Biofuels Mandates Approach a Market Collision Point
AgMRC Renewable Energy & Climate Change Newsletter
Dr. Robert Wisner
University Professor Emeritus,
Department of Economics, Iowa State University
The 10% blend wall and substantial increases being proposed in conventional biofuel (corn starch ethanol) and advanced biofuels for 2013 are creating a challenge for corn starch ethanol producers, petroleum refiners, and other blenders of ethanol with gasoline. The challenges will almost certainly increase in the next several years. Biofuels mandates that are driving this situation originate from the 2007 Energy Independence and Security Act ( EISA) (1). The two main large scale commercial producers of advanced biofuels currently are (1) the U.S. biodiesel industry and (2) the Brazilian sugar cane ethanol industry. The cellulosic biofuels industry is still in the very early stage of its infancy, although industry sources indicate its production will increase substantially in the next few years with the emergence of ethanol production from corn stover and other cellulosic feedstocks. Some sources have called for Congress to restructure or eliminate the mandates to avoid the emerging collision of mandates, the blend wall, and supplies from two different types of ethanol production. The cellulosic industry, however, is urging that the advanced biofuels mandates be maintained as specified in the EISA. The concern is that to encourage development and investment in the cellulosic ethanol industry, a readily available and assured market for its product is needed as supplies increase. It is generally expected that cellulosic ethanol will be more expensive to produce than corn starch ethanol, at least in initial stages of its emerging production. For that reason, cellulosic ethanol would be expected to have trouble competing in the market place without some form of government assistance or mandates. The potential problem for the corn starch ethanol industry is that cellulosic ethanol and/or imported sugar cane ethanol, which also qualifies as an advanced biofuel appears likely to reduce the available market for corn starch ethanol. This crowding-out effect could emerge as early as the last few months of this year and is likely to become a more significant challenge in 2014 and 2015.
In this article, we examine these issues and note some possible longer-term alternatives for resolving the problems. The Environmental Protection Agency (EPA) decision of whether to implement its proposed 2013 mandates (2) will be a major influence on how serious this problem may be this year.
Source of the problem: the blend wall
The blend wall represents the approximate maximum amount of fuel ethanol the domestic market can absorb under current conditions. When the EISA was approved, U.S. use of gasoline had been trending upward and that trend was expected to continue indefinitely. If that had been the case, the potential market for ethanol under current policies and marketing practices would have been much larger than it is at this time. Thus, the blend wall would have been at a higher level although it might have eventually been reached. However, various developments including a severe economic recession and increased fuel efficiency of the automobile and light truck fleet have caused a decline in U.S. gasoline consumption, as shown in Figure 1. Peak annual gasoline use was slightly over 142 million gallons in 2007. Since that year, U.S. gasoline use has declined steadily. In figure 1, use is considered to be represented by gasoline supplied, as reported by the U.S. Energy Information Administration (EIA). This is the closest measure of domestic gasoline use that we have available since the data source noted in Figure 1 does not report actual consumer use. Actual use could vary slightly from this, depending on inventory changes at retail and user levels. The EIA defines motor gasoline as follows in its data source for the information shown in Figure 1: “Motor Gasoline includes conventional gasoline; all types of oxygenated gasoline, including gasohol; and reformulated gasoline, but excludes aviation gasoline."
Gasohol was the early terminology used for gasoline-ethanol blends when ethanol fuels first emerged in the late 1970s and that term is still used in some EIA data definitions. Thus, the decline in gasoline demand reflects a reduction of total motor fuel demand by motorists, not the reduction in unblended gasoline demand that resulted from increased use of fuel ethanol.
