April 22, 2013 6:30 pm
Commodities: Against the grain
Ethanol was hailed as the super-fuel to end US dependency on imports, but demand has stalled
Each petrol pump has a dual identity at Neal Hoff’s convenience store. One side bears the familiar shield logo of Phillips 66, the oil refiner. The other side, which dispenses petrol mixed with 15 per cent or more ethanol, carries a bright red warning: “Not a Phillips 66 Fuel Product.”
Mr Hoff’s store, in Lexington, Nebraska, is two miles from a refinery that turns the local corn crop into ethanol. So he leapt at the chance to sell more of it.
Phillips 66 did not. Like the rest of the oil industry, it believes too much ethanol can harm car engines and demanded the warning labels.
World biofuel production is stagnating. The stand-off evident in Nebraska is a big reason why.
In the US, which produces 60 per cent of the world’s ethanol, optimistic mandates emanating from Washington are crashing into a post-financial crisis reality of weak petrol demand and emptier roads.
The breakneck rise of ethanol and biodiesel in the previous decade transformed the behaviour of commodities, yoking energy markets in London and New York to Chicago’s agricultural futures pits.
It also sowed tensions between rich countries and poorer food importers hit by grain price spikes in 2007-08, 2011 and 2012 as rich nations forged ahead with policies that, in the words of Bill Lapp, a former ConAgra Foods chief economist, “mandated burning of our food”.
The US is not the only country where biofuels have stalled. Ethanol pioneer Brazil’s production peaked in 2010. Europe is meanwhile pondering a limit on grain-based ethanol use. Global biofuel output is “certainly flattening”, says Christoph Berg of consultancy FO Licht, an authority on the sector. “The engine is spluttering, to say the least.”
After years of double-digit increases, world ethanol production fell in 2011 and 2012 and – excluding Brazil – will probably shrink again this year, according to FO Licht. The smaller biodiesel market expanded by 1 per cent last year.
The US is the biofuel engine’s main combustion chamber. Washington will be crucial in determining whether it regains momentum. Without policy changes, some analysts see a range of dire outcomes from higher petrol prices to a global vegetable oil supply squeeze. The oil and renewable fuels industries, two of the most powerful lobbies in America, are battling over the best way to avert these scenarios.
Supporters of the US biofuels mandate saw it as a step towards energy independence and away from petroleum. Since then, the shale oil boom has knocked US crude oil imports to a 15-year low, while greens are alarmed over how much sensitive land has been ploughed and planted with corn.
“Environmentalists liked it, agricultural interests clearly supported it and there was a security issue with self-sufficiency,” says Greg Page, chief executive of Cargill, the US-based agribusiness. Now, “the environmentalists have left, and the whole issue of the US’s energy exposure to imports is being diminished. So it’s going to be a single-issue constituency that supports it.”
The story is entwined with the US economic bust. In December 2007 Congress enacted the Energy Independence and Security Act. The law dictated steep rises in the amounts of biofuel sold at petrol stations, from 9bn gallons in 2008 to 16.55bn gallons this year and 36bn gallons in 2022.
The Renewable Fuel Standard showered money on corn belt states such as Nebraska. Ethanol plants owned by companies such as Archer Daniels Midland, Koch Industries, Poet and Valero Energy raised their corn consumption from 2.1bn to 5bn bushels between 2006 and 2011. Corn prices doubled. Farm income broke records.
The US was already in recession when Congress passed EISA and nine months later would be plunged into the worst financial crisis since the Great Depression. US gasoline demand has not recovered since. This year the Energy Information Administration projects drivers will pump 133bn gallons – 6 per cent below the peak of 2007. But the mandate requires annual rises in ethanol use irrespective of demand.
Petrol stations could meet the mandate by adding more ethanol to each gallon. But the oil industry refuses to blend more than 10 per cent, roughly 13bn gallons. Mr Hoff’s is one of only 23 US locations to sell the “E15” ethanol blend years after the Environmental Protection Agency approved its use in vehicles made after 2000.
Jeff Lautt, chief executive of ethanol producer Poet, says: “People like to say that we’ve got this ethanol mandate. In reality, what we have in this country is a 90 per cent gasoline mandate. We’re trying to get access to 15 per cent of the gasoline gallon, but ultimately we’d like to have access to 100 per cent of that gallon and let the consumers choose. For the first time in the history of this country we’re creating a viable alternative to gasoline, and that’s good for consumers.”
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Consumers are not exactly clamouring for etanol, however. AAA, the motoring organisation, recommended suspending sales of E15 as many drivers are unaware it is not appropriate for every vehicle. At Mr Hoff’s store, in the heart of a county where farmers usually grow 180 bushels of corn per acre, pure gasoline is by far the biggest seller despite costing most at the pump. The volume of E15 purchased is “a little under 100 gallons” per day, he says. “We can produce the amount required under the RFS. But the RFS is not a production standard. It’s a consumption standard. It’s not possible to consume the required quantities,” says Mr Berg.
In the absence of more ethanol blending, fuel companies can straddle the gap between mandated and actual biofuel sales by purchasing credits known as Renewable Identification Numbers, or RINs. Exploding RIN markets show the dramatic impact of US biofuel policy crashing into the reality of the petrol market.
A RIN is issued alongside each gallon of ethanol or biodiesel as it is produced. Oil refiners and petroleum product importers unable to meet their biofuel obligations can instead purchase a RIN in the secondary market to comply with the law.
With the blending obligation rising but petrol consumption static, a virtual panic over a shortage of credits has driven RIN prices from five cents to more than 90 cents. While the value of the credits is dependent on government policy, the costs are real. Valero, the biggest independent oil refiner as well as an ethanol producer, warned analysts of $500m-$750m in RIN costs this year. At CHS, a farmer co-operative with oil refineries, RIN expenses have trebled from a year ago.
