Wild Cards for the Ethanol Industry
AgMRC Renewable Energy Newsletter
Professor of Economics and Energy Economist
Ag Marketing Resources Center
Iowa State University
After extremely rapid growth in the previous three years, the U.S. ethanol industry’s expansion rate has slowed in response to tightening profit margins, periods of negative returns, risk-management problems, and current excess capacity. In previous articles, we’ve noted that numerous plants have been idled. A sizeable number of ethanol producers have experienced severe financial losses and/or bankruptcy, and some construction projects have been halted. In light of the current ethanol crisis, a key question is “What are the future prospects for the corn-starch ethanol industry?” This question is critically important for the ethanol industry as well as for corn growers who supply feedstock to ethanol plants, firms that design, produce, and market inputs for the crop sector, grain elevators, transportation firms, the livestock sector, foreign buyers of U.S. corn and distillers grains, and other businesses associated with the industry. It is also an important question for investors, lenders, the petroleum industry, and policy makers.
|The potential future growth of the corn-starch ethanol industry is at least 45% from current production levels.|
In the current marketing and corn processing year, USDA expects the ethanol industry to produce about 10.36 billion gallons of fuel ethanol. Government mandates prescribed by the 2007 Energy Independence and Security Act (1) call for 15 billion gallons of corn-starch ethanol to be blended with U.S. gasoline in 2015. This information shows a potential future growth of the corn-starch ethanol industry of at least 45% from current production levels. Ethanol firms also have a history of producing more than the mandated amount, so growth could be greater than 45%. Based on these considerations, the industry has much more growth potential ahead. However, some major unknowns have emerged that raise questions about whether the mandates will be reached. Policy decisions that determine the outcome of three big wild cards will have a major impact on the rate and amount of future expansion in the industry. In this article, we discuss these issues.
The Blending Wall
With current regulations, as we discussed in a previous article, the anticipated blending wall will be reached as aggregate ethanol production and imports approach a U.S. average ethanol-gasoline blend of E-10. That level appears likely to be reached in the next two or three years -- or quite possibly sooner. Since some automobile drivers prefer not to use ethanol, and the E-85 market is still very limited, it will be difficult to exactly reach a U.S. average blend of 10% -- if that continues to be the maximum blend allowed for conventional gasoline-powered vehicles. Limited infrastructure for transportation, distribution, and marketing has been a dimension of the anticipated blending wall. However, it now appears to be a minor constraint when compared to limitations on demand imposed by the E-10 blending constraint.
The ethanol industry and some farm groups are working with the automobile industry and the Environmental Protection Agency (EPA) to raise this maximum allowable blend to 15%. EPA has to determine whether a blend at that level would cause unacceptable levels of any emissions. Issues for the auto industry relate to impacts on emissions equipment, warranty impacts and compatibility with older vehicles. Another proposal has called for intermediate blends of 15% or modestly higher, with pumps labeled “for flex fuel vehicles only.” This would slightly increase the level of the blending wall, but not by very much at this time. The limiting factor for this proposal is the relatively small number of flex fuel vehicles on the road today. A medium-level blend such as this has the advantage that it would reduce the price discount needed for drivers to take advantage of their flex fuel vehicle capabilities. With E-85, a price discount of around 25% to 28% is needed relative to gasoline for the product to compensate drivers for its lower fuel mileage.
Retail Dispensing Equipment Issue
A closely related issue is whether the Underwriters Laboratory (UL) would approve the use of retail pumps and fuel dispensing equipment for use with a 15% blend. Underwriters Laboratory approval is required for approval of the equipment by the Occupational Safety and Health Administration (OSHA). At a recent ethanol conference (2), it was indicated that UL officials a few months ago had approved such equipment for 15% blends, but later changed positions to indicate UL was approving 10% blends, with a tolerance fluctuation range of up to 15%. This leaves the impression that UL does not approve the equipment for continuous use with 15% blends. If so, moving the acceptable maximum blend for conventional vehicles up to 15% will require decisions by UL as well as the auto industry and EPA.
The outcome of these decisions will be very important not only for the corn-starch ethanol industry, but also for the anticipated cellulosic ethanol industry. The 2007 Energy Legislation mandates that total U.S. blending of ethanol in motor fuel by 2022 will reach 35 billion gallons. That is far above a 10% blend. At recent gasoline consumption levels, it would be approximately a 25% blend. Theoretically, as the flex-fuel vehicle fleet expands, this would not be a problem. However, substantial time is required to replace the existing vehicle fleet with flex fuel models. The mandate increases appear likely to out-pace the expansion in flex-fuel vehicles and retail E-85 facilities. Another difficulty with relying just on E-10 and E-85 to eliminate the blending wall is the severe discount in ethanol prices that is needed to compensate drivers for the lower E-85 fuel mileage. This discount would substantially reduce the rate of return for investing in cellulose ethanol production and would also reduce the incentive of farmers to produce feedstock for the industry.
|Ethanol mandate increases appear likely to out-pace the expansion in flex-fuel vehicles and retail E-85 facilities.|
In short, the ethanol industry appears to be on a collision course with the blending wall. Future growth of the industry and growth in investments in advanced-technology plants will require a very substantial upward adjustment in the acceptable gasoline-ethanol blend levels. Failure to make this adjustment would not only eliminate much of the potential expansion in corn-starch ethanol, but also would greatly dim the longer-term prospects for cellulose ethanol.
