Emerging Ethanol Issues: Blending Mandates, Advanced Biofuels and Other Concerns
AgMRC Renewable Energy & Climate Change Newsletter
Dr. Robert Wisner, University Professor Emeritus, Iowa State University
and Biofuels Economist, Ag Marketing Resource Center
After six years of rapid growth in ethanol production that triggered changes in the entire grain sector, the corn-starch ethanol industry is moving into a period of leveling off or a slight decline. That in turn is impacting corn markets, corn and ethanol producers, and non–ethanol users of corn. A major challenge now facing the industry is how to create a second-stage growth phase. The leveling off of ethanol production growth or even a small decline in total volume produced is being triggered by two developments: (1) several years of a declining trend in U.S. gasoline consumption, which was not anticipated when the 2007 U.S. energy legislation (i) spelling out the government ethanol blending mandates was passed and (2) the arrival of the 10% ethanol “blend wall.” The blend wall results from a U.S. average ethanol blend of almost 10% in the nation’s gasoline supply. It represents at least a temporary ethanol market saturation and stems from the maximum 10% ethanol blend that has been approved for use in all gasoline-powered cars and light trucks. The Environmental Protection Agency (EPA) which enforces the biofuels mandates has approved E-15 blends (15% ethanol and 85% gasoline) for 2001 and newer vehicles, but for various reasons, E-15 is not widely marketed in the U.S. E-85 (85% ethanol and 15% gasoline) is available at only a few retail gas stations across the nation and is suitable only for flex-fuel vehicles. So far, it represents a small fraction of the total ethanol market. In this article, we look at implications for corn prices from the current lack of growth in corn starch ethanol production, implications of a leaked report indicating the EPA is considering a reduction in the conventional biofuels (corn-starch ethanol) mandate, and possible alternatives for expanding the ethanol market. We also consider the implications of an emerging cellulosic ethanol industry and rapidly rising advanced biofuels mandates may have for corn-starch ethanol.
Impacts on Corn Demand and Prices
Virtually all of the growth in demand for U.S. corn since the early 2000s has come from processing of corn into ethanol and distillers grain as shown in Figure 1. Feed and residual use of corn is not shown in the figure but has been in a modest downward trend in recent years. Part of the decline reflects increased use of distillers grain and solubles (DGS) which is a co-product of ethanol production. It also reflects increased feed efficiency in production of livestock and poultry.
The rapid growth in ethanol production has been a major driver of corn prices as confirmed by several authors (ii). However, Scott Irwin at the University of Illinois demonstrates in a recent article that as the corn starch ethanol industry reaches the blend wall and its growth is halted, ethanol prices will no longer be the main driver of corn prices. (iii) Instead, as corn yields trend upward and increase the corn supply over time, corn prices will shift back to a previous pattern in which they are influenced by exports, livestock feeding, the size of the U.S. and foreign corn crops and related factors. In turn, corn prices will be a major determinant of ethanol prices rather than the other way around. Along with the impact corn prices have on the cost of producing ethanol, ethanol prices also will be influenced by export demand, any progress in raising the blend wall, gasoline prices, Brazil’s sugar cane ethanol supply, fuel policies, U.S. advanced biofuels mandates, the trend in cellulosic ethanol production, and other factors. The cost of corn may be the most important of these various influences on ethanol prices. That is the situation the corn market is starting to face for the 2013-14 and 2014-15 marketing years. With much more plentiful supplies than in the past two marketing years, corn prices have dropped sharply in the last few months. The market impact in 2014 and 2015 may be amplified if the EPA adopts a recently leaked proposed reduction in blending mandates rumored to be under consideration.
Leaked Report on Possible EPA 2014 Biofuels Mandates (iv)
Accuracy of the leaked report has not been confirmed and EPA officials say no decision has been made yet for 2014 mandates. The leaked report indicates EPA is considering a reduction in the conventional biofuels (corn-starch ethanol) mandate for 2014 to 13.0 billion gallons from the 13.8 billion gallons mandated in 2013 and 14.4 billion gallons mandated for 2014 in the 2007 Energy Independence and Security Act (v) (EISA). A possible justification for the reduction would be that the maximum feasible domestic ethanol market is approximately13.0 billion gallons. It is not clear whether such a reduction would meet the criteria indicated in EISA for reducing the mandate. Those criteria include inadequate supplies and economic hardship. A 13.0 billion gallon conventional biofuel blending mandate would reflect the blend wall and slightly less than a 10% U.S. average ethanol-gasoline blend.
