Industry projections suggest that annual U.S. ethanol production capacity could reach 12.6 billion gallons in two to three years, more than enough to supply ethanol to blend with gasoline in states requiring 10% blends. The oversupply, often called the E10 bottleneck, will be a drag on ethanol prices — and dampen corn markets as well.

“We will be sitting with ethanol supplies that exceed demand, which will lower ethanol prices and cut back the profit margins of ethanol plants,” Hart says. “This could lead to a pullback and consolidation of the industry.”

Although other factors also are involved, the stock price of large ethanol refiners already might be reflecting this eventuality. In mid-July, the stock price of VeraSun Energy Corporation, the nation's second-largest ethanol producer (behind Archer Daniels Midland) was about $14, about half of its November 2006 value. The price of U.S. Bioenergy Corporation stock, number three in the market, was hovering at about $11 per share, down about a third from its all-time high of $17 in late 2006.

What will happen to corn prices under the E10 bottleneck scenario is open to debate, but the recent ISU study suggests that $3/bu. is a reasonable price to use for long-term planning.

Corn prices would be under pressure as ethanol prices trended lower, towards a price reflecting ethanol's relative energy value, which is about two-thirds that of gasoline.

“Once we hit that bottleneck, how quickly another outlet for ethanol develops will determine what happens to prices,” Hart says.

The ethanol fuel market for E85 vehicles is unlikely to have a big impact in the short term, because few stations carry E85 fuels and the total fleet of E85 vehicles is relatively small — only 2 to 3% of the U.S. vehicle fleet.

Raising ethanol fuel blend mandates to 15 or 20% would soak up excess ethanol supplies, but such a state-by-state change could take years to go into effect, Hart says. Currently, only one state, Minnesota, has mandated a 20% blend, but with a provision that it goes into effect only if there is proof that vehicle operation isn't negatively affected by the higher ratio.