Tuesday, June 21, 2011

By y Timothy Gardner

With the price of Chicago corn surging 5 percent, or more than 40 cents, above wheat, the economics of a short-term switch are asserting themselves.

For the moment, the switch to wheat does not work in practice: major ethanol firms say the costs of capital investment, reduction in yield and loss of the by-product distillers' dried grain outweigh the short-term potential of a cheaper supply source.

And many in the market don't expect the inversion to last.

But the fact that some may even be looking at the figures comes as a surprise to many in the market, who had previously not considered the potential for a demand shift that, if realized, could alter the margins just enough to take the edge off some of the tightest corn stocks in generations.

"Given the tight carry-out in corn this year, and the fact that wheat does contain fermentable starch, a number of plants are evaluating the technical and economic feasibility," said Neill McKinstray, general manager of the ethanol division for The Andersons, Inc, which operates plants with about 300 million gallons of total collective capacity.

There's good reason that such a switch has rarely been considered. Chicago corn has traded higher than wheat only about a half-dozen times in the past four decades; prior to this year, it did so last in 1996, years before ethanol production took off in the United States.

Now, corn threatens to remain costlier for a while, with wheat supplies boosted by the harvest, as prompt corn stocks shrink for several more months.

NOT FEASIBLE YET

For the moment, there appears a greater risk that ethanol producers might look to shut down in the face of soaring prices and compacted margins rather than switch to wheat, which for most would require a long-term commitment.

"A switch over to wheat, at least a quick and easy switch over, is not feasible," said Bill Day, spokesman for Valero, which owns ten U.S. ethanol plants.

"Valero's ethanol plants - even though they are corn plants - are high-efficiency and fairly low-cost operation. So it's still efficient and profitable for us to run even though corn prices are elevated," Day said.

A spokesman for POET, the world's biggest ethanol producer, said the price advantage could evaporate before a facility was revamped to process wheat.

While July nearby corn futures on the Chicago Board of Trade are higher than nearby CBOT soft red winter wheat, corn for delivery against the September futures contract is more than 30 cents a bushel cheaper than September wheat.

Green Plains Energy, which operates nine plants with a total of 740 million gallons of annual capacity in Nebraska, Iowa, Minnesota, Indiana, Tennessee and Michigan, agreed.

"There is no way we are going to do that. It doesn't make sense right now to do that for us and I don't know for many others that it does," Green Plains CEO Todd Becker said.

"When you use wheat, your yield goes down, so it's not just a one-on-one commodity bushel cost saving. The plant will run very differently and there would have to be a significant discount to corn, much bigger than it is today, to start thinking about that."

YIELD LOSS

Making such a switch would not be simple.

Plants would need to be retrofitted for grinding wheat instead of corn, a costly change of machinery. Wheat yields fewer gallons of ethanol than does corn - 20 to 30 percent less generally - and then producers would lose the additional revenues from the sale of distillers' dried grain.

All things considered, wheat prices would need to be a few dollars below corn, not a few cents, to make such a switch viable, industry experts said.

"Over the years we just haven't seen any economic reason to process wheat for ethanol," said Geoff Cooper, vice president of research and analysis for the Renewable Fuels Association.

"Corn has always been the most desirable feedstock and we expect that to continue."

© Copyright 2011 Thomson Reuters.