20 oil? $200 oil? Does it matter?

May 9, 2017 |

Part 1 of the 3-part Digest series: Carbon 2017

For the world of renewable fuels — the only significant carbon legislation on the books, it really doesn’t matter what the oil price is. The RFS creates a separate market for renewable fuels and they compete against each other as alternatives within that market.

It’s not unheard of. California, for example, has a separate market, anyway, because of the requirement to produce reformulated gasoline, a unique type of anti-smog fuel. To use another example, Colorado and Wyoming utilize 85-octane regular unleaded fuel, instead of 87-octane as we see elsewhere around the country. There are distinct fuels markets for different reasons, and the renewable fuels market is one of them.

No, there’s no cartel in the renewable fuel business

Within the market that the Renewable Fuel Standard creates, it is the competition between renewable alternatives that keeps prices in check for consumers. There is no earthly reason why Green Plains or POET, for example, couldn’t charge $100 per gallon for ethanol — except that they have to compete against every other potential supplier in their class of fuel — not only US producers, but international ones as well. There’s no cartel to control and inflate prices, as we have in the world of petroleum.

In one sense, when Congress established the Renewable Fuel Standard, they did expect to have competition between petroleum and renewable alternatives, and that was in the realm of flex-fuel cars and higher ethanol blends. They expected that a robust market for E85 would emerge and that this would allow the US to avoid reaching a saturation point at E10 around now, and E15 later on when that fuel standard becomes compatible with more cars or retailers establish more pumps.

E85 does compete with the gasoline price — and fuels like B20 biodiesel or B99 biodiesel compete with the petroleum diesel price — because the selection of those fuels is based on consumer choice (so long as the consumer is driving a fuel-compatible car) and consumers in most cases make choices based on price. Given that some wholesalers charge as little as $0.90 for a gallons of E85 and others charge $1.60 — there’s enough gaming in the world of higher ethanol blends that the free market never emerged that Congress envisioned. There’s enough cartel pricing that it appears the route to large volumes of renewable fuels will require a different path than E85.

There’s been quite a bit of hand-wringing about the lack of cellulosic ethanol availability, and at the end of the day that comes down to still-maturing technology and to the uncertainty over the Renewable Fuel Standard’s stability and the volumes within the various classes of fuel.

You see, because of the E10 saturation point and the lack of a large E15 or E85 market for the distribution of added production, cellulosic ethanol competes against conventional ethanol not in terms of the RFS’s separate classes (cellulosic ethanol has its own class), but in terms of distribution. Over time, ethanol distribution will expand, but it is expanding slowly because E15 and E85 are gaining traction slowly — and ultimately cellulosic ethanol has to find a market by displacing conventional ethanol within at the US pump or in the export market. That choice will be made by wholesale and retail customers, generally on price, and it doesn’t yet compete on price. Who knows if it will ever compete on price — corn ethanol producers have become that efficient.

The pathway to 36 billion gallons may well proceed on the basis of diesel fuels and biocrudes. There, we have seen the rise of drop-in alternatives to ethanol and gasoline, and biodiesel and diesel. Renewable biocrude isn’t any of those four, for example.

The distribution (or demand) constraint drops away when we are thinking in terms of biocrude or renewable hydrocarbon diesel. It is possible to replace far more fuels this way than the RFS ever envisaged. From the point of view of vehicle, pump and pipeline infrastructure, it is possible to produce more than 100 billion gallons of these two fuels, for the US market alone.

The constraints on production are entirely related back to production capacity and to price. Clearly, companies like REG, Neste and Tesoro are building drop-in fuels capacity, aiming at a much larger US market (and especially, because of California’s market).

It’s about volumes, not prices

In doing so, none of these companies really have to think much about the consumer price — for now. They have to think about the RFS volumes that the EPA sets, and their competitive price against each other. REG can produce fuels competitive with $20 oil or $200 oil — what will matter is what price Tesoro and Neste will produce them at. Ultimately, companies like UPM and Shell may well enter into this market — and others — and what they will do is compete against each other. Woe betide $55 renewable crude if someone is producing $52 renewable crude — excepting where there is firm offtake agreements or distribution logistics and shipping price to consider.

Perhaps the most interesting play of all is Tesoro’s announced ambitions in low carbon biocrude — because it will allow for very large production capacities and presumably this fuel will meet the 50% thresholds to qualify as an advanced biofuel.

So, to use an example, the EPA, given a congressional target of 36 billion gallons by 2022, could substantially increase the size of the renewable fuels market, should Tesoro or any of its competitors ramp up production capacity.

So long as production capacity is close to the size of the market that EPA establishes, there should be room for all. The more generously that EPA draws the market to accelerate the adoption of renewable fuels and drive down foreign oil dependence, stimulate domestic jobs and reduce greenhouse gas emissions — the more that higher-price fuels will be utilized. There would be room for the highest-cost producer — not just the lowest.

Conversely, if EPA decided to clamp down on reducing foreign oil dependence, stimulate domestic jobs and reducing greenhouse gas emissions, the price of these fuels will fall because the marginal suppliers will be eliminated.

This is a fascinating chart, if an older one now — that shows the global oil market according to producers and prices. It illustrates the problem that renewables have in competing with just about every form of conventional fossil fuels — and is often cited as a rationale for establishing a direct price on carbon.

But its not a very good graphic for the US renewable fuels market. In fact, renewables don’t compete against shale oil — because shale oil cannot qualify under the RFS to enter the RFS market.

It’s not a mandate, it’s a Standard

Think of the RFS not as carbon legislation but literally as a standard. Fracked fuels cannot meet the standard and they cannot enter into the RFS market for the same reason that E30 fuels can’t enter the conventional fuels market. High-carbon fuels have their own saturation points — even if they are very high saturation points indeed.

In this way, the EPA with its rulings on the size of the renewables market — is essentially establishing a carbon price, but without further legislation to establish a price on carbon or without Congress imposing a carbon tax.

Through its rulings in the 2014-2016 period, when the EPA was clamping down on the growth of the market, it was reducing the price on carbon — and signaling “don’t bother” to the marginal cost producers. Those were primarily the potential investors in cellulosic ethanol —something that BIO has been railing against.

The fight against climate change never had such a false friend as the Obama Administration — who gutted the only carbon legislation on the books, and built all its other actions on carbon on such a flimsy footing that President Trump swept them away with a stroke of the pen.

But there’s hope, ironically, in this Administration, which is generally regarded to be the least climate-friendly in recent decades. But the President is RFS-friendly — so far.

Good luck selling gasoline to an airline

To the extent that companies like Tesoro, REG, Neste, Shell and other major producers of renewable diesel and biocrude are able to ramp up production, the issue is not at all going to be about their ability to compete with the global oil price. Just as it is with other fuel standards — such as reformulated gasoline for the California market — which doesn’t compete in any way, shape or form with non-reformulated fuels sold in other markets. Just as 82-octane gasoline could beat 87-octane gasoline on price, any day of the week — it just can’t enter the market because it doesn’t meet the standard. And gasoline beats kerosene any day of the week, but good luck selling gasoline to an airline. It doesn’t meet the standard.

The fuels that meet the standards — they will always compete against each other — and that is why we have the low corn ethanol price that we do. Within fuel classes, what matters is that there is a vibrant set of competitors — that will keep prices in check. For this class of drop-in fuels, it’s all about ramping up production capacity and ensuring that EPA will expand the market covered by the standard.

 

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