Many markets, both commodities and equities declined substantially during the month of May. Two weeks ago, we mentioned that we were nearing fundamental value areas in certain markets. This week, we’ll make the case for a bottoming sugar market as well as its effect on the coming corn crop’s prices.
First, lets review the global ethanol market. The ethanol here in the U.S. is made from corn and the finished product is, “anhydrous ethanol.” Anhydrous ethanol is blended with gasoline. The end result is E85 at the pump. E85 is the maximum ethanol blend allowed. It consists of 85% ethanol and 15% gasoline. This mixture was just approved in 2010. The typical ethanol blend here in the U.S. is up to 10% ethanol and 90% standard gasoline.
The primary source of ethanol on the open market is made from sugar cane. Brazil is the world’s largest sugar producer and is responsible for about one third of global production. Brazil’s sugar cane derived ethanol is a much more efficient process both in terms of the finished ethanol and product cycle regeneration. Brazilian ethanol production also produces, “hydrous” ethanol. Hydrous ethanol is used in 100% ethanol fueled vehicles, which we see as E100 as well as any Flex-Fueled vehicle.
Ethanol production from sugar cane is much more efficient than production from corn. Ethanol production from sugar produces about 5,166 liters per acre while production from an acre of corn yields only 1,894 liters. The self-sufficient energy mandate that has been the guiding force here in the U.S. for the last 10 years or so has allocated nearly 35% of this year’s corn crop to the production of ethanol. So, why are we basing our future on such an unfeasible model? The answer lies in the government subsidies going to the farm and energy industries. This year marks the end of the $.45 per gallon ethanol subsidy as well as the end of the $.54 tariff we impose on ethanol imports. This combination fostered the proliferation of business entities whose primary profit center was the exploitation of a protected and subsidized market to the tune of $.99 per gallon.
Both of these policies expired at the end of 2012. The price swing of nearly $1 per gallon made U.S. subsidized ethanol inventories a bargain on the open market. Ironically, this led to Brazil being the number one importer of corn based, U.S. ethanol on the global market. Our subsidized production paid for by the taxpayers was sold at the discounted price to Brazil by the blending stations earning the tax credits. It is important to note that further corn subsidies also exist here to the tune of $3.5 billion to corn farmers in the U.S. and $0 subsidies to U.S. sugar cane growers.
The loss of the ethanol subsidy combined with the remaining direct government subsidies for growing corn should shift total global production of ethanol from corn to sugar. The interesting point will be how many corn based ethanol plants here in the U.S. go the way of Solyndra as the poster children of a misdirected governmentally mandated and subsidized pipe dream. Meanwhile, excess sugar production over the current growing season should be digested, as it is shipped world wide for foodstuffs while Brazil works through their own domestic surplus. This shift will allow the largest corn crop ever planted to be diverted to traditional uses. The net effect will be falling corn prices, perhaps under $5 per bushel and a sugar price base around $.185 per pound.
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