Greenhouse Gas Emissions (GHG)
The ethanol industry also appears to be on a collision course with GHG emission requirements (see our article on this topic.)
The Energy Independence and Security Act of 2007 requires that corn-starch ethanol plants where construction began after 2007 must reduce greenhouse gas (GHG) emissions by 20% vs. those of gasoline. (3) Cellulose ethanol plants must reduce GHG emissions by 60% and “Advanced” biofuels must reduce them by 50% when compared to gasoline. Measurement of the emissions involves determining the change in carbon release and sequestering that occurs in crop production with land-use changes, if any occur, as well as emissions in all aspects of ethanol production, marketing and distribution. In evaluating these emissions, “indirect land use impacts” and resulting emissions changes have become a major issue. The logic behind indirect land use issues is that diverting land from feed and food production in North America may cause increased land clearing elsewhere in the world, most likely in South America. Environmentalists as well as those who are concerned about global warming do not want to see the U.S. biofuels industry cause clearing of portions of the Amazon rain forest. The rain forest is a major mechanism for absorbing carbon dioxide (a major greenhouse gas) from the atmosphere.
California Regulations Highlight the Indirect Land Use Issue
Regulations issued and tentatively approved in late April by the California Air Resources Board (CARB) (4) bring GHG emissions to the forefront – especially those dealing with indirect land use emissions. At least 13 other states reportedly are considering adoption of California’s aggressive policies to reduce GHG emissions, so its policies have much broader implications than just for the California ethanol market. California is the largest user of gasoline in the U.S. Even if its regulations are applied only in California, the implications are important for the U.S. ethanol industry. California plans to increase its required state average ethanol blend in gasoline from 5.8% currently to 10% next year. Its new GHG emissions regulations are scheduled to go into effect in 2011.
We discussed the CARB regulations and their implications in more detail in the article noted earlier, but the discussion below provides a brief summary of their content and some general implications. The California regulations call for a gradual reduction in GHG emissions from motor fuels vs. their baseline (reformulated gasoline) over the next several years. In general, the CARB regulations indicate E-10 Greenhouse Gas (GHG) emissions for ethanol are essentially the same as for the baseline, if 20% of the ethanol is processed in California and the distillers grains co-product is sold wet, with the other 80% of the ethanol coming from Midwest plants that dry the distillers grains. CARB’s assessment of E-10, with 100% of the ethanol coming from Midwest plants that dry distillers grains, shows slightly higher GHG emissions than the baseline. That is troubling to the Midwest ethanol industry and raises questions of whether this product will be allowed in California in future years when mandated GHG emission levels are reduced. The regulations appear to favor California ethanol plants and Brazilian ethanol over that produced in the Midwest.
Indirect land use emissions are a major reason why Midwest ethanol is not rated favorably when compared to reformulated gasoline. There will almost certainly be much further discussion of how to accurately identify and measure indirect land-use effects before CARB's standards are applied in other states and nationally. CARB is using higher indirect land use emissions value for sugar cane than for corn-starch ethanol, which may surprise some analysts. Even so, Brazilian sugar-cane-ethanol is rated much more favorably than Midwest ethanol. That is why the current version of CARB’s standards provides a strong E-10 advantage to sugar-cane ethanol from Brazil and probably from other locations if it is available.
Corn-starch ethanol produced in California using 80% natural gas and 20% biomass for refinery energy without drying the distillers grains, is close to being competitive with Brazilian ethanol on GHG emissions, but is not quite there. Similar plants in the Midwest are at a considerable disadvantage relative to Brazil and California, even with wet distillers grains, for ethanol marketed in California. The indicated Brazilian advantage may create increased pressure to lower or eliminate the import duty on Brazilian ethanol. However, doing so would mean the U.S. would be subsidizing Brazilian ethanol producers.
A partial view of CARB's GHG emissions values for various fuels can be seen from Table ES-8 on page ES-20 of their report.
National decisions on the allowable maximum ethanol blend in gasoline will be one of three important policy decisions affecting the future size of the corn-starch and cellulose ethanol industries. A closely related decision will be the acceptable maximum level of ethanol blends that can be used for retail fuel dispensing equipment. A third issue is greenhouse gas emissions – their measurement and acceptable future levels.
2 Ethanol 2009 Emerging Issues Forum, April 2-3, 2009 sponsored by the Nebraska Ethanol Board with cooperation from a number of other organizations.
3 Energy Independence and Security Act of 2007, op. cit.
4 California Environmental Protection Agency Air Resources Board, Proposed Regulation to Implement the Low Carbon Fuel Standard, March 5, 2009 (Tentatively Approved in late April 2009)