U.S. gasoline use as shown in Figure 1 in 2012 was approximately 133.4 million gallons. For practical purposes in the current motor fuel market, the blend wall or maximum feasible amount of ethanol to be blended in the U.S. gasoline supply is 10% of the total gasoline use. In 2012, that would have been about 13.34 million gallons of undenatured ethanol. The 10% blend is the current normal amount of ethanol blended with gasoline. That percentage originated in the late 1970s. There was little or no public discussion of the choice of the 10% level at that time, and it has since become the base level for the motor fuel industry. Some ethanol is marketed as E-85, a blend of 85% ethanol and 15% gasoline. E-85 is approved only for use in flex fuel vehicles. EPA studies and antidotal consumer reactions as well as ethanol’s 1/3 lower energy content than gasoline indicate E-85 has substantially lower fuel mileage per gallon than gasoline. Flex fuel vehicles are a small but increasing percentage of the total U.S. automobile and light truck fleet. However, E-85 currently is not being priced competitively enough to create a large additional ethanol market. Its market size also is greatly limited by being accessible only at a very small number of retail stations, especially in heavily populated East and West Coast regions.
Now consider the proposed biofuels mandates for 2013 through 2015. The proposed advanced biofuels mandate is 2.75 billion gallons in 2013 as shown in Figure 2. It increases to 3.75 billion gallons in 2014 and 5.5 billion gallons in 2015. When the legislation was crafted, Congress envisioned that large-scale cellulosic ethanol production would have emerged by this time and would create large volumes of advanced biofuels from 2013 through 2022. However, the industry’s production facilities are still in their infancy. It looks almost certain that in the next three years, production of this and other domestic advanced biofuels will be far below the 1.0 to 3.0 billion gallons envisioned when the 2007 EISA was passed. Also, a blend wall was not envisioned when EISA was passed.
These developments create a serious challenge for the conventional (corn starch) ethanol industry. Its mandates from EISA increase from 13.2 billion gallons last year to 13.8 billion gallons in 2013, 14.4 billion gallons in 2014, and 15.0 billion gallons in 2015. Each of these levels from 2013 onward exceeds the currently estimated blend wall. A challenge the corn starch ethanol industry faces is the likely need to share its already limited market with cellulosic ethanol and imported sugar cane ethanol that will be needed to meet rapidly increasing advanced biofuels mandates (3). This challenge increases very rapidly from 2016 onward if the original EISA RFS2 mandates are implemented.
EISA established the minimum biodiesel annual mandate at 1.0 billion gallons for 2012 and later years. To get its ethanol equivalent gallons, the actual biodiesel gallons are multiplied by 1.5 to reflect biodiesel’s 50% higher energy content than ethanol. The biodiesel mandate is embedded in the advanced biofuels mandate. The EISA provides authority for EPA to increase the biodiesel mandate beyond this minimum level. EPA has proposed to do that for 2013 by increasing it to 1.28 billion gallons, to help meet the sharp increase in the advanced biofuels mandate. EPA also has authority to set the advanced biofuels mandate at a lower level than specified in the EISA, but is not proposing to do so for 2013.
When the proposed 2013 biodiesel mandate is converted to its conventional (corn starch ethanol) biofuel equivalent, 1.92 billion gallons of the advanced biofuels mandate can be filled by the basic biodiesel mandate, which as noted above is imbedded in the advanced biofuel mandate. That leaves another 0.83 billion gallons of advanced biofuels to be filled by other sources. A small amount is expected to be filled by other domestically produced advanced biofuels, but imported sugar cane ethanol is the most likely candidate for filling a large part of the remaining advanced biofuels mandate this year and almost certainly in the next several years. If biodiesel production exceeds 1.28 billion ethanol-equivalent gallons, that also would fill a portion of the remaining advanced biofuels mandate. In 2014, and 2015, the advanced biofuels mandates increase to 3.75 and 5.5 billion gallons. At the same time conventional biofuel (corn starch ethanol) mandates increase from the current 13.8 billion gallons to 14.4 and 15.0 billion gallons.
