Will Oil Prices Rescue Ethanol?

Time is running out for the ethanol blenders credit and the matching ethanol import tariff, which at least one industry publication suggests are likely to survive, but at "sharply reduced rates." Although I'm among those who suspect that the blenders credit probably benefits consumers more than ethanol producers, as long as the national Renewable Fuel Standard is binding on blenders, it seems fortunate for the US ethanol industry that this situation is playing out when crude and gasoline prices have risen to levels we haven't seen since spring, and could go higher if current economic indicators hold up.

The US benchmark futures price for crude oil is suddenly flirting with $90/bbl again, and UK Brent crude, a better gauge of world oil prices whenever WTI inventories at Cushing, OK are this high, has already surpassed that mark. Even if oil's move is at least partly the result of recent currency fluctuations, it is supported by fundamentals in the form of gasoline and distillate inventories that for the first time in months are back within their normal seasonal ranges. Crack spreads, an indicator of refining margins, look strong, reflecting solid demand. All of that suggests that if crude prices move higher, increases will be passed on in product prices, rather than being absorbed partly by refiners. That doesn't sound like good news for motorists, but how could it help compensate the ethanol industry for the potential loss of some or all of the $0.45 /gal. blenders credit?

It helps in two ways. First, by pushing wholesale gasoline prices above those for prompt ethanol even without factoring in the credit, this gives refiners more incentive to add as much ethanol to gasoline as they can, to increase their profit margins. That should put positive pressure on ethanol prices, even as blenders approach the 10% "blend wall" that the recent EPA decision on E15 hasn't yet affected. That opens up headroom for ethanol producers who have recently seen their margins, or "crush spreads", squeezed by strong corn prices. And it's especially crucial for those producers who only recently emerged from Chapter 11 protection after a protracted margin squeeze in late 2008 though mid-2009. This is an industry that spent the last five years in a frenzy of capacity building, and that only escaped creating a severe and persistent glut of ethanol because some of the marginal operators couldn't afford to run their plants. If gasoline prices fell while corn prices remain high, losing the blenders credit could put a number of plants back into bankruptcy; rising gasoline prices constitute a lucky break.

It's anyone's guess whether the present configuration of markets will remain in place long enough to ease the ethanol industry through the transition it faces after December 31, if the Congress cuts the blenders credit and tariff or allows them to lapse. After all, Europe has just dodged another bullet with Ireland, and the Euro could come under renewed threat from Portugal, Spain or Italy at any time. If recent shopping results are any indication, the US economy is looking healthier, although joblessness remains high and unemployment benefits for millions are set to end before the holiday bills come due. If oil prices swooned in the next few weeks, consumers might be relieved, but ethanol producers would see it as another lump of coal in their stocking.