Record corn prices and sluggish gasoline demand are squeezing profits for U.S. ethanol companies, prompting some producers to idle plants or slow production.
Valero Energy Corp., VLO +2.33% Abengoa Bioenergy US Holding Inc. ABG.MC -1.55%and Nedak Ethanol LLC have idled plants since mid-June, citing poor market conditions for the corn-based fuel additive. And Archer Daniels Midland Co., ADM +1.76% the biggest U.S. ethanol producer by capacity, said that its ethanol margins had eroded to a loss of well over 20 cents a gallon.
Ethanol makers are grappling with higher spot prices for corn amid tight domestic supplies, due to disappointing crop yields in the last two years and continued strong export demand, including from China.
Meanwhile, their hopes for some price relief this autumn have diminished as a drought in the Farm Belt has withered the current corn crop, driving corn-futures prices to all-time highs last week. Prices have eased this week but are still up roughly 42% since early June.
The ethanol sector consumes about 40% of U.S. corn output.
At the same time, gasoline demand has been lackluster during the peak summer travel season. The average U.S. price at the fuel pump has dipped to about $3.49 a gallon recently from a 2012 peak of $3.94 a gallon in early April, according to the Energy Information Administration. But motor-gasoline demand is still falling modestly after a 2.8% drop last year, the EIA said.
The profit squeeze for the $45 billion U.S. ethanol industry is one more reflection of how a weak economic recovery is depressing consumer demand and corporate profits. It also highlights how ethanol producers face continued pressure since the expiration last December of a federal subsidy for ethanol blenders.
Ethanol production in the week through July 20 dropped to 796,000 barrels a day, down 0.7% from the preceding week and 9.9% from a month earlier, hitting a record low for the second straight week.
The Energy Information Administration started issuing the data in June 2010. Production already was on track to decline in 2012—the first annual drop since 1996.
Archer Daniels Midland Chief Executive Patricia Woertz in June said the company's ethanol margins had fallen to a loss in the "high 20s" per gallon, compared with a loss of 13 to 15 cents a gallon in early May. ADM will report its fiscal-fourth-quarter results on Tuesday.
In a survey of about 60 ethanol plants by Christianson & Associates PLLP, an accounting firm in Willmar, Minn., the middle half generally broke even during the first quarter this year, while the least-efficient 25% lost an average of 25 cents per gallon producing ethanol.
The slump could lead more ethanol companies to idle plants this summer—and could trigger bankruptcies and greater industry consolidation if it's protracted, analysts say.
"Even the most profitable plants out there are barely breaking even in the current environment," said Matthew Farwell, a New York-based analyst for Imperial Capital LLC.
At this point, analysts and industry executives don't expect a downturn as dramatic as in 2008, when similar challenges sank ethanol margins.
At that time, many producers were recently formed and had poor risk-hedging strategies, which led some to file for bankruptcy when corn prices soared. Among them was VeraSun Energy Corp., whose bankruptcy ultimately led oil refiner Valero to enter the ethanol market by purchasing a group of VeraSun ethanol plants.
But the margin squeeze has increased pressure on companies already wrestling with the fallout from the expiration of the federal subsidy at the end of last year, worth $6 billion annually.
The subsidy granted fuel blenders, like Chevron Corp. and Phillips 66 PSX +1.58% —formerly part of ConocoPhillips COP +2.18% —a tax credit of 45 cents per gallon of ethanol they blended. Its expiration resulted in a supply glut that hasn't abated, after inventories ballooned late last year as producers rushed to take advantage of the subsidy before it ended. Sluggish gasoline demand is exacerbating the glut.
Another major factor limiting ethanol demand from blenders is a government rule that, until recently, capped ethanol's share of gasoline at 10%. While that cap has been raised to 15%, auto makers and gas stations generally have yet to adopt that standard.
And although federal mandates require 13.2 billion gallons of conventional biofuels—a category dominated by ethanol—to be blended into transportation fuel this year, that doesn't mean there is a floor on ethanol demand. Blenders can also meet their requirements using credits stored up from earlier surplus use.
In late June, Valero, the third-largest U.S. ethanol producer in terms of capacity, idled two of its 10 plants, in Linden, Ind., and Albion, Neb., citing poor margins but says it expects to resume production at the plants before the corn harvest this fall, as long as market conditions improve.
Valero reported operating income of $9 million for its ethanol business in the three months through March, down from $44 million a year earlier.
In June, Nedak, a smaller ethanol company, suspended production at its lone Nebraska plant, citing high local corn prices and weak gasoline demand.
Green Plains Renewable Energy Inc., GPRE -13.01% the fourth-biggest U.S. ethanol producer, slowed production at two of its plants that use less-efficient processing technology early this year, cutting its ethanol output by about 5%. And Pacific EthanolInc., PEIX -5.96% a smaller producer based in Sacramento, Calif., cut its capacity by about 10% early this year.
"I think we'll continue to contract," Todd Becker, chief executive of Omaha, Neb.-based Green Plains, said in a recent interview. "We have to get into a point where stocks are tighter and production is lower."
In a sign that ethanol production could remain depressed for months, the U.S. Department of Agriculture earlier this month trimmed by 2% its forecast for corn demand from the ethanol industry in the year that will begin Sept. 1.
Valero spokesman Bill Daly said that "this summer, with margins being what they are currently, it wouldn't surprise me to see others scale back production or temporarily shut down."
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