By Chris Prentice, Jarrett Renshaw and P.J. Huffstutter

NEW YORK/CHICAGO (Reuters) - Biofuels pioneer Archer Daniels Midland took another step toward abandoning its pure-play ethanol assets on Friday, the latest sign of the industry's struggles with U.S. President Donald Trump's trade wars, thin margins, and overproduction.

U.S. law requires ethanol to be blended into gasoline but domestic demand for the biofuel added to gasoline has flatlined in recent years as consumers have opted for greater fuel-efficiency and electric vehicles. Ethanol producers have been forced to look abroad for demand growth.

They had banked on China to buy excess capacity, but punitive tariffs in the last two years have halted buying, exacerbating the industry's substantial overcapacity. ADM executives acknowledged that problem on Friday when the company reported that profit tumbled 41 percent in the first quarter.

ADM said it may spin off three large dry mills, which primarily produce only ethanol, after unsuccessfully searching for a buyer for those mills since 2016. At the time, its move to exit ethanol shocked the industry due to ADM's status as a leading biofuels producer.

ADM Chief Financial Officer Ray Young said on an earnings call that the industry must stop the self-inflicted wounds.

"Our decision to monetize the dry mills is frankly a strategic decision on our part to basically help the industry consolidate," Young said.

Last week, U.S. ethanol production hit 1.05 million barrels per day, highest in at least five years seasonally, according to U.S. Energy Information Administration data. Inventories climbed to 22.75 million barrels, not far from the record of 24.45 million hit in March.

Producers such as Green Plains and Pacific Ethanol have laid off workers and idled or sold plants to stay afloat during the sustained downturn. Ethanol prices are down 42 percent in the last five years, while Green Plains and Pacific Ethanol have seen their shares fall 33 percent and 92 percent, respectively, in that time.

"We don't have a demand problem as much as we have a supply problem. There are just too many inefficient plants out there, and they need to go before we see a rebound," said one ethanol trader on Friday. "It's not like we are producing DVDs or CDs that no one wants."

China emerged in 2015 as a significant buyer for the first time, and subsequent plans to use ethanol in gasoline nationwide by 2020 raised hopes that the world's second largest economy would scoop up excess U.S. supply.

But Beijing hiked import taxes on the biofuel in 2017, and then twice in 2018 as the United States and China ratcheted up the stakes in a trade war that has killed demand for U.S. imports. The two countries are still negotiating a trade deal that would end the tariff conflict.

Young said margins will improve with resolution of the trade dispute and purchase commitments from China expected to accompany any pact.

Still, some say that will be a temporary boost.

"Exports may provide some temporary relief," said Scott Irwin, an agricultural economist at the University of Illinois. "(But) without substantial growth from higher ethanol blends you are looking at situation where the U.S. ethanol industry has to shrink" over the next 5-10 years."

(Reporting by Chris Prentice, Jarrett Renshaw and P.J. Huffstutter; Editing by David Gregorio)

General News Reuters