Rising crop costs are squeezing biofuel margins and may see production fall or stagnate in the United States for the first time since 1996, adding to challenges in Brazil and Europe.
A long-run correlation between US corn and crude oil broke down this month, stemming from new fears for the world economy coupled with harsh conditions in key corn growing areas.
The changing dynamic illustrates challenges for the sector.
US corn ethanol production margins are driven by oil markets and costs driven by corn markets: correlation between the two is net neutral for biofuel margins, but they are now diverging and driving grain-based ethanol further in the red.
In Brazil, meanwhile, ethanol is made from sugar where high prices have also made ethanol uncompetitive with subsidised gasoline.
In Europe, a long-run over-capacity in biodiesel continues.
In its short-term energy outlook this month the US Energy Information Administration forecast ethanol output this year would remain flat at about 14 million gallons, still comfortably above the minimum blending mandate this year of 13.2 billion gallons.
That would be the first time of flat demand since 1996. Some analysts predict a fall.
Challenges for the U.S. industry include the expiry at the end of last year of subsidies including a domestic blending credit and import tax.
In addition, corn prices have risen on low inventories plus tough growing conditions including a drought in US Midwest.
Meanwhile US road fuel demand is falling, with knock-on effects for ethanol consumption which fell in the first two months of this year, EIA data show.
US spot ethanol margins have been negative for much of the past year and stocks are rising.
That has led some ethanol plants to idle production. For example, Valero Energy recently shut a 110 million gallon plant until the next harvest.
On the upside, refining demand remains given continuing positive blending margins where the price of gasoline exceeds ethanol.
Meanwhile fuel manufacturers are now allowed to market higher blends of 15 per cent ethanol (E15) compared with 10 per cent previously, pending commercial rollout.
In number 2 producer Brazil, most cars are flex-fuel, running on various combinations of gasoline and ethanol.
Gasoline prices are persistently low, unchanged since 2006 and under-cutting a pure ethanol alternative whose production costs rose with the price of sugar last year.
On Monday, the Brazilian government raised the gasoline price but also lowered the tax, netting no change to consumer prices and doing nothing therefore for ethanol economics.
Analysts estimate gasoline prices need to rise by 9 to 15 per cent at the pump to make ethanol production sufficiently attractive to stimulate investments again.
But Brazilian ethanol production could rebound, depending on the relative economics of producing sugar or ethanol, as world sugar prices fall.
In Europe, meanwhile, grain shortages have curtailed biofuel production, while the biodiesel market is suffering from chronic over-capacity.
The European Union's renewable energy directive requires countries to achieve a 10 percent share of green energy in road transport by 2020, the vast majority of which will be met using biofuels.
In addition, the bloc's related directive on fuel quality forces oil companies to cut the carbon content of transport fuels by 6 per cent by 2020, again chiefly through biofuel blending.
But the market has been paralysed by uncertainty over how regulators will account for the carbon emissions of the alternative fuel, as well as cheap US imports and tight vegetable oil and grain markets.
The global biofuel picture therefore is of muted growth, owing to rising crop prices and reduced fuel demand.
The longer term future is also clouded, by profitability doubts and the rollout of advanced biofuels, as well as continuing doubts over the CO2 and food price impacts of first generation fuels.
This article was first published by Reuters. Republished with permission.