Gasoline and Ethanol Price Relationship and Blending Margins
By Sampath Jayasinghe
Decision Innovation Solutions, 11107 Aurora Avenue, Urbandale, IA 50322
The Weekly Petroleum Status Report released October 19, 2016 by the U.S. Energy Information Administration indicates weekly U.S. refiner and blender net input of fuel ethanol was 915,000 barrels per day for the week ending October 14, 2016. The same report also shows the weekly U.S. product supplied of finished motor gasoline was 8,798,000 barrels per day for the same time period. This shows gasoline supplied to the U.S. market for the week ending October 14, 2016 consisted of an average of 10.4 percent ethanol. As shown in Figure 1, this set a record for ethanol blending in the U.S. gasoline market. The previous high was 10.21 percent for the week ending September 23, 2016. According to the Renewable Fuel Standard (RFS) enacted in 2005 and modified in 2007, the Environmental Protection Agency’s (EPA) legal limit for the amount of ethanol that can be blended is 10 percent, which is known as the “blend wall.”
In this brief report, we look at some of the basic economic factors driving higher ethanol blending rates in the current gasoline market. A straight and simple answer — the value of blending ethanol is determined by the value of petroleum-crude oil and gasoline. Here, we revisit and extend the study done by Hill (2015).
Monthly average wholesale (rack) ethanol prices, monthly average wholesale (rack) unleaded gasoline prices, and monthly average D6 ethanol RINs (Renewable Identification Number) prices from January 2014 to September 2016 are shown in Figure 2. The monthly average ethanol RINs are based on RINs generated within the respective calendar years (vintage RINs).
In 2016, wholesale ethanol prices in the Midwest were below wholesale gasoline prices from March through September, with the exception of July. However, with the sharp decline in crude oil and gasoline prices in the latter months of 2015, wholesale gasoline prices were below wholesale ethanol prices from November 2015 through February 2016.
There are two other notable periods shown in Figure 2 in which wholesale unleaded gasoline prices were lower than wholesale ethanol prices. Wholesale ethanol prices spiked at the end of the first quarter of 2014, mainly due to winter-related ethanol transportation issues. The price differential between November 2014 and February 2015 was due to the sharp decline in crude oil prices.
As discussed in the October 2016 AgMRC Renewable Energy Report, the value of D6 RINs increased dramatically in recent months after the EPA released its proposal for the 2017 RFS. The monthly average vintage D4 RIN prices are shown in Figure 2 as the difference between the green and blue lines. A recent analysis by Irwin (October 5, 2016) explains in detail the factors behind the spike in all the RIN prices in recent months. He explains the ethanol RIN price movements are tied to D4 biodiesel RIN prices, because biodiesel acts as marginal gallon for compliance with conventional ethanol.
In very simple terms, D6 ethanol RINs are used to ensure the mandated amount of ethanol is actually blended into gasoline. These are generated with ethanol production and then transferred to the refiners, blenders or importers, who are required to blend a portion of their gasoline supply with ethanol. Once the ethanol is blended into retail gasoline, the blender turns the RINs into the EPA, showing its compliance. However, if there are excess RINs, these can be sold and purchased. In general, ethanol RINs are demanded by blenders who don’t see it as profitable, or don’t have capacity to blend ethanol in their gasoline supply. The vintage RINs can be used as credits against the mandates in the current year or next year before their expiration. With this kind of credit system, blenders are allowed to bank and borrow RINs to help with their current and future blending decisions.
Ethanol blending is economically attractive when the gasoline-ethanol price spread is larger. However, the wholesale average gasoline and ethanol prices were hovering below $1.80 and $1.50, respectively, during September. According to Hill (2015), when the economics of ethanol blending with gasoline is unfavorable based on current wholesale prices, a higher RINs price can reduce the cost of ethanol blending. Hill (2015) described this as the “net of RIN” — ethanol minus RIN value — making it harder to choose the option of purchasing RINs rather than blending ethanol. According to Wisner (2009), the value of RINs increases as the blending economics become unfavorable, plus as the supply of RINs becomes tighter.
The major assumption in the above descriptions is that the blender is the obligated party and has compliance options that must be met by either buying ethanol or buying RINs, and there is no other reason to buy ethanol. However, there are many factors that can limit and complicate this reasoning. For instance, the blenders are not always obligated parties and vice versa. Also, ethanol has a high octane value, so it qualifies as an octane booster. Ethanol is an oxygenate, which is required in the reformulated gasoline specifications. Ethanol also contains energy, and there is some value to be gained by blending it with gasoline. We thank Shashi Menon from EcoEngineers for his comments on this section.
Recent Developments: Record Corn Export Sales
According to the October WASDE report from the United States Department of Agriculture (USDA), U.S. corn production is forecast to be 15.057 billion bushels for the 2016/17 marketing year (October 2016-September 2017). Very strong domestic demand for corn use in ethanol production is forecast to be 5.275 billion bushels in the 2016/17 marketing year.
The U.S. corn export forecast for the current marketing year 2016/17 is projected at 56.5 million metric tons, according to the October Feed Outlook released by the USDA-Economic Research Service (ERS). As shown in Figure 3, outstanding sales at the beginning of October is approximately 15.2 million tons which is twice as large compared to October 2015. There has been a very strong pace of exports sales during the last few months. The September 2016 corn export inspections were twice as big as September 2015.
Figure 3: U.S. Corn Exports versus Commitments at the Beginning of October (Source: Feed Outlook published on October 14, 2016 by USDA-ERS)
Hill, S. “Higher RIN prices support continued ethanol blending despite lower gasoline prices” Todays in Energy, U.S. Energy Information Administration, February 23, 2015.
Irwin, S. "What's Up with RINs Prices?" farmdoc daily (6):188, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, October 5, 2016.
U.S. Energy Information Administration (EIA), various. Weekly Petroleum Status Report.
USDA-ERS (U.S. Department of Agriculture, Economic Research Service), Feed Outlook. Downloaded October 17, 2016.
USDA-National Agricultural Statistics Service (NASS) World Agricultural Supply and Demand Estimates (WASDE). October 12.
Wisner, R. “Renewable Identification Numbers (RINs) and Government Biofuels Blending Mandates” AgMRC Renewable Energy Newsletter, Ag Marketing Resource Center, Ames, IA, April 2009.