The recovering US economy is fueling demand for crude oil, and the demand for crude oil is boosting demand for ethanol. Corn prices, which had been low for months, have recently risen sharply on expectations that demand for ethanol will continue to rise and that corn exports, particularly to China, will do the same.

Daily ethanol production in the US rose to 833,000 b/d, 32% higher than production a year ago, and about 98% of US ethanol production capacity. Demand for ethanol rose to 795,000 b/d, up almost 34% year-over-year.

Archer Daniels Midland Corp. (NYSE:ADM) is the country’s largest producer of corn ethanol. For the company’s third quarter, ending March 31, 2010, ADM processed nearly 5 million metric tons of corn, most of which was made into ethanol. For the reported nine months, production has grown by nearly 1 million barrels, more than 600,000 of which were produced in the third quarter.

The other major US processor of corn ethanol is Valero Energy Corp. (NYSE:VLO), which owns and operates 10 ethanol plants with a total capacity of 1.1 million gallons/year. Valero bought seven plants in the bankruptcy sale of the assets of Verasun.

In its first quarter report, Valero noted that its ethanol sales posted operating income of $57 million, the highest total since the company got into the ethanol business. The company produced more than 2.5 million gallons/day of ethanol at a gross margin of $0.63/gallon.

Both ADM and Valero profited from low corn prices, which only started to rise in the middle of February. And while prices are rising currently, corn plantings in the US are also rising which could act as a brake on corn prices later this year.

The single largest impact on ethanol producers, though, will be a decision by the US Environmental Protection Agency on whether to allow a boost from 10% ethanol (E10) to 15% (E15) in blended gasoline. The EPA is testing the effects of an increase in the ethanol blend on older car engines. The agency doesn’t believe there is any adverse effect on newer engines.

The maddening thing about ethanol blending is that the lower energy content of ethanol reduces the mileage a driver can expect. That decrease can be as high as 10% with E10. If the E15 standard is adopted, mileage will drop even further. The result is that drivers pay the same, or in some cases more, for a gallon of fuel only to find that they have to stop at the gas station more often.

The makers of corn ethanol have managed to deflate somewhat the concerns that using corn to make ethanol reduces the world’s supply of corn as a foodstuff. A byproduct of ethanol production is a mash called distillers’ dried grain (DDG) that can be used as animal feed. About 31% of corn used to make ethanol is left as DDG, which is sold to livestock and poultry producers, in effect returning that much corn to the food chain. A DDG futures contract just became available where ethanol producers can hedge their corn and natural gas costs, and farmers can hedge their feed costs.

The toll among small public ethanol companies has been very high. There was Verasun, of course, but Aventine Renewables is in bankruptcy and Pacific Ethanol, Inc. (NASDAQ:PEIX) recently filed an amended plan for bankruptcy protection. At one time these companies were all the rage.

But high gasoline prices in 2008 led to less driving and lower demand for ethanol. Meanwhile, corn prices had skyrocketed, and the companies screwed up their hedges. By early 2009, most small ethanol companies were struggling and stock prices had dropped by as much as 90% in some cases. Ironically, smaller cooperatively run ethanol plants have prospered, primarily because they don’t have to impress stockholders.

The comeback of ethanol, even if it is still shaky, is partly a result of having adults run the industry. ADM knows how to run a commodity business, and Valero knows how to run refineries. Falling corn prices gave Valero a chance to get its production going without posting a loss. And now, with the EPA ruling on E15 coming, these companies look set to profit from ethanol production no matter what the EPA decides. A jump to E15 would improve profits even more, of course, but ADM and Valero are not really counting on it.

As long as the federal government mandates that oxygenated fuel and corn ethanol is the only game in town, ADM and Valero will perform well in that segment of their businesses. At this time, nothing appears set to knock ethanol out of its driver’s seat.

Paul Ausick

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