E15 ethanol: bridge to tomorrow, or bridge to nowhere?

June 8, 2011 |

The offices of Eric McAfee, the charismatic Silicon Valley entrepreneur and CEO of AE Biofuels, are just a block or two from the offices of Apple and Steve Jobs, and thoughts of Jobs’ famed “reality distortion field” come easily to mind while threading through the Apple-swamped car traffic en route to a meeting at AE Biofuels headquarters.

Among the subjects, E15 ethanol. Turns out that McAfee doesn’t need a “reality distortion field,” to sell the cellulosic ethanol industry’s vision of expanding market access through E15. A giant Scottish clan sword, right out of the pages of Rob Roy and weighing perhaps 30 pounds, adorns the wall of his office, magnetically attached to the wall and suitably available for extra persuasion, should discussions on E10, vs E15, or higher blend volumes, go badly.

“E15 brings immediate relief,” McAfee says. “E85, or blender pumps for blends like E30 or E40, take too long. The blend wall is here.”

McAfee points out that financing, already difficult for first-of-kind technologies, is made even more difficult by the prospect of ethanol overcapacity. It creates upward price pressure on feedstock and, more importantly, downward pressure on pricing.

“At the levels that we blend ethanol today, it essentially should function like an additive. Additives are supposed to be priced at a premium to gasoline. Instead, ethanol is priced at a substantial discount.”

E15 as bridge to tomorrow

The solution, according to most observers in the ethanol industry and especially among the congnoscenti of advanced cellulosic ethanol – is that only E15 ethanol works. E15 blending, goes the argument, can provide the immediate market growth that will absorb current capacity, and create room in the marketplace to meet RFS renewable fuel mandates, and create a market for cellulosic ethanol.

To the suggestion that opposition to E15, from groups representing non-E15 compliant off-road equipment such as mowers, leaf blowers, and such, McAfee says, “they need an additive, that’s all, and we as an industry would be better off paying a fee for their additive, and getting that larger market through E15, then staying at E10 because of problems with off-road equipment.”

“E15 – it’s the answer”. It’s a common theme from the Advanced Ethanol Coalition, the Renewable Fuels Association, and Growth Energy – formidable organizations that have devoted a lot of resource to thinking through the problem.

E15 as bridge to nowhere

Over at the Digest, the analytic staff for ethanol market economics is a little smaller, which is to say there isn’t one. But we are not so sure about E15.

Now, all E15 supporters describe E15 is a temporary relief measure, not an all-in-one solution. It offers “relief for ethanol producers”, supporters say, “while drop-in fuels, blender pumps and flex-fuel cars are developed”.  RFA, Growth, and AEC describe E15 as a necessary bridge to tomorrow.

But we see E15 as a proposal that has united the opposition to biofuels more than united the biofuels industry. We see it as a “bridge to nowhere”.

Here at the Digest, we take the view that fulfilling the RFS mandate requires a tremendous build-up in advanced biofuels, based on a combination of drop-in fuels and higher ethanol blends such as E30, E40, or E85. E15 is a distracting sideshow. The industry needs to focus squarely on the opportunities and challenges of advanced cellulosic biofuels, and making a market for higher ethanol blends.

With those two markets, the problem is not lack of market access, but lack of market power. Both cellulosic biofuels and higher ethanol blends are at the tender pricing mercy of the existing fuels distribution industry – cellulosic biofuels are sold too cheaply to the distributor to have returns that easily justify the risks, while E85 is not sold at a sufficient discount to gasoline.

Unintended consequences of the RFS: overcapacity

In our view, the pricing and capacity problem of cellulosic biofuels lies in the insidious nature of the RFS mandate itself.

Under the 2007 EISA Act, if cellulosic biofuels capacity is not available, the EPA is required by law to waive down the mandate to meet production.

Naturally, this sets the industry up for overcapacity. It’s impossible for disparate players to magically build exactly the right amount of capacity. So – build too much, there’s overcapacity. Build too little, the mandate is waived down to the expected production.

Meanwhile, obligated blenders have other ways to buy ethanol – for example, through imports. And because cellulosic ethanol is more expensive, producers have no other fuel market available – for instance, exports – to correct the supply and demand imbalance.

It sets up a situation where, by law, there’s always overcapacity in the US, and advanced ethanol producers always will be facing a buyer’s market, with prices distorted on the downside.

Producers have no market power, and have no means to get one.

A solution for cellulosic biofuels: the integrated biorefinery?

The RFS mandate is built on capacity and proposed production, not actual production. There is a mandate to blend, but there is no mandate to produce under adverse price conditions.

The trick is to control production capacity by having two product lines. It’s what they do in Brazil, with sugar and ethanol. In the US, it could be, say, acetic acid, or ethylene – or, say, isobutanol, as in the case of Gevo or Butamax.

Were US producers to have that capacity to produce ethanol or not – by producing an alternative, high-margin product (as opposed to reducing capacity through shut down), that works on the mandate in a different way.

For example, Butamax could indicate a plan to the EPA to produce up to, say 80 million gallons of isolbutanol – a qualifying advanced biofuel – at a plant they have recently converted. EPA then converts that capacity into the mandate.

Now, Butamax is not required to distribute isobutanol into the fuels market at whatever price a fuel blender is willing to pay. It can distribute into the multi-billion isobutanol market. But the mandate is still there. The blender has to bid up, to induce Butamax to sell into the fuel market, or go out into the market and buy the equivalent in cellulosic RINs.

“Why would you make a $2 fuel, when you can make a $5 chemical?” Cobalt Technologies CEO Rick Wilson famously asked last year.

The answer? You’d make a $2 fuel if the blender was facing a $4 RIN.

Now, that’s market power. The cellulosic biofuels producers, who have integrated biorefineries under development, can do just fine with the existing E10 market, so long as RIN values move in an appropriate direction. Their problem is not the 13 billion, or 19 billion ethanol market that E10 or E15 provides. Their problem is to manage to make a market for cellulosic biofuels under the RFS. There’s plenty of opportunity to do so, even without E15.

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