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By Geoffrey Styles on Jul 24, 2013 with 10 responses

Crashing into the Ethanol Blend Wall

We’ve Arrived at the “Blend Wall”

The Energy and Commerce Committee of the US House of Representatives has been holding hearings this week on the Renewable Fuel Standard (RFS). It’s otherwise known as the ethanol mandate, although it covers biodiesel, as well. These hearings are timely, since at least two bills have been introduced to reform or repeal the RFS.  During Tuesday’s session Rep. Waxman (D-CA) referred to the “gasoline blend wall, which may be around the corner.” In fact, a review of current gasoline sales and this year’s ethanol target confirms that the ethanol “blend wall” has arrived, at least for some of the nation’s refiners. That explains the urgency of the debate about the future of the RFS.

The blend wall is simply the threshold at which the RFS requires more ethanol to be blended into US gasoline than the quantity necessary to dose essentially all of it with the maximum 10% ethanol content for which most cars on the road were designed. Because the Environmental Protection Agency, which administers the RFS, has been unwilling to exercise its flexibility under existing law, the fuels industry must now choose from a set of unattractive options: It can limit mainstream gasoline to 10% ethanol content and absorb substantial RIN costs (see below) or penalties for failing to blend the required volumes of biofuel. It can produce less gasoline than the country needs, or export more of its production, to reduce its renewable fuel obligations. Or it can produce higher-ethanol blends such as E15 and risk the integrity of millions of cars and large portions of the country’s fuels infrastructure, including all but the newest gas station pumps and tanks. All of these choices affect the price consumers pay at the pump.

Not Another Arbitrary Crisis

In order to understand why the blend wall is a serious problem, rather than another arbitrary crisis, we need to examine its two main elements. The first is fairly straightforward, relating to the mechanical integrity of the pumps and seals in automobile engines and fuel systems, as well as refueling infrastructure. While most of these function acceptably with blends of up to 10% ethanol in gasoline, there’s significant controversy about what happens above that threshold. As I noted last month, this issue has become relevant much sooner than the 2007 law anticipated, because US gasoline sales have declined instead of continuing to grow by 1-2% per year, while sales of E85 remain small and mainly regional.

As the head of the American Automobile Association (AAA) indicated in his testimony Tuesday, any new product like E15, which consists of 15% ethanol and 85% petroleum gasoline, should have been tested thoroughly before release. Although the EPA conducted extensive testing before certifying E15 for use in 2001 and later model cars, as best I could tell their focus was on vehicle emissions systems, rather than mechanical integrity. Other tests conducted at the behest of the fuels industry identified problems with higher ethanol blends in vehicles not specifically designed as “flexible fuel vehicles” (FFVs) which can use up to 85% ethanol. UL previously tested existing service station product dispensers (gas pumps) and observed leaks and other failures above 10% ethanol. The uncertainties that have been raised by independent testing may not be conclusive, but they can only be resolved by a lot more testing on actual vehicles, not by rhetoric. The bottom line for consumers is that most carmakers won’t warrant any but their latest models for use with E15.

What Are “RINs” And How Do They Affect Gas Prices?

Another important but more obscure aspect of the blend wall relates to a feature of the RFS called Renewable Identification Numbers, or “RINs”. The RFS regulations created RINs for tracking purposes, to provide “the basic framework for ensuring that the statutorily required volumes of renewable fuel are used as transportation fuel in the U.S.” But they also have another purpose. RINs can be separated from the physical gallons of renewable fuel and traded in the market — effectively becoming paper ethanol. Enabling this RIN market, which includes both “obligated parties” — mainly refiners and importers of finished gasoline — and non-obligated parties such as gasoline blenders and traders, provides some flexibility in the RFS compliance system. It allows refiners that cannot blend any more ethanol into their direct fuel sales — or cover their typically larger sales of pre-ethanol product — to satisfy their legal obligations under the RFS by presenting a certificate, instead.

This worked reasonably well when the annual blending target was lower and refiners and marketers could bank RINs for future use by blending more ethanol than required, while remaining under the 10% limit. However, only 20% of the RINs generated in that manner last year could be carried over into 2013, restricting the supply just when the market approached the overall 10% blend wall. My understanding from those who follow this market is that this “bank” will become insolvent sometime next year, limiting new RINs largely to those generated from sales of E85 in the Midwest.

Now, with the blend wall a reality, the limited stock of RINs from past blending is being drawn down at prices that have spiked from a few cents per gallon-equivalent at the start of the year to well over $1.00 recently. Some refiners are spending hundreds of millions of dollars on RINs. It’s hard to determine how much of that is being passed on to consumers in fuel prices, because of the complexities of the RIN market and the agreements that various participants have made concerning the allocation of RINs. If 100% of their cost were passed on, then RINs at $1.00 would add $0.10 per gallon to the price of gasoline at the pump. The higher the annual RFS target ratchets, the higher RIN prices could go, with a recent estimate setting the potential impact on gasoline prices in 2014 at $0.19/gal, with the possibility of even larger increases in diesel prices.

Another potential outcome mirrors a comment made in Tuesday’s hearing by the CEO of Cumberland Gulf Group, a large gasoline distributor. He characterized the functioning of the RFS and its RIN provisions as “subsidizing exports and taxing imports.” Refiners that don’t have enough RINs to cover their gasoline production will weigh current RIN prices against the profit they could generate by exporting more of their output to other countries, thus reducing the volume that must be covered by RINs. This could have an even bigger impact on the US gasoline market, because prices are set at the margin, and small shortfalls can translate into large price increases. That’s exactly what seems to be happening now in the artificial market the EPA has created in RINs.

