Statesmanship vs brinkmanship: collision of ethanol blend wall, US mandates is a biofuels inflection point

The EPA seeks a “goldilocks” number to push renewable fuels forward while averting a crisis over ethanol blending and RIN prices.

The biofuels industry faces a significant decision over how to structure its response.

The key: keep an eye on the biomass-based diesel targets.

In Washington, a document identified as EPA’s draft proposal for 2014 Renewable Fuel Standards Renewable Volume Obligation, “proposes a significant reduction in the overall renewable fuel requirements to 15.21 billion gallons, far less than the 18.15 billion gallon 2014 target established by law,” in what Reuters described as an “historic retreat from an ambitious 2007 law and a victory for refiners.”

Corn ethanol was capped, in the leaked document, to 13 billion gallons. Leaving 2.21 billion gallons for advanced biofuels — a 20 percent cut.

According to the leaked documents, the EPA also considered a corn-based ethanol volume at 12.36 billion gallons and a 13.18 billion gallon scenario. All three scenarios are relatively tightly focused on the potential demand for gasoline and, hence, the underlying supply of a blend pool.

In a related story that did not reference documents but focused on informed sources, Greenwire reported similar numbers last week that the biodiesel numbers would stand at 1.28 billion gallons, while the cellulosic biofuels targets would be set at 23 million gallons.

More on that story here.

A friend of the Digest (not from the ethanol industry) writes:

“If left to become law by OMB and the Administration, the proposed RVO for all biofuel categories, especially the Advanced Biofuel Category, would be a complete disaster and a total reversal of the President’s agenda on clean energy. It would have dire consequences on the entire biofuels sector, and not just the corn ethanol or biodiesel industry, it will completely crush any investments in future biofuel developments due to the continuation of destabilization of the sector.

“If people are frustrated with the lack of progress on renewable jet fuel today, this type of policy development will only hinder that industry’s ability to get out of the starting gate even more.”

Our friend advises: “This is the biggest story out there right now and the industry needs to get fired up about pushing back right now. We are losing the battle with API and we need to stop the destruction of our industry from their aggressive efforts to maintain their market share.”

Indeed, at first glance, the EPA appears to be cracking down, in the leaked document, on advanced biofuels far more than corn ethanol. A 20 percent overall cut in the advanced biofuels target – compared to 6 percent in the overall cut in the corn ethanol target.

Despite the fact that drop-in fuels that generally avoid the entire blend-wall issue are produced for the advanced biofuels pool — and despite the fact that the US has generally had far fewer problems with the advanced biofuels pool than any other. And despite their greater potential to cut emissions (fuels must cut emissions by 50% compared to a baseline of 2005 gasoline to be considered “advanced”, compared to a 20% threshold for corn ethanol).

Losing out? Looks like Brazilian sugarcane ethanol to us.

Does EPA have the power?

Renewable Fuels chief Bob Dinneen cautions:

“There is no evidence suggesting the EPA should waive blending requirements. [T]here can be no showing that the statutorily-mandated renewable fuel volumes ‘would severely harm the economy or environment’ of a State, region, or the country, or that there is an ‘inadequate domestic supply’ of total renewable fuel that would prevent the oil industry from meeting its total RVOs.”

The question turns on an interpretation of the RFS2 legislation that gives the EPA the power to waive mandates on the basis of “economic harm” or “inadequate domestic supply”. Given that the EPA did not find sufficient economic harm, even, in the 2012 corn drought, to waive down biofuels mandates, it appears to be taking the view that the shortage of available gasoline to blend, the availability of sufficient drop-in fuels, E15 pumps, E85 markets or other means to blend ethanol constitutes, as a whole or in some combination of the parts, as an “‘inadequate domestic supply’.

The EPA itself is alleged to have commented in the unseen proposal: “”We interpret the term ‘inadequate domestic supply’ as it is used under the general waiver authority to include consideration of factors that affect consumption of renewable fuel.”

