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Economic Consequences of the Renewable Fuels Mandate

19 September 2012

Under US law, US petroleum refiners and other so-called obligated parties must blend ever larger volumes of renewable fuels into the US gasoline and diesel fuel supply.

The programme is known as the Renewable Fuel Standard (RFS). Corn ethanol is not mandated under the RFS. However, 98 per cent of “conventional biofuels” produced in the US and blended into gasoline are derived from corn, thus creating a de facto mandate for corn ethanol, aqccording to a report from the Energy Policy Research Foundation Inc EPRINC.

The RFS mandate for conventional biofuels is set to rise from 13.2 billion gallons in 2012 to 15 billion gallons in 2015. With the additional mandate for advanced and cellulosic biofuels, the total blending requirement rises to 36 billion gallons by 2022.

The US Environmental Protection Agency (EPA) administers the RFS programme and is the only US agency with the authority to waive or delay implementation of volumetric mandates for renewable fuel blending into the gasoline and diesel pools.

In response to concerns over reductions in corn production from the widespread drought, five state governors have petitioned the EPA to either reduce or waive the RFS mandates and nearly 200 members of Congress (from both the Senate and House) have publicly announced their support for a waiver.

The EPA announced on August 20, 2012 that it will accept comments for 30 days on the governors’ waiver request. The EPA is expected to act on the requests before November 13, 2012, but the agency’s likely response, if any, is unknown, the report says.

Drought throughout much of the US farm belt is expected to severely reduce the 2012 corn crop. The US Department of Agriculture (USDA) in June 2012 predicted a record 14.79 billion bushels of corn for the current harvest, but their forecast was revised down to 10.73 billion bushels in September 2012.

The new forecast places the corn harvest at the lowest level since 2006 and 13per cent below 2011 output. Poor expectations on corn harvests are now setting all time price records with corn rising above $8 per bushel. High corn prices have made ethanol production unprofitable for producers with higher cost structures, and several ethanol plants have been idled or are operating at reduced capacity.

The EPRINC study says that ethanol production has declined from 920,000 bbl/d (barrels per day) in June 2012 to 829,000 bbl/d during the final week of August. The Energy Information Administration (EIA) forecasted in its September Short Term Energy Outlook that production will average 830,000 bbl/d in the second half of 2012 and 870,000 bbl/d during 2013. An 870,000 bbl/d production rate would consume 4.9 billion bushels of corn over one year. The US is a net exporter of ethanol, but imports have declined by 80per cent since the beginning of the year to 20,000 bbl/d.

Ethanol is currently blended into the gasoline pool at 9.7per cent concentration and blending volumes plateaued in 2010. But volumetric requirements under the RFS will soon take ethanol past the 10per cent “blendwall.”

EPRINC has calculated that by 2014 the blendwall is likely to be breached. At that time, the gasoline pool will be completely saturated by ethanol at virtually 10per cent concentration, carryover RINs (renewable identification numbers) will be exhausted, and cost and distribution constraints mean that higher ethanol blends such as E15 and E85 will provide little relief for obligated parties to meet RVOs (renewable volumetric obligation).

However, given the potential that US gasoline consumption may continue to decline and that more carryover RINs could be used in the current period to overcome further declines in ethanol production, there is a distinct risk that the blendwall will be breached in 2013.

Obligated parties such as refiners have several means for meeting RFS mandates in 2012 should ethanol production become severely curtailed or blending become uneconomic. There are an estimated 2.4 billion carryover RINs which can be applied towards 2012 RVOs.

Ethanol inventories were at 18.7 million barrels (785.4 million gallons) as of the final week of August and some of these inventories could be drawn upon by obligated parties to help meet volumetric blending requirements.

Obligated parties face a dilemma if they choose to meet current volumetric obligations through greater use of RINs and existing inventories.

This is because ethanol blending is much more costly for obligated parties once the blendwall is reached, and using inventories and RINs now, particularly in a short supply environment, would preclude using them later when they are much more valuable.

Any waiver that does not push off the blendwall, perhaps by as much as two to three years, will not substantially reduce current blending demand. Unless the blendwall is pushed off by several years, obligated parties will continue to face a strong economic incentive to continue blending ethanol at up to 10per cent concentration and acquire RINs in the current period to apply to future obligations.

EPRINC says that ethanol producers have called for no revisions in the mandate for blending of conventional biofuels into the transportation fuel supply.

The ethanol producers have provided econometric studies and other research that concludes that the mandate has provided large benefits to the US such as enhanced energy security, lower gasoline prices, and the production of a large volume of a DDGS (dried distillers grain with solubles), a by-product for feeding livestock.

With regard to ethanol’s effect on gasoline prices, ethanol producers have relied on an RFA (Renewable Fuels Association) sponsored and oft quoted study by the Center for Agriculture and Rural Development that claims the RFS mandate has reduced US gasoline prices by over $1/gallon. EPRINC’s assessment of the economic and energy security implications of the ethanol mandate concludes that the benefits of the mandate are exaggerated and are now imposing substantial costs on the production of transportation fuels and food. These costs are likely to grow as the percentage of ethanol in the gasoline pool exceeds 10per cent.