Conclusions – High Time to Reform the RFS

The original purpose of the RFS and the law that established it was to reduce US reliance on imported oil, along with reducing greenhouse gas emissions. Because of its lower energy content the ethanol blended into US gasoline this year displaces about 540,000 barrels per day of gasoline produced from petroleum, though with questionable environmental benefits. That’s almost exactly the average quantity of finished gasoline and gasoline blending components exported from the US in the last 12 months reported.  Although that might be at least partly coincidental, it’s a further indication of just how much our national energy situation has changed since the legislation establishing the current RFS was passed in 2007.

One of the experts appearing before Congress this week characterized ethanol as an additive, rather than a replacement fuel. Until and unless E85 sales grow dramatically, that seems apt. Our elected representatives should now be asking themselves whether it makes sense — in light of altered circumstances — to subject the US motor fuels market to a new and entirely artificial source of price volatility for the sake of an additive that the CEO of Growth Energy testified would continue to be produced and sold in the absence of the mandate. When considered together with serious questions about its impact on food supplies and prices, the case for at least reform of the Renewable Fuel Standard is compelling.

  1. By PA32R on July 24, 2013 at 1:40 pm

    You forgot to mention one of the primary purposes of the RFS, i.e., to greenwash the placating of ethanol refiners and corn growers.

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  2. By SR arizona on July 24, 2013 at 2:17 pm

    If every gallon of ethanol comes with a RIN, how can it add 10 cents per gallon to the price at the pump on the majority of gas sold? They would only have to buy RINs for the gallons of ethanol short of the mandate, which would be a small percentage of total use.

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    • By Geoffrey Styles on July 25, 2013 at 12:28 pm

      The shortfall vs. the mandate is what makes the RINs so valuable, but that’s not how they affect the price of all gallons. The key is that gasoline containing ethanol is blended not at the refinery but at the terminal, or distribution point. In many cases the party doing the blending is different from the refiner that produced the petroleum part of the fuel–the same refiner that is the “obligated party” under the RFS and must present RINs sufficient to account for the ethanol that went into the fuel they manufactured and sold. So while the blender gets the RIN for free with the gallon of ethanol blended into 9 gallons of gasoline, the refiner that produced those 9 gallons of petroleum gasoline must buy 1 RIN in the market to cover them, if the refiner isn’t also the blender at the terminal. That’s how a RIN costing $1 adds $0.10/gal to the cost of making a gallon of finished gas sold at the pump. At that price, the refiner can’t just absorb its cost, any more than they could absorb the cost of the crude oil from which they produced the fuel.

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  3. By Russ Finley on July 26, 2013 at 12:50 am
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    • By Geoffrey Styles on July 26, 2013 at 9:14 am

      In Europe biodiesel, rather than ethanol, is the main biofuel. Much of it comes from oilseed crops (canola, etc.) but increasing quantities come from imports of palm oil, which is connected to deforestation and large emissions from land-use change. So not only is there a food vs. fuel problem, but a significant source of EU biofuels is unambiguously negative in terms of greenhouse gas emissions.

      see: http://www.theicct.org/sites/default/files/publications/ICCT_vegoil_and_EU_biofuel_mandate_20130211.pdf

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  4. By ben on July 26, 2013 at 10:26 am

    Geoffrey is clearly a gentleman with a diplomatic touch, as he has put the case for needed changes in RFS policy rather charitably. As one who witnessed the sausage-making of the original oxygenate standard in the Clear Air Act Amendments (1990) and the advent of RFS through two subsequent administrations (Democrat and Republican), it’s fair to say the original objective of “aiding independent producers” in a insurgent alternative fuels marketplace was achieved some time ago. We now find ourselves continuing to subsidize through mandate-driven costs an industry that must leave the nest provided by Washington politicians and fly on its own. The dynamics of the domestic energy market have changed markedly in the past two decades and the national objective of greater energy independence/security has enjoyed very modest benefits from biofuels despite a huge investment from the public treasury.

    I commend ETI and its thoughtful contributors for consistently serving as dependable source of analysis in helping to separate fact from fiction in the whole renewable fuels debate. The level of factual misrepresentation that comes out of RFA and other trade associations beating their biofuels drum is pure and simple spin. The fact that Corn Belt farmers allow such antics to besmirch any otherwise proud heritage of independent-spirited enterprise and self-reliance is a tragedy unimaginable only a generation ago. What has become of family-farm entrepreneurship that we might surrender our principles of freedom to the avarice of politicians with their pretenses of “job creation” and “growth” through fiat economics. At the risk of hyperbole, I’m not sure some of our travel on the ‘Road to Serfdom’ hasn’t been paved with Uncle Sam’s renewable fuels “incentives.” Warning: You take the king’s coin, you do the crown’s bidding!

    Again, thanks for the no-nonsense analysis Geoffrey.
    Ben

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    • By Russ Finley on July 29, 2013 at 12:40 am

      Well put Ben ….

      Although I have to admit that when it comes to subsidizing farmers, this has been a very effective way to do it. A book I recently read called “Why Nations Fail” makes a strong case that resistance to creative destruction contributes mightily to the undermining of a national economy.

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  5. By DJ on July 26, 2013 at 11:17 am

    Very well put Ben.

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  6. By Robert Rapier on July 28, 2013 at 12:26 am

    I have to wonder about the possible impact on E85 sales though. RINs at $1.00 a gallon would start to make E85 look pretty good.

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    • By Geoffrey Styles on July 29, 2013 at 6:39 pm

      Robert,
      The analysis at EPRINC to which I linked made that point, too, but the volume is just too constrained. It would take several billion gallons a year of E85 to fill the RIN gap, while current sales are around a few hundred million gal/y.

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