More from the EPA on the Ethanol Mandate
There were a number of articles yesterday suggesting that U.S. Environmental Protection Agency (EPA) is considering dialing back its requirements on the use of ethanol in 2014. This news should not come as a surprise to anyone given the EPA’s commentary back in August:
“Given these challenges, EPA anticipates that in the 2014 proposed rule, we will propose adjustments to the 2014 volume requirements, including to both the advanced biofuel and total renewable fuel categories. We expect that in preparing the 2014 proposed rule, we will estimate the available supply of cellulosic and advanced biofuel, assess the E10 blend wall and current infrastructure and market-based limitations to the consumption of ethanol in gasoline-ethanol blends above E10, and then propose to establish volume requirements that are reasonably attainable in light of these considerations and others as appropriate. EPA believes that the statute provides EPA with the authorities and tools needed to make appropriate adjustments in the national volume requirements to address these challenges.”
The proposed level mentioned in the news is 13.0 billion gallons of conventional corn-based ethanol in ’14, down from 13.8 billion gallons this year.
This news was met with a somewhat jittery response from shares of ethanol stocks, presumably on concerns surrounding potential overcapacity, which is a little confusing to us for a number of reasons:
- While U.S. ethanol production in the first half of 2012 was running close to 13.8 billion gallons as an annual rate, drought conditions and associated corn shortages brought the annual production rate down to 12.8 billion gallons in 2H ’12.
- In 2013, the annual run rate in 1H was also 12.8 gallons, but has been increasing since April to approximately 13.5 gallons the last several months.
- Even if the mandate goes to 13.0 billion gallons, we believe that refiners will still blend at E10 (creating RINs), with gasoline consumption in ’14 likely in the range of 131 – 132 billion gallons.
- While ethanol profitability has suffered in recent years, we believe it has been largely due to the volatility in corn prices (the input). Ethanol profitability has rebounded nicely in ’13 (Exhibit 1).
- In summary, we believe that the industry is capable of profitable operation in the range of 12.8 – 13.2 billion gallons assuming a cooperative corn price, a state of nature to which a lower mandate will likely contribute to on the margin.
Any change to the mandate likely helps the ending corn stock position in ’14, marginally, with negative consequences for agricultural machinery and chemicals to the extent that any downward pressure on the price of corn has a negative impact on farm-level economics.
We should also note that this is far from a done deal, as there are likely a number of interested parties (the Renewable Fuels Association chief among them) that will argue against any change to the mandate, suggesting that doing so will remove incentives and slow the switch to E15 and E85 (higher ethanol blends).
Exhibit 1: Corn and Ethanol Profitability