It is a pragmatic response to the realities of today’s fuel-demand dynamics. Or it is a politically motivated, ham-fisted blunder that will destroy new fuel options. Or it did not go far enough.
When it comes to the Renewable Fuel Standard (RFS), which requires a gradually increasing, minimum volume of renewable fuels blended into the country’s transportation fuels, everyone has an opinion. And now that the Environmental Protection Agency (EPA) is proposing in 2014 to waive renewable volume obligation (RVO) increases for the first time since the RFS was enacted in 2005, proponents and opponents are flooding the agency with arguments for and against, in hopes of affecting the final decision, due this spring.
The central issue facing the EPA: There is simply not enough fuel demand today to absorb the volume of renewable fuels that the RFS originally projected the nation would be consuming by now. Consider that in 2007, the Energy Information Administration (EIA) anticipated gasoline demand in 2014 to hit 153.9 billion gallons. In the wake of the recession blunting the nation’s appetite for fuel, demographic trends eroding the consumer base and the vehicle fleet ramping up in efficiency, the EIA projects gasoline demand of 133.1 billion gallons in 2014—nearly 14% lower than originally projected.
At the same time, the EPA is attempting to hold tighter reins on the value of renewable identification numbers (RINs), which were originally set up to provide greater flexibility to obligated parties under the RFS—refiners and importers—in proving compliance to the RFS volume standards. With blending more actual ethanol becoming difficult, the price of RINs shot up dramatically last summer—the cost of which refiners ultimately could have passed on to consumers.
Something has to give. Just ask Carlton Carroll, a spokesperson for the American Petroleum Institute (API), which has led lobbying against the RFS and in fact believes it should be repealed completely. “We are still forced to blend higher levels of ethanol into smaller levels of gasoline,” says Carroll. “We’re at the point now where … if EPA hadn’t taken steps to resolve the problem, [refiners] would have been pressured to blend more ethanol than is safe for cars on the road today.”
Ethanol supporters, particularly those with roots in corn, believe the blend wall is a manufactured crisis: If only the fueling infrastructure would widely adopt higher blends of ethanol—in particular, E15— the issue would resolve itself. Instead, they charge, the oil industry has spread misinformation and hoodwinked the government, retailers and consumers about the supposed dangers of higher ethanol blends in cars and the fueling infrastructure.
“Instead of investing in infrastructure, knowing that this day was coming since 2005, [the oil industry] continued to litigate and delay and has done everything in their power to stop [the RFS],” says Michael Frohlich, communications director for Washington, D.C.-based Growth Energy, an advocacy group for ethanol producers and supporters. “This problem could easily be solved by simply complying.”
And proponents of biodiesel and second- generation biofuels believe the EPA’s suggested reductions in RVOs for their products ignore their room for growth and will ultimately scare away investment.
But some would argue the EPA had no choice. John Eichberger, vice president of government relations for NACS, Alexandria, Va., is sensitive to the concerns of biofuel proponents. But he believes the agency recognized market realities and took the right step in proposing lowering RVOs, saying this is a case in which making no change could have brought down the entire RFS.
“If you don’t touch the program, you will have massive widespread noncompliance, which is going to result in increased cost for the consumer, with fines passed through, and supply decisions that take product out of the market and impact consumer prices. Ultimately, you will have a backlash against the RFS, which likely would lead to further reductions or repeal,” says Eichberger. “Without touching it, [the EPA would be] playing a really dangerous game of chicken that they would have lost.”
Physical Limitations
The Energy Independence and Security Act of 2007, which updated the RFS, originally mandated an increase in renewable-fuel volumes to 18.15 billion gallons in 2014. Citing the faulty demand projections and need to avoid the blend wall, the EPA now proposes 15.21 billion gallons.
Unlike the API, NACS does not support repeal of the RFS, citing the enormous investment the fuel industry has already made in implementing the mandate. But Eichberger wonders whether the EPA has gone far enough in its proposed RVO reductions for 2014.
“What the EPA has done is provide a stretch goal for the market, a goal that will require some additional blending beyond 10%, which means they didn’t come completely under the blend wall,” he explains. “But they got a lot closer to it. So it’s feasible we can satisfy it next year without running into significant problems, but it’s still going to take some work.”