EPRINC’s findings are:

  • A near term waiver of blending requirements (6 months to 1 year) would have little effect on corn demand for the production of ethanol. Obligated parties would still have to plan for RVO compliance once the waiver ends. Blending would still have to occur at high levels now, as obligated parties would want to acquire RINs to prepare for the high (and future) cost of crossing the blendwall. Refiners will also need time to adjust their gasoline yields in response to lower ethanol production. A longer term waiver (2-3 years) at some level at or below the blendwall would allow for a proper assessment of the nation’s crop situation, provide end-users with a stable planning environment, and permit refining operations to adjust fuel output. Such a waiver would likely reduce corn prices, providing economic benefits in the form of feed and food prices, and would reduce the risk of a price spike in gasoline as obligated parties begin blending ethanol at levels above 10per cent of the gasoline pool.
  • There are no low-cost solutions for marketing renewable fuels into the transportation fuel supply in the near-term at levels above 10per cent of the gasoline pool. So called higher ethanol blend options, such as E85 (70-85per cent ethanol blends for flex fuel vehicles) have failed to achieve market success due to their high cost, poorer mileage performance relative to gasoline, and lack of availability. EPA has recently approved E15 for model year 2001 and newer light duty vehicles. E15, however, faces a large number of infrastructure, liability, and cost issues, all of which will limit widespread adoption. Auto manufacturers have not provided warranties for non-flex fuel vehicles using so-called E15 blends.
  • The energy security and cost savings benefits from ethanol have been exaggerated. Ethanol did not reduce gasoline prices by more than $1/ gal in 2011 as was concluded in the oft quoted study from the Center for Agricultural and Rural Development at Iowa State University (CARD). Extensive independent econometric research and EPRINC cost-based models conclude that ethanol had little or no effect on the price of gasoline.
  • Even if ethanol blending were determined strictly by cost and market conditions, total blending would be unlikely to fall below 400,000 bbl/d from current blending volumes of around 800,000 bbl/d. Ethanol blending at the lower level would continue because ethanol remains a valuable blending component to meet octane requirements and other fuel specifications required by EPA. Higher blending levels would occur depending upon cost and market conditions.
  • Fuel adjustments to reductions in ethanol blending are both low cost and technically achievable given time. A reduction in ethanol blending could be made up through relatively small yield adjustments at US refining plants. For example, if US ethanol blending declined to 400,000 bbl/d, US crude oil refiners could make up the volume through yield adjustments of less than 2per cent, well within technical and historical performance levels of the past decade.
  • By-product production of feed from ethanol production, DDGS, has not substantially lowered the cost of raising livestock in the United States. The ethanol industry purchases approximately 40per cent of the US corn crop and is the largest purchaser of corn in the United States. Even when DDGS volumes are returned to the livestock feed supply chain, 30per cent of US corn production is consumed for fuel production. DDGS prices are directly correlated to corn prices; despite the rapid growth of DDGS production resulting from the boom in corn for ethanol, DDGS supply growth has come at the expense of existing feeds such as corn and soy. Twenty percent of the two most widely planted crops in the US, corn and soy, went to biofuels production during the 2011/2012 crop year.
  • The RFS’ volumetric mandates have created inelastic demand for ethanol. Many supporters of the blending mandate have claimed that the program has substantial flexibility since it permits obligated parties to use RINs in a subsequent year or even carry a deficit into the next year. However, the use of carryover RINs, or even carrying a deficit, is of limited value. RINs expire one year after the year in which they are generated and deficits can only be carried over for one year. The supply of carryover RINs will quickly go to zero as obligated parties cross the blendwall. Surplus RINs are needed in the prompt period to offset physical blending below RFS mandated volumes. In 2013 mandated conventional ethanol volumes will surpass 10per cent of the gasoline pool. Cellulosic and advanced ethanol mandates provide further volumetric requirements. Whatever flexibility is contained in the mandated program disappears when it becomes uneconomic to blend above the RVO on an ongoing basis.
  • A multi-year waiver of both the ethanol and biodiesel mandates would free millions of acres of land for food and livestock uses, even after accounting for a decline in DDGS production. As previously stated, a full and long-term waiver of the RFS would not reduce ethanol use to below 400,000 bbl/d. Current biodiesel production, however, would be almost entirely eliminated. More importantly, a multi-year waiver could free over 18 million acres of existing farm land for the production of crops to meet market needs for food, livestock feed, exports, or fuel.
  • Despite the droughts and record prices for corn and other crops, the RFS has ensured that billions of bushels of corn and soy are set to be converted to fuels which offset less than 5per cent of the nation’s petroleum fuel supply. The US refining industry could make up the loss of all biodiesel and 400,000 bbl/d of ethanol production by adjusting gasoline yields within their historical 10 year range while remaining a net exporter of distillate fuel. The additional fuel production from refiners would require both adequate time to make the adjustments and an expectation that government policy would not impose long-term uneconomic blending requirements, i.e., blending at levels above 10per cent of the gasoline pool. As stated above, EPRINC’s assessment is that ethanol blending would continue at or above 400,000 b/d even in an environment free of blending mandates.

Further Reading

- You can view the full report by clicking here.

September 2012

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