Domestic demand for ethanol in the US has increased. The federally mandated Renewable Fuel Standard (RFS) for corn-based ethanol in 2010 is 12 billion gallons, up from 10.5 billion gallons in 2009. This RFS increases every year, topping out at 15 billion gallons for corn-based ethanol in 2015.

Parenthetically, the market also needs to grow in that the RFS also requires cellulosic and other "advanced" grades of ethanol, making the total ethanol demand 23.5 billion gallons in 2015, and well above that to 2022, when the total volume required (including biodiesel and other fuels) is 36 billion gallons.

Also the price of ethanol is extremely attractive for end-users. A producer of finished gasoline receives a 45-cent federal tax credit for every gallon of ethanol that is blended into finished gasoline.

This means that ethanol would have to be 46 cents/gal over gasoline to be non-economic in a finished blend. On July 1 ethanol in Chicago was almost 40 cents/gal under gasoline.

All that would seem to add up to a bullish ethanol market, but it has not happened. In fact inventories have steadily grown.

Fuel ethanol stocks as reported by the US Energy Information Administration (EIA) have increased all year long. In January, the total US inventories as shown by the EIA was 17.8 million barrels; by April they were 19.682 million.

So, despite a lack of imports, dramatically higher exports, and government-mandated demand increases, inventories at least through April are up, and, by some lights, ethanol producers are being squeezed.

Production costs

Estimating ethanol producer margins is problematic, in that the locations of the plants are scattered, and different producers will have different feedstock and marketing arrangements -- some may have termed up corn supply and/or product sales, or otherwise successfully hedged production costs.

Nonetheless, consider July 1 corn at $3.65/bushel on the Chicago Board of Trade (CBOT). That bushel will produce 2.75 gallons of ethanol and 18 pounds of Distillers Dried Grains (DDGs).

The ethanol produced by one bushel of corn was worth $1.63/gal (the Platts assessment) times 2.75 gallons or $4.49; the DDGs on the CBOT futures market were worth $92/ton, or will yield 82 cents worth of DDGs.

Add $4.49 for the ethanol and 83 cents for the DDGs, and the value produced by one bushel of corn in $5.32, or $1.67/bushel, or about 60 cents/gal for every gallon of ethanol. .

Out of that 60 cents/gal margin, a producer would have to pay all operating, salaries transportation and debt service costs.

Transportation from the plant to Chicago which by rail would be at least 5 cents/gal; to New York or Houston it would be another 12 cents/gal.

To increase demand further

So ethanol proponents clearly see the need to increase demand, and the preferred method is to increase the percentage of ethanol in every gallon of gasoline, from the current 10% to 12% or 15%, or even higher, a change that would have to be implemented by the Environmental Protection Agency (EPA).

So far the EPA has delayed any decision regarding higher blends. The president of the Renewable Fuels Association (RFA), Bob Dinneen, said in a press release after the announcement on June 17 that the EPA had “dropped the ball” on the issue.

Gasoline that contains ethanol in the US today is blended at 10%; market sources estimate that today ethanol is about 8% of the total "gasoline pool;" (as some grades of conventional gasoline do not use any ethanol).

Proponents of ethanol clearly see that soon, within a year or two, ethanol will be blended in every gallon of gasoline in the US, but that even that will not be enough to satisfy the RFS, putting an effective cap on demand, referred to as the "blend wall."

And that does not even begin to address the RFS requirements to use cellulosic and advanced ethanol.

Warranty Issues

By law, the US Department of Environmental Protection must approve any increase in the ethanol blend percentage. The Alliance of Automobile Manufacturers association does not specifically oppose any increase in ethanol blends, but, a spokesman, Charles Territo, told Platts that his group has "a concern over the long term impact of blends of gasoline on engines that were not designed to run on."

The concern, Territo added, are the long term effects on seals and fuel line degradation, all of which are warranted in some cases, up to 100,000 miles in a modern car.

Other potential pitfall abound. If Brazil prices fall further and they compete with the US it would also hurt US exports; also, the state of California has a proposal that would effectively mandate the use of sugar-based ethanol based on land-use issues, another hit on US demand.

The RFA and another major ethanol advocacy group, Growth Energy, have filed a lawsuit challenging that effort in federal court.

According to the RFA, the total fuel ethanol production capacity in the US is about 13.519 billion gal/year, with another 1.183 billion gal/year under construction.