Last Thursday the U.S. Environmental Protection Agency proposed raising ethanol limits in gasoline. The agency said it is seeking public comment for the proposal to raise the limits of ethanol blends in gasoline from 10% to 15%. The increase has largely been driven by a petition initiated by the trade group Growth Energy, which cited a Department of Energy study that found raising ethanol blends to 20% would result in no significant drivability issues.

The increase would obviously be a benefit to corn growers and the ethanol industry, which has been plagued by production cuts and stale inventories recently.

Not everyone is in support of the measure though. Many warranties for existing flex fuel vehicles only cover ethanol blends up to 10%, and any damage to vehicles resulting from the increased ethanol mix would potentially negate owner warranties. So needless to say the car industry and the farmers are somewhat at odds on this issue.

Farmers, producers and environmental groups are all pushing for the increase, as it would help to support corn prices going forward and ethanol, which is widely viewed as a strong substitute for oil consumption, is considered a greener form of energy. Jeff Broin, chief executive officer of POET, a Sioux Falls based ethanol producer, was quoted in the WSJ saying, “If we don't move that regulatory cap, without question grain supplies are going to grow and the next group looking for a bailout will be the American farmer.”

This argument, although dramatic, may actually have some merit.  Currently one fourth of the U.S. corn crop is used in ethanol production compared to 12% in 2004, and the industry is not exactly thriving. Major ethanol players like Archer Daniels Midland recently posted a quarterly loss in their ethanol division and other companies like VeraSun Energy Corp and Aventine Renewable Energy Holdings both recently filed for bankruptcy protection.

Implementing increases in the blend percentage clearly would help to support corn prices and relieve some of the supply pressures for farmers and ethanol producers, but this may just be a quick fix to a broader supply and demand issue.

In my view the recent performance in the industry is a result of too much too soon. For the industry to work, it is clear that consolidation is needed. The recent ethanol “gold rush” clearly resulted in too much supply which isn’t being matched by demand and it seems that this increase in blending percentages being mulled over the EPA could offset some of that mismatch in the market.

It is clear that ethanol is not going away, but as mentioned in previous posts, the economics for the industry still need to be worked out. The market demand right now is not matching supply, but if this increase does go through oversupply concerns would likely be alleviated, further supporting crop prices.

-GDH