In early October, rumors began to circulate that the Environmental Protection Agency (EPA) was set to reduce the minimum ethanol blend that it mandates the U.S. fuel industry blend into gasoline. Over the past decade we’ve seen explosive growth for the U.S. corn-based ethanol industry. In the early 2000s, only about 10% of the U.S. corn crop was turned into ethanol. Back then, the USDA did not even include ethanol statistics in the monthly crop report that is available to the public. The ethanol market then experienced explosive growth. Currently, about 35% of the corn crop is used for ethanol.
The possibility of a shrinking U.S. ethanol market added a bearish slant to a market that had already fallen substantially over the past several months. Without government pressure to maintain the ethanol blend at current levels, it was reasoned, U.S. corn stocks could become burdensome.
The news made for some catchy headlines, but was largely misunderstood. Even if the EPA adopts these proposals, it is not really much of a bearish factor for corn. When the original ethanol mandate was formed, the government projected that by 2014, U.S. gasoline demand would reach 154 billion gallons per annum. That forecast for gasoline usage was off by a wide margin, partly because of the recession and partly because of the advent of more fuel-efficient cars. The estimate for 2014 gasoline consumption has fallen to only 133 billion gallons.
The new legislation would cut the ethanol mandate to 13 billion gallons, down from the current 14.4 billion gallons. The 10% minimum ethanol-blend mandate will not change, just that the industry will not have to scramble to fit the existing required amount of biofuel into a gasoline market that is not growing as quickly as the legislation was designed for. As it is, estimated ethanol production for 2013 is about 13.5 billion gallons, which is right about at the target 10% of gasoline usage. The government is not abandoning the program, only attempting to tailor it to economic realities. So it is hardly a bearish factor, and certainly not as far reaching as the initial headlines may have intimated.
The federal government shutdown has ended, and data will start flowing soon. In the meantime, market participants have traded in the dark. The key October USDA crop report will be omitted entirely, and we won’t see another estimate for comprehensive national supply/demand statistics until the November 8 installment.
Despite late planting and periods of poor weather, U.S. farmers are expected to harvest a record 2013-14 corn crop of 13.5 billion bushels, according to the now-dated September crop report. In the absence of government data, private forecasters have weighed in with their own estimates. Generally, the outlook is for much higher yields than the USDA’s estimate for 155.3 bushels per acre in the September crop report. Some estimates put the yield over 160 bpa, which would mean the output estimate would swell to over 14 billion bushels.
The Monday-afternoon weekly crop report was the first bit of post-shutdown information regarding the crop to be released and it confirmed the revisions of private forecasters. It showed that the good-to-excellent portion of the crop jumped to 60%, up 5 percentage points from the last pre-shutdown report. That’s a fairly large change and bodes well for a sharp uptick in the yield estimate.
Global production is expected to reach a record 956 million tonnes, up 11% from 2013-14, and that figure could increase meaningfully if the U.S. crop estimate is increased to reflect the improvement in crop conditions.
Consumption is forecast to grow as well, but by only 6.5%. The September estimate for ending stocks was 16.3% of consumption, up from an average of 14.7% over the previous three year. If the U.S. crop is revised upwards, ending stocks would grow to more than 17% of usage.
We’re still shy of 2008-09 and 2009-10 levels, when ending stocks averaged 18% of consumption, but global corn inventories are being replenished. We believe the market should be traded from the short side, but with prices at three-year lows (Chart 1), we recommended looking for rallies to establish short positions.