From the perspective of the Petroleum Marketers Association of America (PMAA), Arlington, Va., the volume mandates will need to be extended as well.
“We do believe EPA needs to lower the ethanol mandate for 2014 and probably for 2015,” says Dan Gilligan, president of PMAA. “There’s no place for the product to go. E15 is not ready for prime time, and it’s not ready to make a serious impact on the E10 market. … E85 will probably do better as years go forward, but certainly not enough to make up a 1-billion-gallon difference next year.”
In regard to E15, Gilligan cites continuing concern about whether the fuel storage infrastructure can handle it. While underground storage tanks can generally hold E15 without issue, some of the other infrastructure components—leak detectors, piping, adhesives, gaskets—may not. It could be very difficult for a retailer to identify a manufacturer of all components, he says, let alone whether they are certifiably compatible with E15.
“The juice doesn’t equal the squeeze,” he says. “If you have to invest $200,000 to $300,000 to replace underground components … you’re talking about breaking concrete, taking out lines, putting in new ones. … The margins just aren’t there to pay for it.”
That’s not to say retailers aren’t finding an opportunity in E15. More than 60 sites in a dozen states currently sell the blend. In December, Murphy USA began selling E15 at a site in Arkansas and, with nearly 1,200 total sites, has room to grow. Frohlich of Growth Energy says that even more retailers could be selling E15, but he contends that major oil has included burdensome rules in their franchise agreements as a roadblock. He cites the example of Scott Zaremba of Zarco USA, who chose to debrand after his fuel brand, Phillips 66, requested additional measures for selling E15 that could have undermined its sellability.
“It’s a difficult burden to overcome and buy out these contracts,” says Frohlich. “When they have that kind of control, it’s very easy to put a halt on it, instead of allowing retailers to install flex-fuel pumps or providing any incentives in terms of the infrastructure.”
While Eichberger acknowledges that renegotiating a contract can be complex, he believes this is not a true barrier to selling E15. Instead, he believes the biggest reason E15 has not rolled out faster is lack of demand: “Why would a retailer offer a fuel [that] is always a big investment when switching it out, when the level of consumer demand is so uncertain and so small?”
RIN Reaction
With no physical room for ethanol to expand within the market—at least until more fuel retailers provide it—the weight of complying with the RFS volume mandates has fallen on RINs. This market, however, has taken on a life of its own. Indeed, corn-ethanol RIN values shot up from only 5 cents per gallon in December 2012 to about $1 per gallon in March 2013 as concerns about the approaching blend wall intensified. Reports surfaced in The New York Times about banks trading speculatively in RINs, possibly further inflating values.
“The RINs market was never intended to become a commodity trading program, which is what it’s become,” says Eichberger, describing it as more of a compliance tool. “But when you have mandated demand outstripping potential compliance, you’re going to have wacky market fluctuations and elevated prices.”
Meanwhile, large fuel retailers who were blending their own fuel found a big financial opportunity in selling RINs back to refiners, which Gilligan of PMAA says was an unfair advantage. For example, small retailers can find themselves significantly underpriced by large retailers that can blend, buy and trade their own ethanol, and make a profit from RINs.
“When you get to $1 a gallon, that’s a huge distortion in the real market,” he says. “This then creates an un-level playing field for competitors.”
Should the EPA’s proposed volumes become law, Eichberger says, fuel blenders who have been trying to amass and sell back RINs to obligated parties will likely lose money. Most fuel retailers should see no effect. However, the cost of not adjusting RVOs for ethanol is great, he warns.
“If RVOs are not adjusted down, and you had widespread noncompliance, the cost of product would be the concern,” says Eichberger, explaining that any fines would be passed down to the consumer. If refiners began exporting product to avoid RVO obligations, supply would be squeezed and also affect prices.
“The failure of the EPA to make an adjustment would have had a much more dramatic effect on the market than the EPA taking efforts to protect the market.”
Tom Kloza, chief oil analyst for GasBuddy, Brooklyn Park, Minn., says the conventional wisdom is that if the proposed RVOs go into effect, RIN values should drop to 5 to 15 cents per gallon. But after the EPA’s proposal was officially announced, values have been padded by an additional 20 cents. “The price says there’s a real considerable risk that what was proposed won’t become law,” he says. “It will become more amenable to renewable interests and reprehensible to refiners.”
From his perspective, the RINs market is far from settled: “If someone said, ‘Tom, will you give us a range for RINs? What will they be worth?’ I won’t take the bet. It’s too uncertain.”
Future Fuels Threatened?
Much of the political wrangling around the EPA’s biofuels volume cuts has swirled around corn-based ethanol, which makes up the bulk of renewable fuels blended and sold in the United States today. But there is also concern about the EPA’s proposals for advanced, or second-generation, biofuels.
For example, while PMAA believes the market is saturated with ethanol, it warns that biodiesel volumes should not be cut; the EPA is currently proposing freezing the 2013 volume levels for 2014 and 2015. Any biodiesel produced in excess of those volumes in 2013 would be counted against the 2014 figure, which could even further trim production. “There’s growth, there’s more capacity, if EPA wanted to increase the biodiesel mandate,” says Gilligan of PMAA, who believes the biodiesel volume obligation should be increased. “A mandate tends to encourage more investment.”
This is the argument of other advanced-biofuel supporters. The EPA felt forced to react to unrealistic volume targets for cellulosic ethanol, which has failed to come remotely close to the 1.75 billion gallons originally mandated. However, supporters of cellulosic ethanol argue that the economic recession chilled investment and growth in the industry, and it is just now finding its footing. To cut the mandate on cellulosic to 17 million gallons, as the EPA has proposed, would be disastrous.
“The proposal is our worst nightmare,” says Michael McAdams, president of the Washington, D.C.-based Advanced Biofuels Association, which represents manufacturers of advanced and cellulosic biofuels. The RFS was instrumental in creating the second-generation ethanol industry, he says; six biofuel production plants have been built since 2007, while no new oil refineries have been built in the past 40 years.
“For the first time ever, the rule does an about-face,” and the decision to roll back the volume obligations for renewables to 15.21 billion gallons was done to address the corn-ethanol blend wall, he says. “There are a wide range of technologies deployed, and many have nothing to do with corn ethanol.”
Meanwhile, producers of non-ethanol, hydrocarbon-based biofuels are also facing cuts. Sapphire Energy is a producer of “green crude,” an algal oil that refiners such as Phillips 66 and Tesoro are now testing. Tim Zenk, vice president of corporate affairs for Sapphire Energy Inc., San Diego, says this drop-in fuel was unfairly lumped in with ethanol in the targeted cuts.
“The effect is to destabilize the marketplace again for the fuels we’ve always wanted, which has been the policy of the administration and the previous administration, which always wanted to move in the direction of advanced biofuels,” says Zenk. “At this stage, it sends the wrong message to investors, which is: ‘We’re going to continue to mess around with the RFS both in Congress and within the administration.’ ”
The lowest carbon fuels should not face volume cuts, Zenk says. “Since that category of the RFS is actually meeting its targets, I think they should not have lowered those targets,” he says. “What they do with the other categories, they know what the alternatives are.”
One thing ethanol supporters and detractors can agree upon is that when it comes to fuel production, uncertainty is a bad thing.
“One thing tax credits do, and having a stable RIN value does, is it helps de-risk the technology economically,” says McAdams of the Advanced Biofuels Association. “That’s why we’re fighting so hard to keep 3.75 billion gallons: It sends a consistent signal that the U.S. government will stand behind its energy portfolio approach.”
Gilligan of PMAA believes RIN prices will stay high enough to keep investment flowing toward biofuels, provided they do not crash. “Even staying with the current ethanol mandate, RINs could get in the 10-, 20-, 30-cent range next year, which would create an ongoing incentive for investment in that infrastructure,” he says.
“In my job, I have to be optimistic,” says McAdams, pointing out that the EPA has several options as it finalizes the volume obligations. “I’m very hopeful after the comments come in … they will recalibrate so it more accurately reflects where the advanced-biofuels industry can go today.”
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