Chicago, 31 March 2011: Reuters

U.S. ethanol inventories crept to nine-month highs last week despite a reduction in ethanol output and the fact that ethanol prices declined to their lowest level relative to gasoline in close to a year. But while continuing rises in stockpiles may undermine the fundamental appeal of the ethanol market, industry participants look set to remain committed to maintaining sturdy output levels as production margins edge higher and industry sentiment remains upbeat on expectations for higher demand from fuel blenders over the coming months.

The latest data from the U.S. Energy Information Administration revealed that U.S. ethanol inventories climbed by 100,000 barrels in the week to March 25 to 20.1 million barrels - their highest level since weekly record keeping began last June. Further, the stocks climb came despite a 10,000 barrel a day cut in weekly output to 903,000 barrels a day.

Although the output reduction may suggest that producers are tapping the brakes on throughout levels in response to the rising stocks levels, they are more likely just adjusting their cruising speed after having sharply increased output over the past four weeks since the early February production cutbacks that were prompted by an industry-wide souring in operating margins as corn prices rallied faster than ethanol.

However, since the corn market's price pullback around the middle of this month, ethanol producer crush margins have rebounded into positive territory again, to spur the accompanying rise in output.

OVERLOOKING RISING STOCKS

Ethanol producers have so far proved content to overlook the swell in stocks on the assumption that ethanol's steep price discount to gasoline should pave the way to heightened demand from fuel blenders. Partly fueling that assumption is the steep discount that ethanol prices are currently trading at relative to gasoline, which is sharply accentuated by the Volumetric Ethanol Excise Tax Credit ( VEETC) which pays fuel blenders 45 cents for every gallon of ethanol they use in their fuel blends.

Stronger demand from consumers as the U.S. driving season gets underway in the spring is another key driver of the upbeat sentiment among the ethanol industry, even though prevailing high gas prices at the pump are serving to keep overall demand in check lately.

Given the prevailing muted mood of consumers, it may take some time for the expected increase in blender demand to show itself by drawing down inventories. But as long as ethanol crush margins remain on their recent rising trajectory, ethanol producers seem likely to remain content to look beyond the also rising stocks levels towards a brighter demand future at some point down the road.

Ends --

By Gavin Maguire, Reuters market analyst - for Commodities Now

The views expressed are his own.