Allegations are flying. Mike Jennings, chief executive of oil refiner HollyFrontier, last month said the RIN market had become a “casino” for commodity brokers and hedge funds. Bob Dinneen, long-time chief of the Renewable Fuels Association, told reporters, “oil companies are trading these RINs among themselves” in a “cynical and sophomoric effort to fuel hysteria” over the Renewable Fuel Standard. A consultant hired by the American Petroleum Institute lobby forecast petrol and diesel costs would rise 30 per cent by 2015 as oil companies scramble for scarce credits.
In a potentially perverse turn, the slowdown in demand for corn-based ethanol could even have the effect of straining supplies of vegetable oil and animal fats, the main source for biodiesel used in trucks, according to economists at the University of Illinois. As stocks of ethanol RINs are depleted and petrol demand wavers, fuel companies may be forced to meet the mandate with biodiesel instead.
“In 2015, the United States would need to use every gallon of fats and oils in the production of biodiesel to meet the mandate, with tremendous pressures on vegetable oil and fats prices around the world,” says Scott Irwin, University of Illinois agricultural marketing chairman. He recommends freezing the mandate at 2013 levels for the next two years.
Even the Renewable Fuels Association has acknowledged that some elements of the fuels mandate it champions will be unachievable, at least until E15 wins acceptance. In comments filed this month, the lobby recommended that the EPA for the first time cut the overall mandate to account for unpredictable imports from Brazil, whose sugarcane-based fuel is one source of “advanced” biofuels that is not distilled from corn.
Companies with a stake in biofuels say higher RIN prices are a critical lever to push recalcitrant oil companies towards their product. In the old industrial city of Newark, New Jersey, entrepreneurs formed a company called Grease Lightning in 2010 to collect used cooking oil for sale to biodiesel refineries. Its smudged steel tank trucks, adorned with lightning bolts, now tap bars, cafeterias, hospitals and restaurants including Manhattan’s Russian Tea Room for raw material.
“In the grand scheme of the biodiesel world we are sort of the frontier drillers, pulling oil out of the ground and shipping it out to refineries,” says Jamie Hutson, director of business development.
Biofuels are also coming under attack in Europe, source of 41 per cent of the world’s biodiesel and 5 per cent of its ethanol, according to FO Licht. Draft legislation in Brussels would cap the share of food crop-based biofuel to 5 per cent of total transport fuel consumption amid concerns planting crops for fuel is undermining greenhouse gas goals.
Rob Vierhout, secretary-general of ePure, the European ethanol industry group, says: “We have seen the big growth. It is now plateauing. The curve is less steep. Maybe it will pick up again, but certainly not the same big numbers we had seen in the past. All the big projects have been built.” New investments will probably be in commercially unproven “second-generation” biofuels made from sources such as wood or straw, he believes.
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The rise of biofuels has already tied together previously disjointed commodity markets. In a recent paper Fernando Avalos, senior economist at the Bank for International Settlements in Basel, found the relationship between crop and oil prices strengthened after the US Renewable Fuel Standard was established in the mid-2000s. “The RFS seems to have changed the plumbing that connect oil and crop prices,” he said at the International Monetary Fund last month.
Biofuels may be slowing but they are not in retreat. The oil industry depends on ethanol to boost petrol octane and improve car exhaust, indicating its love-hate relationship with the biofuels industry will persist. The US Department of Agriculture projects biofuel production in the big world markets will rise 30-40 per cent between 2013 and 2022, although “at a slower pace than in recent years” as expansion depends on biofuels policies that are now under attack.
Others are less sanguine. “There has been a deceleration, if not complete stagnation or decline” in biofuels, says Abdolreza Abbassian, senior economist at the UN Food and Agriculture Organisation in Rome. “Unless the prices of feedstocks were to go down sharply, and oil prices went through the roof, I really do not see a significant upturn in ethanol production.”
Sugarcane: Brazil throws a lifeline to producers
Sugarcane producers in São Paulo, the epicentre of the industry in Brazil, which is the world’s biggest exporter of the commodity, have been looking keenly at the skies.
Heavy rains were delaying what was expected to be one of the biggest harvests in recent times, projected by Bloomberg New Energy Finance at between 580m and 600m tonnes of crushed cane compared with last year’s 532m tonnes.
Last week the weather cleared, the mills cranked up and the “crush” began.
“Under optimum conditions where you get a super good harvest, a big crush and high sugar throughput, then hydrous and anhydrous ethanol production is set to rise,” says Harry Boyle, analyst with BNEF.
Brazilian analysts predict a large part of this harvest is bound for the country’s “flex-fuel” motors – its fleet of cars that can run either on petrol blended with anhydrous ethanol (biofuel with negligible water content) or using only hydrous ethanol (fuel with 3-4 per cent water content).
Part of the reason for this is that Brazil is set to increase the ethanol blend in fuel from 20 per cent to 25 per cent from May 1 – and has announced tax cuts on the biofuel to throw a lifeline to struggling producers.
“The harvest this year compared with last year is going to favour ethanol production,” says Antonio de Padua Rodrigues of Unica, the Brazilian sugarcane industry association.
The industry has been struggling to compete in recent years partly because of a government policy of keeping petrol prices low at the pump as an instrument to suppress inflation.
Petrobras, Brazil’s state-owned oil producer, has been importing part of the nation’s petrol needs and selling it at below international prices, hurting not only its own profits but also those of the ethanol industry.
The other aspect favouring ethanol this year is weaker sugar prices, which will push producers to convert more of the results of their cane output towards biofuel production.
In terms of exports, much will depend on the debate raging in the US, but Mr Rodrigues predicted this year that they would remain constant at about 3bn litres.
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Copyright The Financial Times Limited 2013.
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