Viewpoint: US arb to limit EU ethanol

The US-EU ethanol arbitrage is open after the closure of two UK ethanol plants late this year. These shutdowns, allied with supply disruptions on the Rhine river in recent months, edged EU T2 spot ethanol prices towards two-year highs.

However, high spot prices are likely to fall sharply when US cargoes begin to arrive. Two vessels are bound for the EU carrying 25,000m³ and 30,000m³ of ethanol respectively. These will pressure the spot market on arrival as they reduce supply tightness in the Amsterdam-Rotterdam-Antwerp (ARA) region.

Prevailing forward prices suggest the US-EU arbitrage will remain open into March, at which point the EU spot price is likely to drop back below the arbitrage level. Again, US arbitrage will provide a ceiling price for the EU market following a year in which oversupply has largely depressed values.

Imports into the EU totalled just 85,000t in the second quarter of 2018, down by 21,000t on the year and 4,000t on the quarter. Prevailing low prices in ARA diverted cargoes away from Europe, which is unusual because, typically, the European market fetches a substantial premium to many importer markets. Gains in spot values drove imports up by 18pc on the year to 124,000t in the third quarter. The monthly average T2 spot ethanol price in the second quarter was €448/m³, compared with €490/m³ in the third quarter. Volumes were strongest in August, when average spot prices were €504/m³; incoming supply weighed on spot prices in September, which fell to a monthly average of €491.50/m³.

It was this drop, following months of weakness, that finally led to the closure of the UK's 330,000 t/yr Vivergo plant, which came off line at the end of September. Production margins have been particularly poor for plants that use wheat as feedstock, and the price of wheat has been relatively high in 2018. Both of the UK's major production sites — Vivergo and the 315,000 t/yr Ensus — use wheat as feedstock. Ensus also succumbed to weak margins later in the year, and the site was mothballed at the end of November.

The recent spot ethanol rally has offered some respite to producers that have been battling with unusually low margins for most of 2018. The spot T2 ethanol fob ARA, minus the rolling front-month Euronext wheat price for 2018, has been well-below the previous four-year average, implying weak production margins for wheat-ethanol producers. The ethanol-wheat differential for 2018 has averaged -€3.55/m³, compared with an average annual value of between €44.26/m³ and €108.23/m³ from 2014-17.

Maize prices have been lower than wheat throughout 2018 and offered a significant advantage to plants that use it as a feedstock. The 2018 average ethanol-maize differential, was €52.21/m³. This is still lower than 2015-2018 when annual average value was between €88.49/m³ and €134.36/m³, but exceeds 2014's €3.45/m³ average and greatly exceeds the differential against wheat. Production spreads remain positive into 2019, reducing the risk that maize-ethanol plants will be at risk of heavy losses or shutdowns.

Rising grains demand and drought conditions in Europe over the 2018 summer are likely to keep grains prices relatively high in the coming months, suppressing production margins. Based on T2 ethanol swaps and Euronext grains futures prices, the differential for wheat-ethanol producers from spot ethanol sales and wheat purchasing is likely to be negative throughout the first half of next year. Ensus may come back online around the end of the first quarter, under prevailing conditions. The outlook for Vivergo is uncertain.

The loss of these two plants, totalling around 645,000 t/yr of production capacity, along with rising mandates across Europe and the prospect of E10 introductions in the UK and the Netherlands, should erode Europe's oversupply situation and help bring the market back into balance.

Additional demand could reach around 240,000t in 2019. This assumes flat gasoline demand and ethanol supply-demand balancing before the end of the first quarter, even when accounting for the additional supply injection offered by sugarbeet-ethanol production until February. The sugarbeet yield this autumn has been lower than expected. The EU Commission's Mars Crop Bulletin in October projected the 2018 beet harvest to be 2.8pc below the five-year average. This will also reduce any oversupply.

One potentially major risk to EU producers is the status of anti-dumping duties on US ethanol exporters to the EU. Though much US production does not meet the EU's greenhouse gas reduction and certification standards, its excess production is still greater than total EU production. Without anti-dumping duties, the US could flood the EU market and severely undermine T2 ethanol values.

The anti-dumping duty imposed on US ethanol imports expires in May 2019. EU market participants expect the bloc to reinstate the duty or to impose a similar one, ensuring EU producers are able to remain online. With US inventories and output near long-term highs, the arbitrage level is likely to remain low into 2019.

A relatively low European spot price cap is likely throughout next year, perhaps in a range of €502-529/m³. Domestic oversupply and tariffs from major consumers, such as Brazil and China, have depressed US ethanol prices.

Global sugar prices began to recover from long-term lows in October and neared levels that would tempt sugar-ethanol producers to switch back to sugar production. However, the rally was short-lived and sugar prices have since fallen, while the European ethanol market has seen a substantial recovery. As a result, it is unlikely that sugar-ethanol producers will make the switch back to the sugar market during the first half of 2019.

Sugar was the feedstock for 20pc of EU ethanol production in market in 2017, industry association ePure said — down from 16pc from 2016. The most widely used feedstocks were corn and wheat, accounting for 39pc and 30pc respectively.