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Drought, Ethanol and the RFS: Context is Key

August 9, 2012

           

By Chuck Woodside, CEO of farmer-owned KAAPA Ethanol in Minden, Nebraska, and Chairman of the Renewable Fuels Association. Tomorrow morning's USDA World Agriculture Supply-Demand Estimates (WASDE) report may very well be the most highly anticipated report in the agency's long and storied history. It will offer USDA's first survey-based estimates of the 2012 corn crop and average corn yields; and the universal expectation is that the persisting hot, dry weather in the Corn Belt this summer has substantially reduced the size of the crop. The report will also provide the agency's view of how demand will be rationed for the drought-shortened crop. In a nutshell, tomorrow's reportwill set the tone for the corn market for the foreseeable future. In anticipation of a short crop, trade groups representing the livestock, poultry and food processing industries have already mounted a furious campaign to waive the Renewable Fuel Standard (RFS) for the remainder of 2012 and 2013. The groups recently submitted a letter to EPA Administrator Lisa Jackson asking her to initiate a waiver process that would eliminate or reduce requirements for oil refiners and blenders to use renewable fuels. Their thinking is that such a waiver would "free up" large volumes of corn and reduce their feed costs. Notwithstanding the debate over whether a waiver of the RFS would really impact corn prices in a meaningful way, it is truly disappointing and unfortunate that these groups have rushed to judgment. Had they taken the time to fully analyze the situation and understand the RFS program, they surely would have realized that the flexibilities of the RFS, and the corn market itself, are working as intended to ration demand in response to higher prices and impending tighter supplies. As reported by the Energy Information Administration, ethanol production has dropped sharply since corn prices began to escalate in early June. The most recent four-week average for ethanol production is the lowest in more than two years and down more than 15% from the beginning of this year. Many ethanol plants have reduced production rates, while others have temporarily idled production altogether. Meanwhile, ethanol exports have slowed to a crawl. In short, the ethanol industry will not consume the 5.05 billion bushels of corn estimated by USDA for the 2011/12 marketing year, and our use of the new crop in 2012/13 will almost certainly be lower than the agency's most recent estimate of 4.9 billion bushels. Still, despite this downturn in ethanol production, we are not in jeopardy of failing to meet the RFS. In fact, the ethanol industry's corn consumption could fall by as much as 20% (to roughly 4 billion bushels) in 2012/13 and we would still meet the RFS requirements in 2012 and 2013. How is this possible? When Congress passed the RFS in 2007, and again when EPA wrote the regulations implementing the policy in 2009/10, sufficient flexibilities were built into the program to facilitate compliance even under extreme circumstances such as this summer's drought. Specifically, oil refiners and blenders receive a credit (called a RIN) for each gallon of renewable fuel they blend. Refiners and blenders turn these credits into EPA at the end of each year to demonstrate compliance with the RFS. If they use more gallons of renewable fuel than they were obligated to use by the RFS, they are allowed to carry forward surplus credits for possible use in the next year. Because refiners turn in their oldest credits first and save their newest credits, they can create a rolling "bank" of credits that can be used in the event that blending physical gallons becomes difficult or uneconomical. It is estimated that there are some 2.6 billion surplus RINs available to refiners and blenders today. That means blenders could theoretically be 2.6 billion gallons (the equivalent of some 950 million bushels of corn) short of meeting the RFS with wet gallons and still comply. In other words, corn consumption by the ethanol industry could be rationed by nearly 20% and RFS compliance would still be possible. By the way, the 950 million bushels of corn represented by surplus RIN credits is more corn than the 2011/12 carry-out! Clearly, a waiver is not necessary given this flexibility. On top of the flexibility created by RINs, there are other factors that need to be considered. There are nearly 800 million gallons of ethanol (the equivalent of nearly 300 million bushels) in storage today and those stocks can be drawn down somewhat if ethanol production falls short of demand. Further, in the highly unlikely event that a refiner or blender can't comply with the RFS using physical gallons or RINs, they can carry a deficit forward into the next compliance year. It's also disheartening that some in the livestock business seem to have forgotten that less ethanol and biodiesel production under an RFS waiver would mean reduced production of (and higher prices for) distillers grains, soybean meal, and other feed co-products. In my area, wet distillers grains are a highly sought and highly valuable feed ingredient that allows cattle feeders to maximize inclusion of lower-cost forage sources, such as corn stalks. So while reducing biofuel production under a waiver might theoretically have marginal effects on corn prices, there would be offsetting effects on the total cost of feed because of reduced availability of (and higher prices for) co-product feeds. This summer's drought has been a heart-breaking and emotionally taxing situation for all of us engaged in agriculture-related businesses. However emotional the circumstances may be, the path forward must be based on careful analysis, sound reasoning, and facts. The facts clearly show that between surplus RIN credits and ethanol stocks, there is a corn demand cushion of at least 1.25 billion bushels built into the ethanol market. A rational examination of the RFS program and other important factors clearly demonstrates that a waiver of the RFS is not necessary or sensible.