U.S. grain groups are applauding a presidential announcement to ramp up the biofuel mandate in that country, but one analyst says ethanol’s bubble is about to burst, deflating hopes for ever-rising grain prices.
“We are already well on the way to overbuilding capacity,” said Bill Tierney, former principal grains economist for the U.S. Department of Agriculture’s World Agricultural Outlook Board.
In his Jan. 23, state of the union address, U.S. president George Bush called for an increase in the supply of renewable fuel to 35 billion US gallons (132.5 billion litres) by 2017, up from the 4.9 billion gallons (18.5 billion litres) produced in 2006.
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The announcement came as no surprise, closely echoing legislation introduced by a group of Midwest senators calling for 30 billion gallons (113.6 billion litres) of ethanol and biodiesel production by 2020 and 60 billion gallons (227.1 billion litres) by 2030.
“All the president did was say, ‘me too,’ ” said Tierney, who is now executive vice-president of research and marketing with John Stewart & Associates, an agricultural futures commission and market advisory firm headquartered in San Antonio, Texas.
Bush’s announcement simply confirms the political mood in the United States for a vastly enhanced mandate that builds on the old one, which tops out at 7.5 million gallons (28.4 million litres) in 2012, Tierney said. The president has essentially said he will sign whatever bill the Congress sends his way, he added.
The news was welcomed by corn growers, who are enjoying 10-year high prices due to the explosive new source of demand for their product.
“Corn growers are eager to support this initiative while continuing to satisfy all our markets,” said Ron Litterer, first vice-president of the U.S. National Corn Growers Association.
Tierney said the new mandate fuels what was already an upside potential for corn prices, but he feels that optimism will be short-lived because the U.S. ethanol industry is on the brink of a disaster with a looming overcapacity threatening to drive down profit margins.
“The expected onset of further new construction is so huge it’s going to be a chronic problem for years,” said the former Kansas State University agricultural economist.
With 78 biofuel refineries under construction and seven existing plants undergoing expansions, the U.S. is set to add more than six billion gallons (22.7 billion litres) of new capacity by mid-2009, bringing total capacity to 11.4 billion gallons (43.2 billion litres), which will be nearly double the legislated mandate for that year.
Not only is production outpacing the mandate by a wide margin, it is taxing the ability of oil companies to blend and distribute the product.
“We’re going to be in a situation where we have perhaps billions of gallons of ethanol production capacity that will not be economical to operate and will be mothballed,” said Tierney.
At current energy prices, he predicts ethanol plants will start feeling the margin squeeze in the next six to eight months. Even if oil prices rise by $20-30 US per barrel, the industry will still be confronted by logistical problems.
When margins start to tumble there will be downward pressure on corn prices, leading to a domino effect with wheat, which is priced according to corn, and soybeans, which competes with corn for acreage. Slumping soybean prices would have a trickle-down effect on competing oilseed crops like canola.
In other words, the grain and oilseed crops that have benefited from a profitable ethanol industry will lose ground when ethanol profits tumble. And Tierney thinks it could be two or three years before the industry corrects itself.
He said the lofty new mandate targets are not helping. Such announcements only attract more investors to the sector, he added.
