Ethanol Industry Confronting Major Changes as "Blend Wall" Approaches
By: Theresa Zeidler-Shonat, AccuVal Associates, Inc.
In recent years, ethanol has become the preferred additive to oxygenate fuel, a process that makes gasoline friendlier on the environment by burning more completely. Federal law requires the sale of oxygenated fuels in certain carbon monoxide non-attainment Metropolitan Statistical Areas (''MSAs'') during at least four winter months, typically November through February. The process of using ethanol as an oxygenator was developed more than a century ago but surged in popularity during the past decade when another oxygenator, Methyl Tertiary Butyl Ether (MTBE), was banned by many states due to environmental concerns. Ethanol's popularity has since been buoyed by subsidies and favorable environmental regulations, but the industry has become very dependent on these policies. And it may be facing new challenges ahead.
The Renewable Fuel Standard sets the floor for ethanol demand
In 2005, the U.S. established its first renewable fuel volume mandate, requiring a minimum level of biofuels be blended with gasoline. The original blending mandate required 7.5 billion gallons of renewable fuel be blended by 2012; the Energy Independence and Security Act of 2007 (EISA) significantly increased the 2012 mandate to 15.2 billion gallons with further annual increases and a peak of 36.0 gallons by 2022. As of 2010, 38 states provide incentives for ethanol use and 12 states have biofuel mandates, though the biggest consumers of ethanol are concentrated in the Corn Belt states and near refineries.
In essence, the RFS creates a demand ''floor'' since demand for ethanol is unlikely to drop below the mandated levels, even under weak economic conditions.
What is the ''Blend Wall?''
In most regions of the U.S., ethanol blends may contain up to 10% ethanol, a mix considered ''substantially similar'' to gasoline by the EPA. By some estimates, the nation annually consumes approximately 145 billion gallons of gasoline, of which approximately 120 billion gallons are subject to the RFS blending formula. Even if every one of these gallons were blended with 10% ethanol, refiners would only be permitted to blend 12 billion gallons. With the RFS requirement that 12.95 billion gallons of renewables be used by 2010, refineries are approaching the ''Blend Wall,'' the point at which there is no further gasoline available to blend with ethanol under state maximums. This makes it impossible to meet the RFS minimum fuel requirement.
Even the EPA acknowledges ''to achieve the renewable fuel requirement in future years, it is clear that ethanol will need to be blended into gasoline at levels greater than the current limit of 10%.'' This is why conversations have spiked over whether the use of higher blends, like E15 (15% ethanol) should be permitted.
In March 2009, Growth Energy (a coalition of U.S. ethanol supporters) and 54 ethanol manufacturers applied for a waiver to increase the allowable amount of ethanol in gasoline from E10 to E15. The waiver application included data on the impact of E15 on vehicle emissions, fuel system materials, and drivability.
On October 13, 2010, the EPA partially granted the waiver request, allowing fuel and fuel additive manufacturers to introduce gasoline that contains greater than 10 percent ethanol and up to 15 percent ethanol into commerce for use in certain motor vehicles once certain other conditions are fulfilled. E15 was approved for use in model year (MY) 2007 and newer light-duty motor vehicles; however, other exclusions were made due to insufficient data on ethanol’s effects on certain vehicles and engines.
There are still a number of additional steps that must be completed, some of which are not under EPA control, to allow the sale and distribution of E15. These include, but are not limited to, submission of a complete E15 fuels registration application by industry and changes to some states' laws to allow for the use of E15.
Two lawsuits have been filed in opposition to the waiver. Trade groups for the automotive and engine manufacturing industry are protesting the change, saying that motorists could unknowingly damage their engines by using E15. A second lawsuit filed by the National Petrochemical and Refiners Association asserts that the EPA does not have the right to approve fuels that can only be used in select engines and not others.
Will E15 boost ethanol demand?
The EPA's limited acceptance of E15 does shift the theoretical Blend Wall and increases the theoretical maximum demand for ethanol. However, since the waiver will likely not require E15 but rather simply permit its use, it will still require market adoption to have any real impact on demand, which is likely to be a challenge:
- Petroleum refiners don't want to blend ethanol at percentages higher than 10% unless Congress gives them protection from lawsuits stemming from damaged engines.
- The Petroleum Marketers Association of America notes that limiting the waiver to specific vehicles types means that retailers would have to sell both E10 and E15, increasing the risk of consumer misfueling.
- Small engine manufacturers oppose the measure because they do not design small engines for fuels that burn as hot as E15 does.
- Suppliers of fuel storage tanks and dispensing equipment have also raised concerns about E15 adoption, some having to do with ethanol’s effect on equipment and some having to do with practical challenges of offering E15. The vast majority of equipment installed at stations is certified to handle E10. Operators dispensing fuel with an ethanol content greater than 10 percent risk losing their equipments’ Underwriters Laboratories (UL) approval, or safety certification.
- The American Society for Testing and Materials (ASTM) develops and maintains national standards for certain fuel mixtures; most states require fuels and fuel blends to meet these standards. Currently, ASTM does not have a standard that covers E15.
- Gasoline service stations would need to install additional pumps to dispense and tanks to store E15. Because E10 is legal for use in all automobiles, service stations will likely resist additional investment in pump and tank installation.
Without greater support from regulators, refiners, retailers and equipment manufacturers, market adoption of E15 may be many years out.
Is the Volumetric Ethanol Excise Tax Credit coming to an end?
In 2004, Congress passed the American Jobs Creation Act (AJCA). One provision of the law created the Volumetric Ethanol Excise Tax Credit (VEETC) that replaced a partial tax exemption system with a tax credit for each gallon of ethanol blended with gasoline. The VEETC does not prescribe a certain level of blending but rather grants the credit for each gallon of ''an alcohol fuel mixture'' blended. Under certain market conditions, it provides an incentive for refiners to blend ethanol above levels mandated by the RFS. When the cost of ethanol is lower than the cost of reformulated gasoline, refiners have an incentive to market ethanol blends in geographic regions not covered by the RFS. The VEETC effectively lowers the cost of ethanol to blenders and makes additional blending more likely, thereby increasing ethanol demand.
The gray bars in the figure below indicate periods where such additional blending due to the impact of the VEETC was indicated based upon average rack prices of reformulated gasoline and ethanol, F.O.B., Omaha, Nebraska. Additional blending can occur without the impact of the VEETC under the right economic conditions.
VEETC Impact on Blending
As the above figure shows, the VEETC provides a great deal of support for ethanol demand. From January 2004 to December 2010, there were 32 months (38% of the period) in which market prices suggested that additional blending occurred as a result of the VEETC. This represents a significant demand boost.
Ethanol blends have been either wholly or partially exempt from the federal excise tax on gasoline since 1978. The exemption has ranged from $0.04 to $0.06 per gallon of gasoline during that 25-year period. The federal excise tax exemption was revised, and its expiration date was extended for the sixth time to December 31, 2010. A one-year extension of the VEETC, through December 2011, was passed as part of a broader tax measure, though no further extensions are planned. If Congress fails to renew the VEETC after 2011, ethanol producers are likely to see demand reduction.
In the near term, the ethanol industry will continue to benefit from the recent extension of the VEETC and the RFS-driven ''demand floor.'' The EPA’s granting of the E15 waiver will not result in immediate benefits, but it is expected that a number of factors will encourage it, including changes to individual state regulations and standards, and increased demand from geographic markets with larger concentrations of newer model-year vehicles.
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