Weekly Insights: Contrary Biofuel Predictions Getting Closer to Mainstream
Contrary Biofuel Predictions Getting Closer to Mainstream
There is a difference between reporting on market fundamentals and conducting research. Many research organizations who focus on fundamental analysis of the agricultural markets primarily work to predict USDA published numbers. While Higby Barrett is concerned about what numbers USDA publishes, that is not our goal. Our goal is to identify fundamental changes that will move the market. For example, the April 2020 International Report indicated China either must dramatically increase imports of coarse grains or pull-down coarse grain stocks. The impact of a one-year drawdown is negligible but to decrease stocks for multiple years quickly puts China in a bad purchasing position. With corn prices at low levels, why not take advantage of the market to meet increasing consumption and build stocks? It should be noted that USDA and Higby Barrett are still far apart on China’s coarse grain consumption, which makes our view of the row crop prices over the next five years much more bullish.
Analysts in other fundamental groups will discount the research to issue numbers closer to market consensus because the analysts will get ridiculed when wrong but receive nothing when correct. In this situation, risk avoidance is a very natural reaction, but does beg the question, what are clients buying? Higby Barrett analysts have the freedom to release numbers outside the market consensus provided the reasons for the numbers are explained. Of course, as we receive better information and/or market conditions change, the forecasts will be adjusted.
Another area where we differ from USDA is on the renewable fuel forecasts. It took over six months, but the soybean oil market finally came up to our forecast and hit 50 cents per pound. Biofuels is one area Higby Barrett believes the USDA’s initial 2021/22 forecast was too cautious and that the market was trading too low.
The most significant difference between USDA’s updated outlook and our balance sheets is biofuel projections, notably the corn grind for ethanol production. We are predicting the 2021/22 U.S. corn use in ethanol production will total 5.5 billion bushels, 300 million above USDA’s Forum projection. While the difference is substantial, we believe the prediction is justified.
The new Administration is more focused on environmental initiatives and less concerned about the impact that environmental regulations will have on business, especially energy companies, than the last Administration. Given that the prior Administration nearly approved the year-round sale of ethanol at 15% (E15) per gallon of gasoline, we believe there is a high likelihood the current Administration will support the change. There is also a possibility the new Administration could seek a higher blend.
The Environmental Protection Agency (EPA) opened the door for a high octane (E30) fuel under the renewable fuel standard (RFS), and the auto manufacturers could benefit from the improved engine efficiency from increasing ethanol and octane. The National Highway Traffic Safety Administration’s (NHTSA) corporate average fuel economy (CAFE) benefit of the higher ethanol/higher octane blend would be significant for auto manufacturers, so they would be unlikely to fight the increased availability of E30 from pumps already equipped for E85. In 2017, there were 21 million flex-fuel vehicles (FFV) on the road in the U.S., so the potential benefit of E30 in meeting the original RFS goals could be significant. While Higby Barrett believes the change to E15 is likely over the next two years, the chance of E30 is substantially below 50%. We based the forecast on the implied corn usage of the higher rates adjusted by the probability of their approval.
Outside of the impact of the RFS mandate on the corn grind, the spread of state-level programs, like the low carbon fuel standard (LCFS) in California, could also drive greater ethanol consumption. The state-level programs encourage the use of E85, and although the carbon intensity focus of the programs favors sugar-based ethanol, the imports of Brazilian ethanol into the West Coast open opportunities for U.S. ethanol exports. The potential for increased exports accounts has a relatively minor impact on our prediction, but there is a possibility exports could exceed USDA’s expectation.
Finally, last week, the EPA published renewable identification number (RIN) generation data from the EPA moderated transaction system (EMTS). While domestic ethanol production dropped from 1.14 billion gallons in December to 1.07 billion in January and was down from 1.24 billion last year, the total was roughly in line with Higby Barrett’s prediction. We will monitor monthly data from the EMTS and adjust its forecast accordingly. However, even if ethanol production remains below our forecast over the next several months, we believe that as a larger percentage of the population becomes immune to the coronavirus, through natural immunity or vaccination, gasoline demand will increase. The recent rally in crude oil and gasoline prices has been driven, in part, by the expectation that gasoline demand will recover more than is suggested by the EIA’s Short-Term Energy Outlook report.
The USDA based its forecast on the EIA’s Short-Term Energy Outlook for gasoline consumption. However, USDA’s Forum presentation included a slide that indicated corn used in ethanol production has been above the level implied by the EIA projections since before the sharp decline in gasoline consumption due to the pandemic. Assuming the trend continues and considering the number of workers that will choose to work from home even after offices reopen, we believe the USDA is likely to raise its forecast over the next year.
Will Driving Return to Pre-COVID-19 Levels?
USDA’s 2021/22 U.S. soybean balance sheet was generally in line with our expectations. However, there is a substantial difference between USDA’s crush projection and Higby Barrett’s prediction. USDA predicts 2021/22 U.S. soybean crush volume at 2.21 billion bushels, 115 million below our expectation. Differences in expectations for biomass-based diesel output are the driving force behind the disparity in projections.
USDA predicts soybean oil used in biodiesel production will total 7.8 billion pounds, 150 million pounds above our forecast. However, its non-biodiesel prediction of 16 billion pounds, which includes its projection of soybean oil used in renewable diesel production, is well below our forecast of 17.9 billion pounds. The number of new and converted renewable diesel plants already announced to begin operation during 2021/22 is at the base of our soybean oil use projection, ultimately driving its crush forecast. While state-level programs favor low carbon intensity feedstocks like choice white grease and used cooking oil, the limited supply of those feedstocks will require a substantial increase in soybean oil usage in renewable diesel production.
There is some risk that delays in plant openings result in lower-than-expected production. However, we closely monitor the industry and adjust our forecast as developments warrant. The more significant risk to the projection is a potential lack of crushing capacity driving a surge in vegetable oil imports. Even if there is sufficient capacity, crushers will need to match crush volumes with oil demand, as opposed to meal demand, implying oil share will need to rise well above 50% and likely above 60%. If oil share does not reach that level and meal demand is not strong enough to provide crushers with sufficient margin, soybean oil imports will likely be substantially above our expectation of 750 million pounds.
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