Can corn be too expensive for ethanol?

It is true that ethanol production adds to the demand for corn, although livestock feed is still the largest demand factor; at least it was through 2007. The USDA is projecting that ethanol production will surpass livestock feed as the primary corn demand factor in 2008. However, the high and rising price of corn may prevent that from happening.

U.S. ethanol production capacity was expected to increase from about 8.4 billion gallons at the end of 2007 to about 11.4 billion gallons in 2008. That would have increased corn demand by one billion bushels; from 3 billion bushels in 2007 to 4 billion in 2008. Both the capacity expansion and the increase in corn usage are in jeopardy.

I had another odd thought earlier today.

Considering the relative price of corn versus oil and also that the subsidy on ethanol does not increase with increasing corn prices, it may be possible for corn to become too expensive to sell ethanol for a profit. I did some algebra and estimated that with gas selling for $4.00 per gallon, the breakeven point for ethanol is a corn price somewhere between $6 and $7 per bushel.

I was way off. According to this agricultural report published yesterday, breakeven is close to $8 per bushel. The graph below shows that since early 2007 ethanol went from windfall profits of as much as $0.50 per gallon to selling at a loss.

The bottom line is that in 2008, U.S. ethanol production will probably not reach the 9 billion gallons called for the RFS mandate; ethanol production capacity will not increase much if at all this year; and corn usage for ethanol production will be closer to 3 billion bushels than the forecasted 4 billion bushels. In the case of ethanol production, even with government intervention, the market is working to ration the available supply of corn as feedgrains are being bid away from ethanol production in favor of other uses.

I am digging it, the market works. And it exacts it's revenge.

Since mid-2007, U.S. corn prices have increased as domestic feedgrain supply prospects have caught up with demand. As a result, ethanol production gross profit margins were reduced in the later part of 2007 to the degree that almost no new ethanol plants were announced or planned in the U.S.. In fact, ethanol plants on the drawing boards were canceled before construction could begin, and work was halted on a few plants that were already under construction.

Now, operating ethanol plants are feeling the pain of declining profitability if not outright losses. The astronomical price of crude oil has caused gasoline and ethanol price to rise, but corn price has risen even more on a percentage basis. Some smaller plants, plus a few larger plants that were having trouble with financing arrangements, have already shut down. A recent article reported that 16 ethanol plants either were in bankruptcy or were preparing to file for bankruptcy. The same article predicted many small and medium sized plants would soon be moth-balled until profit margins improved. Anecdotal reports from ethanol producers indicate that even large scale, efficiently run plants are reducing corn grind; in other words they are producing at less that full capacity.

The issue for states where mandated ethanol is sold, is that ethanol prices will be forced to rise to make it profitable. Consider it another tax imposed by a government that sells public policy to the highest bidder, in this case to corn producers.

The bright side of the above is that eventually the value of corn as feed and food is greater than it's value as fuel. Even with today's record high gas prices and subsidies, ethanol costs too much to sell. This can act as a cap on corn prices. The market has chosen it's two.

Read the entire report here.