Implications for corn starch ethanol
With the above mandates in mind, consider the current 10% blend wall and implications for corn starch ethanol. The current approximate total domestic ethanol fuel market is about 13.34 billion gallons per year. The proposed 2013 corn starch ethanol mandate, which comes from the EISA, is about 3.4% above this approximate domestic blend wall maximum market, and will increase to about 7.9% and 12.4% above the blend wall level, assuming there is no change in U.S. total annual gasoline use. These percentages above the blend wall are before considering the likelihood that a sizable portion of the advanced biofuels mandate will be filled in the next few years by imported sugar cane ethanol. If for example 70% of the non-biodiesel proposed advanced biofuel mandate for 2013 is filled by sugar cane ethanol, that would reduce the available market for corn starch ethanol market by about 232 million gallons. The calculations for this are (1) the advanced biofuels mandate 2,750 million gallons minus (2) the ethanol equivalent of the biodiesel mandate (1,280 million gallons x 1.5 to adjust biodiesel to ethanol equivalent gallons) = 1.92 billion gallons) minus an EPA estimated 150 million gallons of other domestic advanced biofuels production. These calculations are summarized and shown graphically in Figure 3.
Figure 3 also contains projections for 2014 and 2015, assuming (1) EPA leaves the biodiesel mandate at 1.28 billion gallons for the next two years and domestic biodiesel production is at that level, (2) that domestic non-biodiesel advanced biofuels production increases by 30 million gallons in 2014 and 20 million gallons in 2015, and (3) that 70% of the advanced biofuels shortfall would be filled by sugar cane ethanol imports. The last assumption, of course requires a fourth assumption that enough sugar cane ethanol would be available at prices competitive with domestic biodiesel to fill the required shortfall (4). If so, and assuming the advanced biofuels mandates for these two years are at the EISA levels, increased imports of imported sugar cane ethanol would be needed in both years. With corn starch ethanol mandates already exceeding the blend wall, the sugar cane ethanol imports as advanced biofuels would further reduce the domestic market for corn starch ethanol. That prospect is shown in Figure 4, with the assumptions noted above. The checkered bars show the change in corn processing for domestic ethanol production vs. projected processing for ethanol in the current marketing year.
Ethanol exports could allow actual corn processing to exceed the levels indicated in Figure 4. With the large U.S. sugar cane ethanol imports that would be required under these assumptions, it is quite possible that Brazil would need to import U.S. ethanol to fill a resulting shortfall in its domestic supplies resulting from large exports to the U.S. If so, the net result would be counter to the intended purpose of the rapidly increasing U.S. advanced biofuels mandates, namely to reduce global carbon emissions. The resulting extra transport costs of cross-trading of ethanol between the two countries also would likely add extra cost to consumers in both nations.
Viewed just from the blend wall standpoint, the combined corn starch ethanol mandate and 70% of the advanced biofuels mandate that is not filled by the biodiesel mandate and other domestic advanced biofuels, if filled by imported sugar cane ethanol, would total 14.03 billion gallons in 2013, to be filled by domestic and imported ethanol. That is 5.2% or 690 million gallons above the likely 2013 domestic market for fuel ethanol. In corn equivalents, this excess beyond the likely available domestic ethanol market would approximately equal the ethanol from 250 million bushels of corn. The gap versus the blend wall would widen further in 2014 and 2015.
Figure 5 provides one other perspective on these challenges. It shows approximations of the excess RINs the corn starch ethanol industry would need in order to offset the mandates that are above the 10% blend wall and the competition from rising sugar cane ethanol imports. If the cellulosic ethanol industry should expand much more rapidly than assumed here and reduce the need for imported sugar cane ethanol, the effect on corn starch ethanol would be essentially the same. In that case, it would be increasing cellulosic ethanol rather than imported sugar cane ethanol that would be crowding out corn- starch ethanol. Figure 5 explains why RIN values have increased sharply since late winter when EPA released its proposed biofuels mandates for 2013.
Alternatives for dealing with the problem?
These conflicting trends of increasing biofuels mandates and the 10% blend wall create a major dilemma for the corn starch ethanol and petroleum industries. They show the high importance of raising the blend wall, from the perspective of corn starch ethanol producers, blenders, and corn growers.
Another alternative we have discussed previously is the possible development of large scale production of non-ethanol drop-in biomass fuels that by-pass the blend wall (5). A third alternative would be to modify the mandates, although this would be counter to the original intent of the EISA legislation (6).
A fourth alternative that may offer some future potential for raising the blend wall is development of specially designed high-compression engines for use of E-30 (7). Some auto manufacturers have been working on this type of engine design. At this stage, many questions about such technology are unanswered, including fuel economy compared with conventional vehicles and likely added costs of manufacturing such vehicles, as well as regulatory questions related to air quality standards.
As a first step in raising the blend wall, EPA has approved the use of E-15 (15% ethanol and 85% gasoline blends) for 2001 and newer vehicles. A number of challenges remain before this develops into a large additional market for ethanol. One challenge is in the infrastructure area, including needed retail facilities and safeguards for preventing accidental use of E-15 in unapproved vehicles. Blender pumps appear to offer a way of assisting fuel retailers in meeting the need for additional facilities to provide several alternative grades of ethanol blends and gasoline while minimizing added investments and space needs.
Another challenge with E-15 that has not been widely publicized is policy changes needed so that this ethanol-gasoline blend can meet the Reid Vapor Pressure (RVP) requirements of EPA. Those requirements are that E-15 Reid Vapor Pressure must not exceed 9.0 pounds per square inch in the May1 to September 15 period (8). These standards are designed to limit emissions of volatile organic compounds that contribute to ozone formation. Warm seasons of the year increase the potential for these types of emissions. Legislation from Congress in 1990 has provided E-10 with a one-pound exception to this regulation. However, E-15 is not covered by that exception and is unable to meet the current regulation. Accordingly, the RVP requirement is a major restraint on the marketing of E-15. Other restraints on widespread marketing of E-15 include liability concerns of fuel retailers and concerns of auto manufacturers about possible engine, emissions, and/or fuel system damage to vehicles. Some off-road gasoline users also have expressed concerns about E-15. In view of Brazil’s use of E-20 to E25 ethanol-gasoline blends for many years, these may not be insurmountable issues.
A serious dilemma faces the corn starch and emerging cellulosic ethanol industries, and the dilemma will become increasingly obvious late this year and in the following several years. The dilemma comes partly from rapidly increasing mandates for corn starch ethanol blending this year and in the next two years and the EISA’s rapid increases in advanced biofuels mandates from now through 2022, combined with the ethanol blend wall. The blend wall along with a downward trend in domestic gasoline use creates a maximum domestic ethanol market that is significantly smaller than the government biofuels mandates. With rising advanced biofuels mandates to support the emerging cellulosic ethanol industry and meet future air quality standards, more advanced biofuel in the short term leads to a potential shrinkage of the corn starch ethanol market. An immediate market solution to this problem is not in sight. High priority on raising the blend wall would significantly reduce these challenges.
1 U.S. 110th Congress, Energy Independence and Security Act, December 2007:
2 For detail on the proposed mandates, see R. Wisner, “EPA's Proposed Biofuels Mandates for 2013 - Challenges for the Biofuels Industry”, AgMRC Renewable Energy & Climate Change Newsletter, March 2013.
3 For more detail, see Randy Schnepf and Brent D. Yacobucci, “Renewable Fuel Standard (RFS): Overview and Issues”, Congressional Research Service, March 14, 2013
4 Whether domestic biodiesel production could fill more than 30% of the advanced biofuel shortfall from the mandates would depend on the cost and availability of adequate vegetable oil and animal fats for biodiesel production.
5 Robert Wisner, “Drop-in Fuels: Are They the Next Phase of Biofuels Development?”, AgMRC Renewable Energy & Climate Change Newsletter, March 2012.
6 See Darrell Good and Scott Irwin, “The Impending Collision of Biofuels Mandates with Market Reality”, FarmDoc Daily, September 26, 2012.
7 For more detail on this topic, see EPA, Proposed Rule, “Control of air pollution from motor vehicles: Tier 3 motor vehicle emission and fuel standards”, March 29, 2013.
8 For details, see the Federal Register, January 26, 2011 and Jeremy P. Greenhouse, “E-15:Cracking the RVP Nut," Ethanol Producer Magazine, October 18, 2011.