Thursday, August 19, 2010

E85 - Is It the Solution?

During the last several months, the key advocacy groups for ethanol have been split on the long term policy they want to advocate for ethanol in the face of the looming expiration of the tax credit and import tariff.  Growth Energy took the lead and changed directions from the drum beat of tax credit renewal exclusively to advocate Flex Fuel Vehicles (FFV) and the construction of E85 fueling stations.  The argument is that the ethanol industry, once provided its own fuels market via E85 that is not controlled by the US refining industry, will then control its own destiny and profitability.

On the surface, this idea has substantial appeal in that it gives the ethanol industry the opportunity to compete with hydrocarbon gasoline on an equal playing field.  In our opinion, for E85 to be successful long term, it must be cost competitive to the consumer on an energy-delivered basis compared to gasoline.  The simple facts are that a gallon of ethanol contains 75,700 btu/gallon, whereas hydrocarbon gasoline contains 115,000 btu/gallon, which calculates as a 35% disadvantage for ethanol.

The three keys to E85’s success are:

  •          Expand the FFV fleet substantially to create demand density

o   Legislation has been introduced to force the auto industry to produce more FFVs
  •          Build E85 Fueling stations

o   The industry estimates that it needs 200,000-300,000  stations
o   Currently, there are 2,500 stations
o   Legislation has been introduced to provide tax credits to build E85 fueling stations
  •          E85 price meets or beats gasoline parity

o   This is the issue

The price parity issue is the one piece of the E85 puzzle that is not falling into place. We have analyzed the price parity issue from two perspectives using Chicago physical prices for gasoline and ethanol.  This analysis assumes no ethanol tax credit is available.  The first perspective is comparing gasoline prices to market ethanol prices and plotting them against the hypothetical E85 energy content parity price.  The following graph shows that the price of ethanol has never dropped low enough to value E85 below the energy parity line during the last 2 ½ years.

The second perspective is to see if E85 can be competitive from a cost-of-production basis, which removes ethanol market influences. The value of ethanol in this analysis is based on CBOT corn plus 30 cpg.  We used this value for ethanol in the following graph and, once again, E85, using this ethanol value, is never less expensive than the E85 parity line.

These results are startling from the perspective that ethanol is unable to compete against hydrocarbon gasoline on an energy content basis without government incentives.  The difficulty is the relationship between agricultural prices and crude oil prices. The question becomes, will the corn price versus crude price separate enough in the future to overcome this differential?  In the near term, the differential is actually going in the opposite direction, with a corn/crude margin squeeze that we will discuss in our next segment.

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