Engineering News

Ethanol's Discount To Gasoline Could Pressure Refiners
April 02, 2010

Corn-ethanol futures are trading at their biggest discount to gasoline futures since the summer of 2008, which could encourage more biofuel blending and pressure the margins of oil refiners.

Over the past several weeks, gasoline prices have surged during the usual seasonal rally ahead of the peak summer driving season. Meanwhile, ethanol prices have been dragged lower by rising output of the biofuel and a drop in corn prices amid ample supplies and a drop in demand for animal feed.

Attractive ethanol prices could push fuel retailers, the middlemen who deliver fuel and even some refiners to blend more of the biofuel, which would damp the recovery in gasoline demand that is crawling back from depressed levels. Refiners are required to blend a certain amount of ethanol into their gasoline or buy credits to meet the mandate.

"One should put as much ethanol as possible into the gasoline pool because ethanol is at a very strong discount to gasoline and corn is relatively weak," said Olivier Jakob, managing director of Swiss consultancy Petromatrix.

On the New York Mercantile Exchange, ethanol for April delivery closed at $1.522 a gallon Thursday, compared with $2.3296 for the front-month benchmark gasoline contract. The 80.8-cent discount is the biggest since August 2008, when it widened to nearly 85 cents largely on the summer's record-breaking rally in crude and gasoline prices, according to data from Thomson Reuters.

The wide spread could hit refiners because higher biofuel blending would tamp down demand for crude-derived gasoline and narrow margins.

Nearly all of the gallons of gasoline sold in the U.S. contain nearly or as much as 10% ethanol, the maximum required by U.S. regulators. This so-called blend wall likely will be raised to 15% this summer, which would hurt oil refiners, said Geoff Cooper, vice president of research for the Renewable Fuels Association, a trade association for the ethanol industry.

Meantime, discretionary blending could rise in regions that haven't yet reached the current blend wall, such as the Southwest. This year California, the largest U.S. consumer of gasoline accounting for roughly 15 billion gallons a year, lifted its ethanol blend wall from 5.7% to 10%.

Refiners are concerned because U.S. gasoline demand, which fell sharply during the recession, has only improved incrementally. The high unemployment rate, in particular, has hit fuel demand with fewer commuters on the road.

Corn-ethanol futures sold at a slight premium to gasoline in December, but the discount has deepened as gasoline futures prices rebounded off of the low hit Feb. 5. Since then, the front-month gasoline contract is up 23%, beating the 18% rise in crude oil, which closed just shy of $85 a barrel Thursday. Meanwhile, ethanol futures fell 13% over the same period.

While the big discount to gasoline is boosting discretionary blending of ethanol, the blend wall will prevent a large increase, said Cooper. However, if regulators allow a 15% blend limit, "with the spread being what it is today, you would see a lot of folks in the marketplace move to E15 or somewhere higher than E10 voluntarily because the economics are just too good not to."

In the meantime, even a slight increase in blending could weigh on the gasoline crack spread--the per-barrel price difference between the motor fuel and crude oil.

The gasoline crack spread has already more than doubled on Nymex to $12.50 from its February low and from the abnormally depressed $2 level hit in September. This has given refiners, struggling to return to profitability, some breathing room but some analysts and traders wonder whether the crack spreads will be sustainable above a healthier level of $15 a barrel, if they even manage to get that high.

Crack spreads have remained fairly pressured through much of 2009 due to high crude oil prices, weak demand for refined products, persistently high inventories and rising global refining capacity. Higher ethanol blending could act as one more bearish factor capping refining margins.

"I don't think it's going to expand very much" from current levels, Jakob said.

Source: Dow Jones Newswires

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