The Critical Importance of Higher Ethanol Blends to Ethanol Producers
by Tristan R. Brown (Seeking Alpha) A new dataset illustrates for investors why the U.S. ethanol sector is staking its future margin hopes on the EPA’s recent decision to permit year-round blending of 15 vol% ethanol. Ethanol blending is very uniform across the U.S. and varies only in the small number of states in which ethanol is cheapest and is supported by particularly favorable state policies. E15 demand growth following the EPA’s decision has been too slow to even offset export demand destruction, let alone boost ethanol production margins.
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The ethanol industry has long argued that the so-called “E10 blend wall”, under which domestic ethanol consumption is limited by infrastructure to blends of no more than 10 vol%, is a regulatory rather than market constraint. The U.S. Environmental Protection Agency’s [EPA] decision last June to allow the year-round sale of E15 was hailed as a win for domestic ethanol producers on the grounds that an earlier limitation on E15 consumption during the summer effectively prevented its use during the rest of the year as well.
New data released by the U.S. Energy Information Administration [EIA] last week illustrates why rising E15 consumption is critical to the future financial outlook of ethanol producers. It has been known for the last several years that U.S. ethanol consumption has been, on average, stuck at roughly 10 vol% of U.S. gasoline consumption. What has not been known, however, has been the prevalence and regional distribution of the ethanol blend rate in the U.S. Only a handful of states have published state-level data, and this paucity has made it difficult to determine if the national average has been due to high levels of consumption of blends such as E85, in which case domestic expansion opportunities would still exist for E10, or if the 10 vol% average has been prevalent throughout the country’s gasoline supply.
The EIA’s recently-released data demonstrates that the latter situation exists. Specifically, there is very little variation in the average blend rates across the U.S. states. Excluding Alaska, which has a tiny gasoline market in which no ethanol is consumed, only one state, Louisiana, has a blend rate (8.95 vol%) that is more than one percentage point lower than the U.S. average blend rate of 10.08 vol%. Only two states, Iowa (11.39 vol%) and Minnesota (12.40 vol%) have blend rates that are more than one percentage point higher than the U.S. average. (Both states are unique in that they account for much of the country’s E85 consumption.) The remaining states all have average blend rates that are very close to the U.S. average (see figure).
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The implication for U.S. ethanol producers is that, barring unexpected growth of exports, widespread E15 adoption is the industry’s primary remaining hope for market expansion. The EIA’s data also illustrates why this hope is a slender one, however. Ethanol that is sold in Illinois and Iowa benefits from a combination of close proximity to the industry’s highest-margin production facilities and very favorable state policies. These conditions are largely absent outside of those two states, neither of which accounts for much ethanol demand (3.3% and 1.2% of the U.S. total for Illinois and Iowa, respectively).
The country’s high-margin facilities have struggled to cover even their costs of capital over the last five quarters (see figure) due to depressed ethanol prices. Ethanol prices have in turn remained low due to depressed gasoline prices, the latter of which has kept fuel retailers from clamoring for higher blends of ethanol. So long as gasoline prices remain at their current levels, then, demand for ethanol will not be strong enough to cause the widespread expansion of E15, which will in turn keep U.S. ethanol producers trapped in the current low-margin environment.
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Continued 50% annual growth would cause ethanol demand from E15 to rise by a mere 100 million gallons through the end of 2021. By comparison, U.S. ethanol exports in the first 11 months of 2019 were 246 million gallons lower than in the same period of 2018 (see figure). It will take five years of 50% E15 demand growth at the national level just to replace the export gallons that have been lost over the last year, in other words. READ MORE
