Data from the Energy Information Association (EIA) on Wednesday showed what many had feared. The U.S. motorist is cutting back on gas consumption as weekly data ending on March 20 showed a massive 10 percent drop on the week in implied usage. And it seems that if the shelter in place orders and social distancing policies continue to expand, the numbers will likely look worse in the coming weeks.
Crude oil started falling several weeks ago in anticipation of the hit, not only to fuel but also the announcement of Saudi Arabia waging a price war with Russia. In a few weeks, crude oil went from $45 a barrel to $20 a barrel and has since posted a modest recovery into the mid-$20 territory. So, crude oil prices need to find a way to accommodate these two massive catalysts.
For ethanol prices, they have clearly followed the trajectory of oil prices as they have gone from a $1.25 per gallon to an all-time low on the futures market of $0.90. But for ethanol, the real issue is not so much the price of oil, but more directly the impact on driving. Indeed, back in 2016, the last time crude oil made a major low below $30, the price of ethanol was relatively immune to crude’s nose dive.
Here’s how we quantify the likely impacts of crude oil and its ultimate impacts on ethanol and corn.
1. Crude oil tends to make V-bottoms with a fairly quick turnaround. Over the last 20 years, there have been six major lows in crude oil and the market takes on average only 14 weeks to get back 50 percent of its low. That’s because crude oil suppliers are quick to respond to low prices and throttle production. That will certainly happen here, but the recovery could be confounded by a stymied demand side to the oil sector. If economic activity starts to normalize in the coming months, that should help the recovery in crude.
2. For ethanol, it will clearly need to cut back supplies to better match lower motor fuel usage. Even before coronavirus, the ethanol sector was seeing dismal margins but now they are unsustainable. This week’s production of ethanol was only off 2.9 percent from last week, so clearly those figures will need to go down to better match at least a 10 percent drop in motor fuel usage.
3. With margins for ethanol where they are, the production should start to curtail rapidly and aggressively. We expect several months of production losses at 20 percent or more during this period. But even if crude oil prices continue to hold at current levels, we would expect ethanol prices to return to normal given its mandated usage in gasoline. How quickly this happens will depend on how severe motor fuel usage cutbacks are and how quickly the ethanol sector responds.
4. However, one bright spot from lower ethanol production is it implies lower DDG supplies for feed. Historically, we see a clear trade-off between the two on the balance sheet, albeit not one for one. FBN estimates that if we lose 500 MBU of corn for ethanol then feed use of corn would grow by about 150 MBU due to fewer DDG supplies.
5. For corn, the balance sheet for 2019 will likely see higher carryout due to constrained ethanol. We could see carryout as high as 2.2 billion bushels versus current USDA projections of 1.9. But given futures in the $3.40 range, we don’t think further downside is needed here. Some analysts may point to $0.90 ethanol and say that translates into $2.50 corn, but we don’t agree with that logic. Again, the ethanol market will self-correct and, secondly, corn has sizable alternative outlets for feed and exports. So while the ethanol implosion is problematic, the effects of ethanol curtailing are being felt with cash corn now trading closer to $3 than $4.
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