What’s causing the problem?

To some extent, the expectation is being caused by a relatively significant decline in gasoline consumption. When the RFS2 was first adopted as law, the Energy Information Administration projected 2014 gasoline consumption at around 157 billion gallons, but now projects. That means that somewhere around 13 billion gallons of ethanol can be blended at E10 rates – compared to more than 15 billion at the time that the original Energy Independence and Security Act was passed.

RFA’s Dinneen says that the blend wall is a fiction. In responding to a Financial Times editorial, he wrote in March:

“The editorial incorrectly states 10 percent (E10) is the “maximum” level of ethanol approved by regulators for use in U.S. automobiles. In fact, regulators have approved 15 percent ethanol blends for use in roughly 75 percent of vehicles. In addition, about half of the new vehicles made by American automakers today are approved to use up to 85 percent ethanol blends (E85). Clearly, automakers responded to the signals sent by the RFS program when it was enacted six years ago. Meanwhile, oil refiners sat on their hands and whistled Dixie, refusing to invest in infrastructure.

“In short, the E10 “blend wall” is a fiction. There are legal and economical ways for refiners to meet their renewable fuel blending obligations. Instead, however, the oil industry continues to refuse to blend more ethanol. They would rather bid up the price of RIN credits to avoid using more ethanol, then complain to Congress that they can’t break through a wall built with bricks from their own kiln.”

Who leaked?

Growth Energy CEO Tom Buis commented:

“The 2014 RVO rulemaking process is not final, and we are not going to comment on an unverified ‘draft’ documents.  There are many steps in the rulemaking process before a rule becomes final.  Unfortunately, as a result of the government shutdown, the process is on hold.  Hopefully, the shutdown ends soon, allowing the rulemaking process to resume, instead of everyone reacting to premature reporting of rumors or unverified leaks, allowing the EPA to follow proper procedures to propose a rule for everyone to comment on.

“Obviously, someone was irresponsible in leaking such market sensitive information.  Because of the dramatic economic impact on commodity markets there should by an immediate investigation by the Justice Department, and the Commodity Futures Trading Commission to determine if this was an attempt to manipulate markets such as corn futures, ethanol futures and/or RINS markets.”

EPA casts doubt

Piper Jaffray agrienergy analyst Mike Ritzenthaler notes: “In order to ease the declining markets stemming from the speculation caused by the Reuters report, the EPA issued a statement stating that the Obama Administration continues to support biofuels and that the EPA has not yet finalized the 2014 proposed renewable fuel standards. The EPA has submitted a proposal to the White House Office of Management and Budget (OMB) and upon approval the proposal will go through a public comment period….we continue to believe the EPA will endorse an increase in biodiesel volumes in 2014, supporting our FY14 projections.”

The impact of shutdown

Reuters reports on the carnage that the government shutdown is having on the RFS2 timelines.

“The U.S. Environmental Protection Agency will take one of the biggest hits of any federal agency if the government shuts down this week, operating with under 7 percent of its employees, according to guidance issued by the agency….The clock would also stop, for now, on the EPA’s eagerly-awaited proposal on renewable fuel volume standards for 2014. “People are not going to be able to be working on these rules at home,” said Dina Kruger, an environmental regulation consultant and former climate change director at the EPA, who worked at the agency when the government shut down in 1996.”

To the courts?

RFA may be signaling that it could resort to the courts to uphold the original Congressional targets. “Let me be clear: any plan to roll back the targets … under the guise of addressing the blend wall would be patently unlawful,” said Dinneen.

As Reuters reports, “The Renewable Fuels Association has previously argued that Congress need not amend the 2007 law because the EPA has enough flexibility under the law to make changes to reflect market realities. The agency is now exercising some of that discretion – but certainly not as proponents would like.”

