Tuesday, April 04, 2006
California Ethanol Market
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1:13 PM
Ethanol as a motor fuel background here.
California is the biggest automobile market in the country, and has phased out MTBE in favor of ethanol as a fuel oxygenate. What are the possibilities for the ethanol market in California? To get an idea, let's look at data from one of the last years of the use of MTBE in California. We'll use Q4 2002 data, since that is the most recent data before the phase-out began in earnest. From that data, we can see that MTBE represented about 10% of each gallon of gas, and the average price of MTBE ran something like 20% less than the actual gasoline cost (not pump cost, which has all sorts of taxes on it), and was very roughly ca. $1/gal. That same data shows California used ca. 0.9M barrels of gasoline/day, or 38M gallons/day (42gal/bbl), or 13.8B gal/year. That means that the California MTBE fuel market was something like a $1.4B annual business (13.8Bx0.10x$1.00).
Now, current California gasoline use 5.7% ethanol, current spot prices are about $2.50/gallon, and current gasoline use has increased to about 16B gal/year. That makes the California ethanol motor fuel market under current conditions something like a $2.3B annual market (16Bx0.057x$2.50), fully served by current out-of-state providers. Using just the 2004 consumption numbers, but the current ethanol spot prices, shows that the transition to ethanol could have caused about a $600M price disruption, or about $0.04/gallon ($600M/13.8B).
So, the key point here is that ethanol runs about double the price of MTBE, but current gasoline formulations use about half as much ethanol as MTBE, so there has been very little net price disruption to the end consumer. If a greater percentage of ethanol were used in each gallon of gasoline, or for any reason the price of ethanol were to continue to rise, there would be noticeable price disruption in the gasoline market.
On the other hand, the long term price of ethanol, particularly prior to the MTBE phase out, is more like $1.30/gallon, comparable to the price of MTBE and to the price of gasoline (remember, were not talking pump prices here, which have all sorts of taxes, etc. on them, and run about double the raw product cost). So, this is clearly a market in flux between supply and demand. A demand disruption due to MTBE phase-out has about doubled the ethanol price. Greater supply coming online may lower that price, but without new demand the overall size of the pie will stay the same.
Now, about that increased demand...It's based on the Federal Energy Policy Act of 2005, which in summary mandates 7.5B gallons annually by 2012. California's portion of that is basically what California uses now, so California has no legislatively increased ethanol demand. Nationally, mid-2005 production capacity was 3.9B gallons, so it seems that production capacity needs to about double by 2012. However, there is a special carve out for "cellulosic sources" (wood like products, not corn, but corn stalks ok), that gives them a 2.5:1 extra credit. That is, 1 gallon of cellulosic ethanol counts as 2.5 gallons against the mandate. So, for example, the 3.6B gal increased production needs could be met by 1B gallons of cellulosic production, and 1.1B increased corn based production.
Given all that, what we want, is an ethanol play that can make money even given the current pie size ($2.3B in California alone) plus natural growth (more people, more miles driven, etc.), but that would be poised to take advantage of any large increase in demand (in particular, a transition to E85 - an 85% ethanol motor fuel). And, of course we want them at the right price.
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