This QuickHit episode, we talked about agriculture commodities with focus on corn ethanol. We are joined by Chris Narayanan with INTL FCStone in their Capital Markets. Chris held several different roles in the commodity space and was formerly a commodities and equity analyst for investment bankers. He explains why we have surplus of corn and other ag commodities and that this problem started way before the global pandemic. What will be the solution, and with crude in trouble, does it mean trouble for corn ethanol as well?
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TN: I wanted to talk a little bit about ag commodity markets. With all of the COVID-related issues, we’ve seen demand really fall. We’ve seen things like potatoes stacking up and milk being poured out. It’s deflationary, it’s wasteful. How is that impacting markets in terms of the expected supply coming on, and how long do you expect this demand issue to be there?
CN: First, I think it’s important to take a step back. When you look at the commodity space, especially at agriculture, in a lot of areas, we’ve been flooded for several years. And then when the Trade War hit, that was another hit to the system. And now the Coronavirus is here, it’s another hit to the system. We’re trying to chew through this as quickly as possible.
People are shifting from eating out to eating at home. The buying patterns are changing. The foodstuff needs are changing. You go all the way back through the supply chain, back to the farmer and the rancher, it changes the dynamic.
USDA came out, with their monthly ag supply and demand report and they’re pretty optimistic for the new crop year. Now, that’s going take some time, and obviously these are just projections.
Looking at my screen right now, the market is a little lukewarm to it. As we get to the growing season, we what kind of supply we can expect, and then once the harvest hits, we’ll know, in terms of the global economy, how much we actually need.
TN: We saw some freezes over the weekend as well in the Midwest. Is that hurting things or is that late freeze something that just happens occasionally and markets just work that in?
CN: It depends on where it is and what stage they are. Planning is all over the place in a lot of areas and it depends on what crop you’re talking about. I don’t think you can make a blanket statement on that. But certainly, depending on the damage and the intensity on the area, there could be some damage. That might be supportive to prices at some point. But I think it’s a little early to say.
TN: What about things like corn? When we can move into talking about ethanol or fuels or some of the downstream products? Do you see this freeze hurting the corn crop, so it would tighten up the demand environment a little bit? Or is it all fine and it’s not really going hurt supply?
CN: It depends on where they are in planning. We’re in the middle of May. A lot of people hope to be done by now. If they didn’t get it in the ground, they might delay for a couple of weeks. If they did have it in the ground, they had some early emergence in some of the southern areas. But where the freeze really didn’t hit, it shouldn’t have that big of an impact.
I think the big thing is how do we use up the corn that we have? In the last decade, we’ve seen a huge increase in corn supplies. I look at the amount that’s left over at the end of a crop year divided by how much we used in that particular year. That’s been on the rise, and I think ethanol is a big portion of it. When people talk about ethanol, they say we need an increase in blend or go from E10, E15, or even higher.
In my opinion, that’s just kicking the can down the road. You’ll see an uptick for a little while — five, seven years or whatever that number is, and then it’s going to level off again back to where we are. You’ve just reset the base, but you don’t really solve the problem in a more long-term fashion.
I think there are two big things that we’re seeing in this current situation. First, driving fuel efficiency on vehicles has increased over the last 15-20 years. We’re driving more miles per gallon of gasoline. So incrementally, you need less ethanol to blend with the gasoline. The second part of efficiency is we are producing more gallons of ethanol with less bushels of corn. You need less corn than you did before. And now with the Coronavirus, people aren’t driving. We have a lot of stay-at-home orders that are starting to expire in some parts of the country. But again, you’re not driving, so you just don’t need to buy as much gasoline. I mean, my truck tank is half-full, and I think the last time I filled it was about a month-and-a-half or two months ago.
What we needed to look at is how can we best work ethanol into global trade and where are the export markets. For example, we have the RFS and the RFS2 – biofuels and advanced biofuels. We can bring in Brazilian ethanol made from sugarcane and export corn ethanol to them. It’s just one example of a symbiotic relationship where the blenders here would get credits.
TN: How is that different? Are there differences between sugarcane ethanol and corn ethanol in terms of the end use?
CN: In terms of the end use, no. It’s the same. It’s really the process in which it’s made and how the EPA and other organizations look at the efficiency, the cleanliness, and the process of producing it all. At the end of the day, it blends, and specs will dictate. But theoretically it’s going to be just another substitute of each other.
TN: I’m just curious just to dig into that, why would the U.S. import Brazilian ethanol and export corn ethanol? Are they substitutional?
CN: To an extent they are substitutes. So that makes it a little bit more practical. Back when we had blending credits, there were different credits that you can get depending on the stage. Corn ethanol was the most basic.
From a completely economic standpoint, if you’re a blender that has to purchase this ethanol to mix in with your gasoline, there was, at the time, an incentive involved for the added cost of doing this. So if we can work through this policy, maybe update the policies, look at our global trade where in any given year, you might have a surplus in one country and the other, why not introduce some kind of a trade scheme where you help each other out, right?
Because if you go to Brazil for example, you can go to a pump and they literally dial in E0 to E100. They can run their engines on most. And they run that mix depending on the economics, I think it was like 70. If the price of ethanol was 70% of gasoline or less then, it was more economic to use ethanol.
Some people say that you see a slight loss in fuel efficiency and so there’s that kind of scale that you can apply and use to your advantage. Look in the fact that you can increase the blend wall and maybe go to E20 or E25. And the tests from the engineers show that that’s not gonna do anything to the vehicle, then that’s great. But again, it’s a temporary fix — temporary meaning in the next ten years versus what I’m looking like 30, 40 years ahead in the future.
TN: So with crude oil prices depressed, how hard will it be to get those refiners to include ethanol? Are those blenders to include ethanol if crude and gasoline are super cheap?
CN: So here’s the thing that nobody talks about. We have the Clean Air Act, which introduced the cafe standards for fuel efficiency. In 30 different partners around the US, you have to introduce some kind of an oxygenate to basically treat the gasoline. MTBE was the preferred substance at the time but it was found to pollute groundwater. 30 some-odd different states banned it, so that effectively made a de facto nationwide ban on it. So to meet the Clean Air Act in those cafe standards, you had to introduce something. Ethanol was what came in. It burned clean. It was renewable. It didn’t pollute groundwater and it helped make that standard.
When I was at a previous job, going back about seven years ago or so, I was working with one of my other commodity analysts and we did a joint paper on corn gasoline and ethanol. If memory serves, it was like E6.2 or something where when you look at the different summer blends versus the winter blend the different metropolitan areas and you distill down to what do we actually need.
Until you find another additive to take the place of ethanol that’s cheaper, safer, or at least
safe, you still have some incremental demand that needs to be put into the gasoline that’s just required by law.
TN: Chris, thanks so much for your time today. I really appreciate it. I’d love to circle back and talk about other ag commodities in a couple of months to see where things are at.