U.S. Biofuel Demand Likely to Slow

Ethanol's smallest discount to gasoline in seven months could reduce demand for U.S. biofuels and make higher ethanol blends such as E85 less profitable, traders and analysts said on Friday.

Ethanol's discount to gasoline shrank to 17 cents per gallon this week from a two-year high of $1.11 at the end of September, with slow shipments on U.S. railroads keeping futures for the biofuel high despite the overall slump in energy prices.

"If (the spread) goes to even money, you price out some of that extra demand," said an Iowa ethanol trader. "But you still have to satisfy the RFS."

Under volume targets set by the Renewable Fuel Standard, or RFS, nearly every gallon of gasoline sold in the United States contains about 10 percent of ethanol. But lower-than-expected demand for gasoline means those ethanol volumes are likely to be cut sharply by the U.S. Environmental Protection Agency by the end of the year.

A steep downturn in crude oil and the seasonal end of the summer driving season resulted in gasoline futures falling to four-year lows even as a slowdown in ethanol production helped push up ethanol prices to the highest in two months.

However, gasoline futures trimmed losses to finish the week nearly unchanged at $2.13 per gallon while ethanol futures eased 1.3 percent on Friday to $1.87 per gallon - indications that the spread may have bottomed for now, the trader said.

Farmers are also harvesting a record-large corn crop, with plentiful supplies for the main feedstock in ethanol production expected to reduce costs for biofuel makers.

Still, ethanol's smaller discount makes selling higher blends of ethanol such as E85 (containing 85 percent ethanol) less attractive, said Iowa State University economics professor Bruce Babcock. E85 is cheaper than E10 but also less fuel efficient.

"Right now, it pays to blend E10; it doesn't pay as much to blend E85," he said.

(Reporting by Michael Hirtzer; Editing by Lisa Shumaker)