Commodities 2023: European ethanol market to face high energy costs, feedstock challenges

The European ethanol market was rocked by the ripple effects of the Russia-Ukraine crisis in 2022 as high fuel prices led to mandate reductions across EU member states, while high energy prices cut into producer margins and procurement of grain supplies out of the Black Sea region became challenging. The ethanol market will continue to be faced with these issues in 2023 and will likely have to navigate a recessionary demand environment.

Producers said they were concerned that seasonally low demand coupled with rising energy costs in winter could lead to a period of negative production margins that extends to the first quarter of 2023 and beyond.

The evolution of the Russia-Ukraine war and Europe's solution to the energy crisis will be a leading driver of how the European ethanol market unfolds in the year ahead as grains and natural gas are key input costs for European producers. Despite Europe's gas storage levels reaching around 95% full, a cold winter could keep natural gas prices volatile and elevated, said Vitol Head of LNG Asia Sid Bambawale at the Financial Time Live conference.

"The whole of Q1 [2023] is not looking good, [producers] are considering slowing down production as negative margins don't cover variable costs," said a Europe-based source. "Q2 is looking a little better -- April and May [margins] are better but still below the level of variable costs."

According to S&P Global Commodity Insights, European fuel ethanol production is projected to rise just 2% on the year to 96,000 b/d, or 5,590 million liters, in 2023. German and France production is expected to remain steady on the year at 16,000 b/d each in 2023.

"We expect little change in operating circumstances next year with the energy crisis in Europe not expected to resolve anytime soon, cautious outlook for grains production and exports from Ukraine and continued strength in European sugar prices in 2023," said an analyst with S&P Global.

Despite negative margins for European producers, the ethanol market is set to be well supplied in first-half 2023. Heading into Q1, the European ethanol market is in a contango structure from January into June. Sources said that the contango environment is unnatural for the ethanol market, which is a structurally short market, and therefore typically in backwardation.

"The physical market is high in supplyand people are wondering where to put imports," said a Europe-based trader. "Production margins for EU producers are horrendous. I still see the arbitrage for US ethanol is open from Q2 onwards and Brazil could be open from April."

The market is set to be well supplied by imports and S&P Globalsees European fuel ethanol imports reaching 12,000 b/d in Q1, 16,000 b/d in Q2, 19,000 b/d in Q3 and 13,000 b/d in Q4, totaling 60,000 b/d in 2023, down from 62,000 b/d in 2022.

A recession could dampen demand for fuel and gasoline, squeezing the ethanol blend pool size. Demand is set to be further subdued as Poland and the Czech Republic shelve plans to roll out the E10 fuel grade in the near term. Northern Ireland rolled out the E10 grade in Q4, but its impact on 2023 consumption is expected to be limited on the wider ethanol market due to the low consumption in the country.

Consequently, S&P Globalexpects European fuel ethanol consumption to decrease 3% on the year to 114,000 b/d, or 6,577 million liters, in 2023. Germany's fuel consumption is set to fall 1,000 b/d on the year to 23,000 b/d and France's consumption is expected to decrease 1,000 b/d on the year to 25,000 b/d.

Market participants will also be tracking the development and progress of the Russia-Ukraine grain corridor in 2023.

The UN-brokered Black Sea Grain Initiative was extended for a further 120 days in November, extending into 2023. Russia's prior abrupt withdrawal from the corridor deal showed that there is potential for the deal to be reneged on, which adds a key risk for grain supplies and grains prices in Europe.

High imports and a weak demand environment offer downside potential to European ethanol prices in 2023, but upside risks could emerge if grain supplies from the Black Sea become strained again and energy prices remain elevated.