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Gold Report 2015

Goodbye Biofuels!

Commodities / Bio-Fuels Nov 12, 2012 - 02:12 PM GMT

By: Andrew_McKillop

Commodities

Best Financial Markets Analysis ArticleTo be sure, there are biofuels and biofuels. Some, called second-generation non-crop biofuels have "good long-term outlooks", but others are clearly uneconomic and a recipe for bankruptcy for any unwary producer and investor. The first major point is the volume output of "present generation" biofuels makes them a side issue for world energy, for the simple and basic reason they are uneconomic. We can start with the big numbers - for production of "present generation" bioethanol fuels able to subsitute gasoline - dominated by the US and Brazil, noting that world biodiesel production (from vegetable oils and animal fats) is far behind the total for bioethanol.


Reports from the US EIA in November show that US ethanol production is headed for its first year-on-year decline in 16 years, driven by higher production costs and lower demand. Shrinking distilling margins in the first 10 months of 2012 resulted in a 14% drop in bioethanol output to an average of 827 000 barrels a day, or 12.7 billion gallons annually, on a 98% pure ethanol basis. This is equivalent on an energy basis to about 551 000 barrels a day of gasoline (1 gallon of pure ethanol = approximately 0.67 gallon of gasoline). In turn this can be compared to US motor gasoline consumption, still running at well below its 2007 peak, and estimated by the EIA at around 8.5 million barrels a day in August.

On a gross basis therefore, this is about 7% of US motor gasoline demand, but ethanol of any kind (either oil-derived, or bioethanol mainly from maize in the US) enters into the complex mixture of ingredients for gasoline blending, with firm limits on percentage alcohol in gasoline blends, making it highly theoretical to compare gross ethanol output with total gasoline demand. The EIA, for example, claims that US bioethanol substitutes or "displaces" as much as 9% of recent national oil-based gasoline demand. Federal and State requirements for alcohol in gasoline also vary, with legislation and regulations, and refiners' needs for alcohol also vary from summer to winter and depending on altitude, among other factors, excluding the price of the ethanol. For 2012, US EIA data shows that bioethanol producers were 500 million gallons short of the amount that refiners are mandated to use under the RFS (renewable fuels standard) of George W Bush, set in 2007, which requires a constant escalation of biofuel consumption, theoretically attaining about 1.75 million barrels a day in 2017.

Outside the US, the only other major producer of bioethanol (mainly from sugarcane) is Brazil which in 2012 is likely to produce an annual total close to the USA's approximate 50 billion litres or 13 billion US gallons. Production by countries other than the US and Brazil is increasing, but at present only accounts for about 20% of world total production. World total bioethanol output in 2012 is estimated by agro-industry analysts such as FO Licht at probably no more than about 80 bn litres gasoline equivalent, or around 115 bn litres ethanol, per year. World motor gasoline consumption in 2012 will be about 1450 billion litres or more than 2000 billion litres ethanol equivalent.

THE ECONOMIC LIMIT
The most simple and most basic reason that bioethanol fuel production is declining in both the US and Brazil is: price. The market price for ethanol made in the US mainly from fermented maize starches has risen in 2012, to be sure, but this price has constantly been below distilling and other production costs, making the most recent bioethanol price, which has risen 6.5% since Jan 1st, of $2.345 a gallon on the Chicago Board of Trade in early November, a completely uneconomic price for distillers.

In 2012, at least 10 major bioethanol producer companies, including Valero Energy Corp. and Biofuel Energy Corp. have closed distilleries after the worst drought since the 1950s sent the price of maize to a record, while oil-source gasoline prices declined significantly. Barack Obama’s administration has until November 13 to decide whether to agree to calls from an all-party group of lawmakers for suspending the RFS legislation of George W. Bush’s supposed plan "to wean US motorists off oil". Due to bioethanol being uneconomic (and ignoring the large number of technical reasons it is difficult to raise its role in motor gasoline and other fuels) the present rate of gasoline substitution in the US, of around 7% - 9%, is probably a "high water mark".

Input costs of all kinds, to distilling, have risen but oil-based gasoline prices have not. Called “an ugly situation that only gets worse” by many observers, this is translated on the ground by fuel ethanol distillers being unable to run full capacity, or in some cases even at all, in their purpose-built fuel grade ethanol distilleries that when built, mainly in the 2005-2008 period, cost up to $125 million each. One US gallon (3.785 litres) of fuel grade ethanol of 98% alcohol content is the equivalent of more than 5 standard bottles of beverage spirits, such as whisky, rum, gin or vodka but the prices of the two commodities, with fuel ethanol valued at about $2.30 a gallon, are very far apart.

Ethanol, made in the US by fermenting starches from grains, especially corn is basically the same product as "moonshine" or "hooch liquor", which even at the height of the Great Depression was able to command a market price well above one-dollar a bottle. Year on year, fuel ethanol prices in the US have fallen by about 12.5%.

FOOD VERSUS FUEL
This simply underlnes the fact that food commodities are even more vital, even less substitutable than energy commodities. The maize or corn used to make fuel ethanol in the US (or sugar for Brazilian fuel ethanol) has a distinct and incompressible value. Corn futures for Dec. delivery are presently around $7.40 a bushel in Chicago, but attained a record $8.49 a bushel on August 10, and converting this food to fuel ethanol is now simply uneconomic, with the present per-gallon loss on converting the corn to ethanol, rather than selling it as corn,  estimated by analysts at an average of 36 US cents loss on every gallon: this compares with a profit margin of about 24 cents one year ago. Both of these figures exclude by-product gains from selling dried distillers’ grains, and by-product gains from corn processing as a food-only commodity. The present per-gallon average loss, for "the fuel route", is a possible understatement of real losses, including financial and other operational losses for distillers.

