Tuesday, January 15, 2013

Gas Vs. Ethanol Prices -- 2012 Review

The below pink line is the commodity/wholesale price of 100% ethanol (E-100). But as a N.Y. Times story explains, ethanol gets less MPG than gasoline. The green line adjusts (increases the price) for the lower energy efficiency of ethanol, allowing an "Apples to Apples" comparison with the wholesale price of gas (blue line). The red line is the average of all U.S. retail pump prices of regular grade gasoline.
A good "Rule of Thumb" for U.S. consumers in making ethanol decisions at the pump (ethanol blends above 10%, such as E-85) is that used in Brazil. In Brazil, flex-fuel drivers generally buy gasoline when the price of ethanol is more than 70% of gasoline, and buy ethanol when the comparable price is lower. For example, during the Spring, U.S. ethanol was a good deal (as low as 65% of the wholesale RBOB gasoline price). But for most of the year, ethanol has been more expensive on a MPG adjusted basis.
It should be noted however, that this current "Rule of Thumb" may soon change as a result of on-going breakthroughs in engine engineering design (e.g., Ricardo Engines Turbo Boost). We will address this improving fuel efficiency of flex-fuel engines (as well as aviation bio-fuels being tested by the U.S. Military) in future blog posts.

The below chart gives an illustration of just how significant these improvements in engine efficiency could be -- where the only data changed from the original chart is the use of efficiency data that Ricardo Engines' is currently achieving in field tests -- where adjusted ethanol prices are a clear winner.

Retail Gasoline Prices: The below map shows the current national average (above chart's red line) by region.

Current Retail Gasoline Prices by Region
At year-end 2012, wholesale and retail gas prices were about equal to a year ago (2¢ higher) with ethanol trading 7¢ per gallon lower.

Ethanol Prices: A simple linear regression statistical analysis shows that U.S. ethanol prices can be almost entirely explained (a R2 of .91) by the commodity price of #2 yellow corn (which is not used for human consumption). The extreme volatility in ethanol prices since July is the result of a series of initial over-reactions and then corrections in corn futures markets as to the actual severity of the drought in the Midwest on crop yields. As a result of this price increase, ethanol production levels have decreased up to 20% since July. With low or negative profit margins, many ethanol plants have either reduced output or temporarily shut down entirely.

As the below chart reflects, high corn feedstock costs are clearly having an adverse impact on U.S. ethanol production. The levelized (orange line) represents the theoretical monthly bio-fuel production level necessary to meet the yearly Renewable Fuel Standard's requirement of 13.95 billion gallons of bio-fuel use for 2012. In every month except January, actual production (purple line) was below the orange line.

Because of this shortfall in new bio-fuel production, the RFS was met using a combination of 3 market mechanisms: (1) Using RIN Credits from the previous year (where bio-fuel use exceeded RFS requirements); (2) Drawing down of existing bio-fuel inventories; (3) Bio-fuel imports (from Brazil).

During 2012, we agree with two studies (here and here) that ethanol use has had a negligible impact on retail gas prices. This is because the greatest use of ethanol is a 10% or less blend with gasoline (E-10). Year to date, 10% of the cumulative price differential between the wholesale price of ethanol (adjusted for efficiency) and gasoline is ~3¢ per gallon. Also recognizing that without ethanol, fuel blenders would have to substitute higher cost sources of octane additives, the price differential is probably only about 1¢ per gallon.

However long term, Supporters of ethanol must recognize a clear reality. As long as the adjusted price of ethanol (green line) is higher than the wholesale price of gasoline (blue line), ethanol use will always be criticized and lack acceptance by the U.S. Public even at low E-10 blend levels.

This lower cost can happen in two ways: (1) lowering ethanol's production cost through cheaper feedstocks and better conversion technologies (e.g., cellulosic enzymes); (2) greater auto engine efficiency utilizing ethanol's higher octane levels (smaller engines using turbo-boost).

The Renewable Fuel Standard: The recent volatility and price spikes of ethanol from the Mid-western drought is a good illustration that the future of ethanol is not from corn. Feedstock and production technology diversity is needed from other sources (sorghum, cellulosic). In passing the Renewable Fuels Standard requiring ethanol blending with gasoline, Congress recognized this point by capping the use of corn feedstocks (which current ethanol production has almost approached).

For all the criticism that ethanol use receives, what is generally lost by the general public is the amazing success story that has been so quickly achieved in accomplishing national goals for greater energy security and job creation. This achievement would not have been possible without using the existing corn industry's infrastructure in the Mid-west.

Did you know?: The Renewable Fuels Standard has resulted in a fundamental shift in gasoline formulation. The refining industry has now moved to using predominantly 84 octane "conventional" gasoline and then blending it with higher octane ethanol (around 113) to produce the 87 octane gasoline that is the most popular level with consumers. This change in refining practices is not easily reversed. While other octane enhancers could be used, ethanol's price make it the current lowest cost octane source of choice by refiners.

Data Sources:
Per numerous Sources (DOE, EPA), E-10 (10% ethanol) has ~3% less efficiency than E-0 (zero ethanol). Ethanol on a "net basis" has less BTU content, but higher octane.

-- Wholesale Ethanol prices are from the Chicago Board of Exchange.
-- Wholesale Gasoline prices are from the Chicago Board of Exchange.
-- Retail Gasoline prices are from Bloomberg's survey of national gas prices.
-- Corn Feedstock costs are calculated from Chicago Board of Exchange.
-- Distiller's Dried Grains (DDG) Futures (100 short tons) from CBOE.

-- Wholesale Gasoline Real Time Daily Trading Data.
-- Wholesale Ethanol Real Time Daily Trading Data.

No comments: