Fuels: Backing Away From the Blend Wall

EPA's proposed biofuel volumes have implications for retailers, future fuels

Samantha Oller, Senior Editor/Fuels, CSP

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.”