When looking into the factors that affect the price of ethanol, it’s easy to look only in the way of the factors that affect agricultural products like corn and sugar, since they are a major source of ethanol. Theoretically, since there is usually a frequent swing in the prices of these agricultural products, it is expected that the price of ethanol would be volatile.
In the real world, however, the price of ethanol is relatively stable. This simply means that the price of ethanol is not entirely dependent on the factors that affect the prices of corn and sugar. Here is why. You need to bear in mind that corn and sugar are usually bought on contracts, which helps ethanol avoid the day-to-day price swings that occur in the commodity market. In this sense, it’s the negotiation of new contracts that have a higher chance of affecting the price of ethanol, since the price of new contracts would affect the production costs of ethanol. The lesson here is that, the negotiation of new corn or/and sugar contacts can affect the price of ethanol.
Weather conditions and transportation are also a big factor that affects the price of ethanol.
Relate to the chart above as a reference. It shows that, during the first quarter of 2014, there was a spike in the price of ethanol. As a reminder, an extremely cold winter was an event that plagued the first quarter, an event that affected the entire economy. The result of the cold winter on the ethanol industry was that it disrupted transportation of ethanol, which in the end affected supplies as shown by the chart below.
Source: Schneider Electric
The reason why the price of ethanol is so sensitive to weather conditions and transportation is that ethanol, itself, is very volatile (prone to evaporation) and corrosive in nature. This necessitates that ethanol is transported in tanks on trains and trucks, as opposed to the use pipelines. Note that there are only a few pipelines that are designed to transport ethanol at present. Its prominent form of transportation, therefore, makes it susceptible to changes in weather conditions. In essence, during the last winter, or any other cold winter, transporting ethanol became difficult, and, hence, supplies slowed down, which in the end drives the price of ethanol. Rail congestions have also driven the price of ethanol high, historically.
Another direction to look is the production data of ethanol. Historically, the price of ethanol has seen a dip whenever there is an increase in the production data of ethanol. For instance, it was reported on June 18, 2014 that there has been an increase in the production of ethanol. This ramp up led to a decline in the price of ethanol to a six-week low. One of the reasons for this is that an increase in the production of ethanol helps the production process of RBOB gasoline, which reduces the price of gasoline. In the end, this helps the consumer spending data, which is good for the economy.
In the hindsight, it can be said that the price of food also have effects on the price of ethanol. Of course, the relationship between these two is traditionally vice-versa (i.e. ethanol driving food prices). However, think about this. While it might be true that the ethanol mandate encourages higher food prices, it is also true that the fact that ethanol competes with food for the use of corn has inherently set the price of ethanol ‘high’. The truth is if the only use for corn were in ethanol production, the price of ethanol would be cheaper. Therefore, a change in the process could bring down the price of ethanol. The point is, the use of corn wastes like the stover, would reduce the production costs of ethanol, thereby, reducing the price of ethanol below current levels. So investors might want to take note of this.
Another important factor is what I like to call the Big Oil effect. It refers to the effect that crude oil have on ethanol. In general, the crude oil industry resists the ethanol industry. This should be expected since it’s the vision of the ethanol industry to overtake the crude oil industry. So it means that any slip in the crude oil market makes traders a little bit more optimistic about the future of the ethanol industry. The price relationship is that, an increase in the price of crude oil has the potential to raise the price of ethanol. Here is why. In most cases, an increase in the price of crude oil results from fears over the future of the crude oil market. Such fears make the market more optimistic about ethanol as a substitute, thereby raising the value of ethanol in the energy market. The chart below shows the relationship between crude oil and ethanol prices. Note that the relationship between these two commodities became more relevant toward the end of the 2000s.
One other factor that affects the price of ethanol is the consumption of gasoline. Since ethanol is now important in the gasoline market, the more gasoline is consumed, the higher the demand for ethanol, which, in the end, drives the price of ethanol. And as the chart above shows, the movement of the prices of gasoline and ethanol has been relatively close, which indicates an interdependence of the two commodities.
Tariffs and taxes on ethanol also move the price of the commodity – albeit artificially. In many cases, they push the price of ethanol upward, especially when a foreign source of ethanol is involved. Consider the Brazilian ethanol for instance. Brazilian ethanol is supposed to be cheaper to purchase in the US. However, the tariff on its importation makes it as expensive as, or even more expensive than, domestic ethanol. Such moves are made to keep the domestic ethanol industry competitive.
In a similar fashion, tax breaks and other incentives also have the potential to tamper with the price of ethanol artificially. All of these point to how important the understanding of the present climate in the ethanol industry is to the process of predicting the direction of the price of ethanol.