The EPA’s rationale

In the proposal, as reported by Reuters, the EPA set out a “durable methodology that could be used in 2015 and beyond to reduce market uncertainty” through a combination of forward industry estimates of production and Monte Carlo option modeling, to estimate domestic supply of fuels and gasoline.

More on the Monte Carlo approach, here.

The Digest’s Take: Devil in the Details

Whoa, Nelly.

First, let’s get an actual EPA proposal on the table — though forewarned is forearmed.

Second, let’s look carefully at the biomass-based diesel numbers. If they are carefully constructed — this EPA proposal could be a big win for biofuels, and especially advanced biofuels. Badly constructed – it could spell disaster in a wide set of circles.

At 1.28 billion gallons — while hardly a push forward for biomass-based diesel — the EPA target seems well set to limit much chance that Brazilian sugarcane ethanol could fill up this pool and generate a problem with the US blend wall.

If the biomass-based diesel numbers are smaller — then we could see sugarcane ethanol pouring in to meet the advanced numbers, and then you have a biodiesel crisis, a US ethanol crisis, and a corn depression. The only happy parties might be Brazilian sugarcane producers, and oil refiners.

You see, with a 2.17 billion gallon mandate — setting the biomass-based diesel number that high would make it virtually impossible to use anything else, because biodiesel gallons count for 1.5 gallons each in terms of ethanol-equivalent gallons under the RFS, and renewable diesel for 1.7 billion. (Note: diesel fuel has far higher energy density than gasoline, or ethanol).

In our view, the target could be safely set for biomes-based diesel at 1.5 billion gallons — better ensuring that advanced biofuels gallons fill the diesel pool — causing less potential push-back on the gasoline side, and more in line with production growth on the biodiesel side.

Indeed, the biodiesel industry has produced, according to the EPA, 768 million gallons through July, or 110 million gallons per month, on its own. That’s a rate of 1.3 billion gallons for the year. The industry — when you factor in the 212 million gallons of US renewable diesel capacity — seems highly capable of producing more than 1.5 billion gallons, especially when Neste Oil’s offshore renewable diesel capacity is factored in (Neste has more than 500 million gallons of capacity).

And, in this case, there’s no blend wall facing the diesel side right now. Diesel usage is growing, and the biomass-based diesel mandate right now is hugely below anything resembling a curb imposed by vehicle infrastructure.

With the mandate set in that fashion — and the cellulosic pool will be small again, though growing — there will be no real opportunity for substituting sugarcane ethanol for corn ethanol except on price, and in the face of huge corn harvest numbers, we have fast-falling corn prices, negating some of that risk.

Bottom line. With falling corn prices, ethanol producers might have a reasonable chance of making some money in the spread between ethanol and corn, for the mandated amounts. Excess production capacity? The focus may well shift to E85, where the margins could be huge between gasoline prices and E85 prices — and a market could be established based on market prices rather than mandate forces.

At the same time, if the biofuels industry gets behind the EPA proposal — and behind ensuring that the biomass-based diesel number is high — they would tend to validate the view that the EPA has the power to effectively regulate RFS2 through its existing authority.

This, in turn, could take substantial air out of the legislative efforts on EPA. In turn, do wonders to build belief among lenders and lower the cost of capital for the next generation of biofuels plants that needs to be built to meet future mandates. At the same time, reduce pressure on the RFS from a coalition that has built up over E15 blends, RIN prices and high corn prices.

An effective industry response will create stability — stability for now, and perhaps through 2022 and beyond, with the blessings of lower cost of capital for new producers facing a shutout in financial markets.

A knee-jerk response will possibly kill off future biofuels investment, knit the coalition aimed at destroying RFS into a permanent guerrilla force, and confirm what some have said all along, that biofuels producers are only interested in reducing gasoline usage and increasing energy independence if it advantages them, and that they are only interested in supporting the EPA’s regulatory authority to manage RFS2 if the rulings always go their way.

It’s time for statesmanship, not brinkmanship — by industry, refiners and EPA