Preliminary data suggest 2012-13 marketing year U.S. corn starch ethanol production was about 12.92 billion gallons. Net export data for the full year are not available at this writing. Monthly data from September 2012 through July 2013 from the Energy Information Agency (EIA) show net U.S. exports during that period were only 5.5 million gallons (vi). Thus, nearly all of the production was used domestically. Production fell short of the 13.8 billion gallon mandate because the blending industry took advantage of excess RINs (renewable information numbers) that are assigned to each gallon of ethanol when it is produced or imported (vii). Excess RINs had been built up from previous years when ethanol production exceeded the government mandates. RINs can be bought and sold. Their prices fluctuate with the available supply and the demand for them. A substantial part of the excess RIN supplies were used during the past year in place of actual ethanol blending, due to the high cost and drought-reduced supply of corn as well as a mandate that exceeded the blend wall. Consequently, availability of RINs for use in place of actual ethanol blending in 2014 is more limited than a year ago. With tight supplies and expectations of strong demand for RINs in 2014 and 2015 to accommodate mandates exceeding the blend wall, recent RIN prices were relatively high and volatile. When information became available about a possible reduced EPA 2014 conventional biofuels mandate in mid-October, RIN prices dropped sharply.
The Blend Wall
For a better understanding of the blend wall, Figure 2 shows the trend in annual U.S. gasoline use during the last 18 years. Data for the chart are from the Energy Information Administration (EIA) and represent gasoline supplied, including adjustments for imports and exports as well as stocks changes. EIA does not directly measure demand, so this is the closest proxy to demand that is available. When EISA was passed, Congress expected U.S. gasoline use to be around 150 billion gallons per year by this time. Instead, high gasoline prices, high unemployment, and improved vehicle fuel efficiency have led to a downward trend in the nation’s gasoline use. Current annual use is about 132 billion gallons. A 13.0 billion gallon corn-starch ethanol mandate represents a U.S. average ethanol blend of 9.85% in the nation’s gasoline supply.
If the corn-starch ethanol mandate is not reduced from the EISA mandates, ethanol blenders would be able to fulfill mandated volumes beyond the blend wall by purchasing unused RINs and/or expanding the E-15 and E-85 markets. As noted above, excess RINs were generated in years when the ethanol industry produced or imported more ethanol than blending mandates required. These excess RINs can be held over and substituted for actual blending in years when the industry is unable to blend the required volume of ethanol or other biofuel. The recent high prices for RINs were partly due to the reduction in ethanol production that has resulted from the drought-reduced 2012 U.S. corn crop. High prices also reflected expectations of very strong demand for RINs in 2014 and 2015 to accommodate mandates that were expected to moderately exceed the E-10 blend wall.
Possible Expansion in E-85 Use
From a corn grower or ethanol producer perspective, a positive dimension of this fall’s much lower corn prices than in the past two years is that they may set the stage for an expansion in use of E-85. EPA E-85 (85%% ethanol) fuel mileage estimates for combined city and highway travel for a wide range of vehicles confirm that ethanol’s one/third lower energy content per gallon than gasoline causes sharp reductions in E-85 mileage when compared to gasoline. Mileage reductions vary modestly among vehicle makes and models. A few vehicles have E-85 mileage reductions as low as 21% or as high as 33%. Most show reductions of 25% to 29% when compared to gasoline. Thus, E-85 prices need to be about 25% to 29% lower than gasoline to provide the same dollar cost per mile as gasoline (viii). At this writing, nearby ethanol futures prices are about 30% below RBOB gasoline prices although the cash price differential is considerably smaller. In the few gasoline retail stations where E-15 is available in central Iowa, E-85 prices in late October were 15% below E-10 and 20% below E-0. That differential was not quite low enough to get the attention of flex-fuel vehicle owners who watch these price differentials.
Another incentive for expanding the market for E-85 would come from retention of the 2014 and 2015 conventional (corn-starch ethanol) biofuels blending mandates that would be larger than the blend-wall restricted E-10 market. If ethanol blenders are unable to market the mandated volume of ethanol, one alternative for them is to buy RINs. Many in the ethanol industry have hoped that a combination of the EISA mandates and high costs of RINs would be an incentive for the industry to expand the marketing of E-10 and E-85 to avoid the RIN costs and thus raise the “blend wall”. In a recent article, Bruce Babcock indicated that based on his research, it might be less expensive for the petroleum industry to invest in E-85 retail infrastructure to expand this market than to purchase RINs and avoid blending as much ethanol as directed by EISA. He indicates that each addition of 2,500 new E-85 stations with the current flex-fuel fleet could expand the market for ethanol by 800 million to one billion gallons. That in turn could expand the demand for corn use in ethanol plants by 290 to 360 million bushels. The main needed infrastructure would be the addition of E-85 facilities to existing gas stations, either by adding tanks or by converting existing tanks to E-85 (ix). For some retailers, lack of space for additional storage tanks would be a limiting factor preventing them from adding E-85 pumps. For others, it might involve comparing the added revenue potentially gained from adding an E-85 pump versus the revenue lost if that pump currently is used for E-10 or premium gasoline.
In short, if E-85 wholesale prices are competitive or almost competitive with gasoline, it may be less expensive for the motor fuel industry to market more E-85 than to buy RINs and blend less than the mandates. Several issues appear to be constraints to current retail expansion of E-15 facilities. There are reports of fuel retailers being concerned about legal exposure to accidental or intentional use of E-15 in unapproved vehicles as well as warranty issues for some vehicles. In addition, E-15 does not have the waiver that is available to E-10 and is needed in many states to meet summer vapor regulations. Our sources indicate congressional action would be needed to obtain the waiver for E-15. Even so, a few Midwest retailers have installed blender pumps for E-15.
