Natural Gas Price Drop Will Boost Ethanol Profits

I think we have all read with nauseating frequency how high corm prices are shrinking margins for ethanol producers (the irony here is that these very same producers are reporting record results). What we have not read is how multi year low natural gas prices should provide another boost to earnings. Guess what, now you are.

August natural gas touched $6.68 per million British thermal units today (Thursday), the contract's lowest level since late May of 2005. It was last down 5.7%, or 40.3 cents, at $6.68, after the Energy Department reported a bigger-than-expected rise in last week's natural-gas supplies. During its tenure as the near-month contract, the futures contract for July delivery at the Henry Hub posted a decline of $1.012 per MMBtu or nearly 13 percent. Natural gas in storage was 2,443 Bcf as of June 22, which is 18 percent above the 5-year average (2002-2006).

Nearly 95 percent of U.S. ethanol distilleries use natural gas boilers. Citigroup analyst Gil Yang estimated 28 billion cubic feet of natural gas would be consumed for every one billion gallons of ethanol produced.

The cost of producing ethanol varies with the cost of the feedstock used and the scale of production. Approximately 85 percent of ethanol production capacity in the United States relies on corn feedstock. The cost of producing ethanol from corn is estimated to be about $1.10 per gallon. Although there is currently no commercial production of ethanol from cellulosic feedstocks such as agricultural wastes, grasses and wood, the estimated production cost using these feedstocks is $1.15 to $1.43 per gallon.

The second largest cost in ethanol production, second to corn is the cost of energy, generally natural gas. Energy costs typically make up about 15 percent of a dry-mill plant’s total costs. for large producers like ADM (ADM), Verasun (VSE), The Andersons (ANDE) and Pacific Ethanol (PEIX), the costs run well into the millions.

A glut of natural gas is expected on the market soon. So much in fact, Dow Chemical (DOW), a prolific user of the stuff is not signing any new natural gas contracts in the near future in anticipation of a "dramatic fall" in prices as large amounts of new production comes on line.

What does this mean for ethanol producers? It would appear we are at the peak of the cost cycle for them. A record corn harvest is coming in better than the most optimistic projections and this has caused corn prices to fall over 11% since their February highs. With natural gas falling and no real impetus to reverse that, we have declining input costs and with gas prices having no reason to fall, a steady or rising price for the finished product.

All in all a nice scenario.