GRAIN, MEREDITH AGRIMEDIA, KWWL TELEVISION, INC., BROWNFIELD AG NEWS, THE GAZETTE