Advanced Biofuels Mandates and Related Concerns for Corn-starch Ethanol
As shown in Figure 3, the EISA advanced biofuels mandates have already begun a rapid increase that is scheduled to continue through 2022. These mandates include the cellulosic biofuels, biodiesel, and other advanced biofuels categories shown in Figure 3. Total advanced biofuels mandates for the individual years are shown in the figure. Advanced biofuels are those from renewable feedstocks that reduce greenhouse gas emissions by at least 50%. As the figure indicates, the original mandates from EISA were 2.0 billion gallons of advanced biofuels for the year 2012 and 2.75 billion gallons of this category of fuels for 2013. The two primary categories of advanced biofuels that have been available in large commercial quantities so far are biodiesel and sugar cane ethanol, with most of the latter supply imported from Brazil and Caribbean countries. A few cellulosic ethanol plants are currently under construction and are expected to be in production within the next year or two. However, it appears likely that several years will be needed before advanced biofuels production reaches the EISA mandates. For that reason, EPA is expected to substantially reduce the advanced biofuels mandates from the original EISA advanced biofuels levels in 2014 and the next several years. Significant imports of sugar cane ethanol are expected in the next few years as a way of helping to meet the reduced mandates.
With an ethanol blend wall that limits the maximum amount of ethanol used in U.S. gasoline, the net effect of sugar cane ethanol imports is to reduce the available market for corn-starch ethanol. As cellulosic ethanol production emerges and expands, it too will compete with corn-starch ethanol because of the increasing mandates for advanced biofuels and the blend wall. These conflicting trends imply that the market for corn-starch ethanol may shrink significantly in the next several years unless a way can be found to raise the ethanol blend wall. That prospect is further complicated by mandated increases in car and light truck fuel mileage that are required in future years by EISA and other government regulations. The current corporate average mileage requirement for new vehicles is about 29 miles per gallon. New standards require an increase to 36.6 miles per gallon in 2017 and 54.5 miles per gallon for the 2025 model year.(x)
Implications for Corn and Corn-starch Ethanol
Rapid growth in corn processing for ethanol and DGS has been an important contributor to increased corn prices in the last six years and has helped make corn prices more sensitive than in the past to drought and other developments affecting supplies. Ethanol industry growth also has contributed to westward and southward expansion of the Corn Belt, especially in the northern Great Plains, and to regional and national changes in wheat and soybean acreage. The prospects of a stable to shrinking corn-starch ethanol market and a resumption of the long-term upward trend in corn yields imply that corn supplies may become more plentiful to non-ethanol users than in the recent past, and at a lower cost. They imply that key determinants of corn prices will shift back to the pattern of earlier years. These developments also signal to the ethanol industry to focus on possible development of drop-in fuels such as biobutanol and synthetic gasoline that are not subject to a blend wall, as well as on ways of raising the blend wall. (xi)
These trends also indicate the ethanol industry needs to place high priority on ways of raising the blend wall. If information indicating EPA is considering reducing the corn-starch ethanol mandate to less than that required by EISA becomes a reality, that will reduce the pressure on the motor-fuel blending industry to expand E-15 and E-85 markets. EISA requires EPA to announce its blending mandates for the coming calendar year in November, but the announcements have been delayed in the past and might be delayed again.
ii See C. Carter, G. Rausser, and A. Smith, “Commodity storage and market effects of biofuels”, Ethanol Paper, University of California, Davis, September 2013 and Scott Irwin, University of Illinois. “Ethanol prices drive corn prices, right?”, FarmDoc Daily, October 9, 2013
iii Scott Irwin, “Ethanol Prices Drive Corn Prices, Right?”, FarmDoc Daily, University of Illinois-Urbana, October 9, 2013
iv Based partly on Mark Drajem and Lucia Kassai, “EPA Considers U.S. Ethanol Mandate Cut Amid Refiner Concerns”, Bloomberg News Service, October 10, 2013 and Cezary Podkul, “EPA proposes reduction in 2014 ethanol blend volume: documents”, Reuters News Service, October 10, 2013.
v Energy Independence and Security Act of 2007, op. cit.
vii See R.W. Wisner, “Renewable Identification Numbers (RINs) and Government Biofuels Blending Mandates”, AgMarketing Resource Center, Renewable energy and climate change newsletter, April 2009, for an explanation of RINs.
viii U.S. Department of Energy, “Fuel economy of 2013 flex-fuel (E-85) vehicles”
ix Bruce Babcock, “RFS Compliance Costs and Incentives to Invest in Ethanol Infrastructure,” Center for Agricultural and Rural Development, Department of Economics, Iowa State University
x John M. Broder, “U.S. sets higher fuel efficiency standards”, New York Times, August 29, 2012
xi For discussion of drop-in fuels, see R. Wisner, “Drop-in Fuels: Are They the Next Phase of Biofuels Development?”, AgMarketing Resource Center, Renewable energy and climate change newsletter, March 2012