With no surprise, a wave of bankruptcies has hit the industry. More than a dozen producers, including VeraSun Energy Corp., at one time the largest American fuel ethanol distiller, have filed for Chapter 11 bankruptcy protection since October 2008.

The 2007 RFS mandate and related laws enacted under President Bush took no account of the real world economics of fuel ethanol based on food commodities. RFS was set as a permanently and massively growing programme, and assumed that oil prices could only further rise, food commodities would for some reason not rise in price, and motor fuel demand could only go on growing. For 2013, notably, the RFS mandate and laws applying to US refiners, requires that they will take and use 13.8 billion gallons of fuel ethanol. This is probably impossible, without much higher subsidies.

Unappreciated by the Bush administration officials who drafted RFS, each annual rise in mandated use of fuel ethanol in gasoline blends will require a greater take of the annual US maize crop. The 2012 corn harvest is estimated by the USDA at 10.706 billion bushels, the lowest in six years, and 42% of this will go to fuel ethanol production. If the RFS program continued to 2017 as originally planned, perhaps as much as four-fifths (80%) of recent and current annual corn crops would be taken.

Maize production, like any other intensive agro-crop is in no way "infinitely scalable". Limits on raising both yield per acre and total output notably include irrigation water requirements, but other factors as basic as transport infrastructures, both of corn and fuel ethanol, are also in play. All-party action by US lawmakers to "limit the damage" includes the governors of Arkansas, North Carolina, Maryland, Delaware and Georgia, and legislators in both chambers of Congress who have asked the RFS's ultimate administrator, the EPA-Environmental Protection Agency, to suspend the mandate because of the almost certain impact on food prices with a smaller corn crop and a still-growing legal requirement to supply fuel ethanol.

Until or unless the RFS is heavily reformed, or fuel ethanol can be economically produced from non-food resources, the food price threat of the programme will certainly continue. Sometimes even more dramatically outside the USA (for example in Europe, where wheat-based biofuels production is targeted by some countries), the food-versus-fuel conflict will continue, as long as fuel ethanol is considered a potential major alternative to oil-based fuels, gas-fuelled vehicles, and electric vehicles.

SUPPLY GLUT
Both in Brazil and the USA, an apparently surprising and additional uneconomic aspect of biofuels production is supply glut. Both are related, due to export/import of Brazilian sugar-based fuel ethanol and US corn-based fuel ethanol, with a recent multi-year trend for US ethanol producers and suppliers to import Brazilian ethanol, with some re-export to Europe and Asia. The result is especially strong in the US: according to the US EIA, inventories reached a record 22.7 million barrels (close to 2 years total consumption) in March. This of course also weighs on ethanol market prices.

More complex, and even pernicious given the present economics of US fuel ethanol, each gallon of ethanol is assigned a RIN or Renewable Identification Number by the EPA, to enable tracking if obligated parties - especially distillers and refiners - are complying with the minimum required amounts of bioethanol to be produced by distillers and taken by refiners. Very similar to Europe's carbon emissions scheme (ETS), the number of RINs has built up due to past overrproduction and imports of Brazilian bioethanol, creating a total present "overhang" of around 2.5 billion excess RINs. These can be purchased and traded, and refiners have purchased large amounts of RINs, to avoid having to blend bioethanol into "phyical gallons" over and beyond the technical and market requirements for alcohol from any source (oil-based or "bio") in their blend mixes. A certain cost penalty of US-refined motor fuels is therefore operating, because refiners prefer to buy RINs to avoid blending-in bioethanol, to gasoline, over and beyond the real technical and market needs for belnding alcohol.
 
The US bioethanol fuel system is therefore at present confronted by a combination of physical oversupply and virtual or paper oversupply (RINs), at a time when any producer of bioethanol is unable to recover their production costs, and can only produce at a loss. This can be considered a veritable 'chef d'oeuvre' in bad planning, bad management and sloppy execution.

The outlook is also negative, firstly due to the likely decline of oil prices, but also due to existing energy industrial technology, and emerging technology. Highly ironically and in "productivist terms" the bioethanol industries of the US and Brazil have built their capacity to the present and probably all-time peak of about 100 billion litre per year. This is for 98% pure alcohol, making their fuel output capacity - if transformed into beverage spirits (by simply watering it down) - equivalent to producing around 225 billion standard bottles of whisky, rum, gin or vodka equivalent: this is enough for around 30 bottles per year for every single inhabitant of the Earth! The world oil, gas and even coal industries have both existing large alcohol production capacities, and major potentials for producing more alcohol when or if the market demand exists. Other industries, in the agro sector, also have major potentials for producing alcohol or increasing present output - because alcohol is a highly simple product, able to be produced from bases as simple as water and carbon dioxide (H2O and CO2).

The nearer-term outlook in both the US and Brazil is therefore towards a "pure market solution", more radical in the US case. This will feature further temporary or permanent shutdowns of production. Where producers decide to "soldier on", which is the case for several foreign-owned bioethanol operations in the US, and some foreign-owned producers in Brazil, they will go on producing, at a loss, "until the banks shut them down".

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2012 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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