Article

by Carey Gillam

KANSAS CITY, Missouri (Reuters) - The U.S. ethanol industry is keeping its foot on the gas pedal at production plants, and if the trend continues it could defy a government forecast that the industry will have its first drop in corn use since the turn of the century.

The government forecast, which was issued on Monday, was based on expected weaker gasoline use and higher corn prices. Ethanol is blended with gasoline. In addition, some analysts said the expiration of an industry tax credit at the end of the year could also eat into profits.

But for the near term, both domestic and export sales are strong, plus profit margins -- though volatile -- are largely healthy, factors that should feed continued strong demand for corn for ethanol.

"Plants are making some money. People are feeling pretty good about things," said Chuck Woodside, general manager of farmer-owned KAAPA Ethanol in Nebraska and chairman of the Renewable Fuels Association. "I anticipate we're not going to see a huge reduction in demand."

Government mandates for more biofuel only encourage more corn demand, Woodside said. The U.S. mandate for conventional biofuel, which is mostly ethanol made from corn, will rise 600 million gallons next year to 13.2 billion gallons.

The ethanol industry uses about 40 percent of the U.S. corn crop to make the alternative motor fuel, a factor which drives persistent criticism from food and livestock producers who say it drives up both corn prices and food prices.

Indeed, corn prices have soared this year on strong demand from food, feed and fuel sectors.

As harvest of the new U.S. corn crop gets under way, there simply may not be enough corn to go around, some ethanol experts said. That could drive corn prices even higher than the recent record levels.

"At current expected production levels of corn ... there's absolutely no question that demand has to be rationed," said Linn Group analyst Jerrod Kitt.

On Monday, the U.S. Department of Agriculture said in its monthly crop production report that it expects an average U.S. corn yield of 148.1 bushels per acre, lower than the 153 yield predicted last month, reducing the overall new corn crop by more than 400 million bushels to 12.5 billion bushels.

In drawing up its balance sheet, USDA said corn for ethanol would drop 100 million bushels in 2011/12 to 5 billion bushels from its August forecast. USDA left unchanged the 2010/11 usage at 5.02 billion bushels.

A decline in corn usage would be the first since the turn of the century, said Linn Group's Kitt.

The tight corn supplies will make for a more competitive environment and could put some plants at risk. But at this point, production levels continue to run strong, and many ethanol industry players saw the government outlook as too conservative.

"We've never taken our foot off the pedal," said Jim Stark, spokesman for Nebraska-based Green Plains Renewable Energy, which operates nine ethanol plants totaling 740 million gallons of capacity. "We've not slowed down."

"It is going to be a tight corn market, but we should have enough," Stark said.

Government data tracking weekly production of ethanol shows average volume at 892,000 barrels a day, up nearly 4 percent over this time a year ago based on a four-week rolling average. The latest report, issued Wednesday, tallied weekly production at 879,000 barrels per day, up from 872,000 a year ago at this time.

Not all saw production levels continuing to expand, however.

"Ethanol production probably won't expand this year. The recent USDA projection of 5 billion bushels used for ethanol is pretty close to the 5.02 billion bushels consumed during the 2010/11 crop year," Jeff Lautt, president of POET, the world's largest ethanol producer, said in an email.

While Lautt said this would be the first time in years that ethanol production has not grown, there will be opportunities for future expansion due in part to more Flex Fuel Vehicles and Flex pumps. That will help POET and others to produce cellulosic ethanol from such things as corn cobs, leaves and husks.

Efficiency Factor

One factor that could explain the reduced corn for ethanol demand forecast by the government is that plants are producing ethanol more efficiently now than in the past, according to the Renewable Fuels Association industry group.

USDA's standard measure says each bushel of corn produces 2.7 gallons of ethanol but producers say they are making up to 2.9 or 3 gallons per bushel.

"Most of the new gigantic ethanol plants are dry mill technology and they are seeing their yields increase," said RFA spokesman Matt Hartwig.

Domestic demand may also be hit by the expiration of a key tax incentive at the end of this year, which will squeeze industry profits.

And export demand to Brazil remains an open question. Exports have been increasing, and many see that continuing through next year due to problems with the Brazilian sugar cane crop, which is the main feedstock for Brazilian ethanol.

But Brazil has reduced its blending mandate and a reduction in imports could follow.

Still, total U.S. exports of ethanol, mainly to Canada and Brazil, hit a record 127.4 million gallons in July and are on pace to reach 900 million gallons by the end of the year.

"Export demand is still and should remain pretty strong," said industry analyst Tom Waterman, who publishes The Ethanol Monitor newsletter.

(Reporting by Carey Gillam; additional reporting by Timothy Gardner in Washington; Editing by Bob Burgdorfer and Jim Marshall)