Proposed 2011 Renewable Fuel Standards

This week, the EPA issued a notice of proposed rule making to address Renewable Fuel Standards (RFS) for 2011 that, pursuant to RFS2 regulations, need to be determined by November of each year for the upcoming year. The table titled “Proposed Percentage Standards for 2011” indicates the percentages that obligated parties need to meet for 2011. The numbers are lower than last year due to the inclusion of small refiner volumes in 2011, even though the total mandate increases.

Cellulosic ethanol continues to be a large failure. The 2011 mandate calls for 250 million gallons, and the EPA is anticipating a range of available cellulosic ethanol of 6.5 million to 25 million gallons.

What is to be done about the shortfall, and how will both the Advanced Biofuels and Total Renewable Fuel requirements for 2011 be adjusted to address this shortfall? The EPA is proposing not reducing the totals, but just adjusting the Cellulosic mandate and anticipating that biodiesel and sugarcane ethanol will pick up the slack. The adjacent table titled “2011 EPA Proposed Rule Changes” describes the 2011 mandate. The Advanced Biofuels mandate consists of three types of biofuels based on feedstock minimum 50% GHG reduction performance: cellulosic biofuels, biodiesel, and undifferentiated advanced biofuels. A renewable fuel meeting cellulosic requirements can satisfy the cellulosic and advanced biofuels requirements, but not biodiesel. Biodiesel can satisfy the biodiesel and advanced biofuels requirements, but not cellulosic. The only approved pathway for undifferentiated advanced biofuels is sugarcane ethanol, and a gallon of this material can satisfy the advanced biofuels requirement, but cannot satisfy either the cellulosic biofuels or biodiesel requirements. One gallon of physical biodiesel generates 1.5 RINs because of biodiesel’s higher energy content.

The EPA also admits that the biodiesel industry has been struggling and is currently not producing enough biodiesel to meet the mandate. They also believe there is enough idle biodiesel capacity that can be restarted to produce a minimum of 800 million gallons in 2011. The adjacent bar chart titled “United States Biodiesel Production” indicates that the most the industry has produced in any calendar year is 670 million gallons in 2008. The EPA shrugs off the lack of a biodiesel tax credit and an industry that today is producing at a 360-million-gallons rate for 2010. The EPA blithely mentions that there are 2.2 billion gallons of capacity just ready to restart. They, however, do not address the numerous bankruptcies and facility abandonments since Congress’s failure to renew the biodiesel production tax credit; this makes estimating what capacity is left to surge production in a short time frame next to impossible. The EPA also makes no mention of the $1.00-per-gallon price premium for biodiesel over regular diesel that exists in today’s market. We are extremely skeptical that 800 million gallons of biodiesel will be produced at today’s feedstock prices without a significant change in tax policy to support the industry, which, in today’s political climate in Washington, appears to be next to impossible.

In proposing no change to the total Advanced Biofuels mandate, the EPA is also assuming that sugarcane-based ethanol, essentially from Brazil, will be available to fill the gap left unfilled by cellulosic biofuels and biodiesel. The EPA assumes 144 million gallons, or 544 million liters, of ethanol will be available for export to the US in 2011. They further point out, more specifically, that the California Low Carbon Fuel Standard (LCFS), which begins in 2011, should attract sugarcane-based ethanol, and that can be applied to the Advanced Biofuels mandate. With government regulators in the US, California, Europe, and Japan all wanting to use sugarcane-based ethanol to meet their GHG reduction goals, colliding with the hard facts of weather-related negative pressure on Brazil’s sugarcane production and expanding Brazilian domestic demand, will force importers to bid ethanol away from Brazil’s domestic market. So far this year, Brazilian exports are 665 million liters, which are 50% below previous year’s exports, and the outlook for 2011 is not any better for material available for export. None of Brazil’s exports this year have come to the US for use in the transportation fuels market. If the import tariff on Brazilian material is left in place, CBI hydrous ethanol dehydration plants may start processing again by being able to offer a 10-20 cpg discount to direct shipped anhydrous ethanol from Brazil.

In summary, the Advanced Biofuels portion of the RFS2 is struggling. The hard taskmaster of economics is proving to be a difficult hurdle. With a highly efficient cornstarch ethanol industry producing cost-competitive ethanol, it will require strong government support and a long-term financial incentive to bring high-cost cellulosic ethanol to market. The biodiesel industry is in the same situation, with a product that is not cost competitive. We question the ability of the government to follow through with the needed financial and market support to make cellulosic ethanol a reality. The EPA is counting on imported sugarcane ethanol to meet a portion of the US renewable fuels mandates, even when there are significant quantities of US-produced cornstarch ethanol available. It appears that US environmental policy is promoting the importation of transportation fuels, which is diametrically opposed to stated policies of promoting energy independence. Conflicting government policy on Brazilian sugarcane ethanol has the EPA promoting the importation to meet renewable fuels goals, while the same US government continues to impose a 54 cpg import tariff on Brazilian ethanol to protect the US cornstarch ethanol industry in the name of energy independence.

E15 Update

The EPA announced last week that the agency was delaying the decision on whether to grant a waiver to allow E15 in gasoline, citing the agency’s desire to wait until the DOE has completed its engine testing in September. The DOE engine testing is focused on late model Tier II emission control vehicles that went into production in 2007. In announcing this delay, the EPA intimated that it may only approve a waiver for these types of vehicles, and older vehicles may not be part of the waiver. The ethanol industry was hoping for a minimum waiver that included vehicles 2001 or younger that would have made more than half the existing fleet eligible for E15. Backing up the waiver to 2007 or younger will shrink the available vehicles to approximately 20% of the fleet. This type of waiver will do little for the ethanol industry. As we have discussed previously, a bifurcated market will have gas station liability issues, product labeling issues, and distribution issues for the gasoline marketer offering clear unleaded 87, E10, E15, E85, and premium gasoline.

ADM has petitioned the EPA to consider an E12 waiver based on the “substantially similar” concept that bypasses any engine testing by deeming the product substantially similar. This approach appears to be a long shot. The year and half delay in making any type of decision by the EPA is indicative of the difficulty in moving the gasoline market past E10 with the existing fleet of vehicles. Always keep in mind that when a difficult decision is required by a government bureaucrat that involves risk, the “make no decision” reflex will win out, as evidenced by the long delay on this E15 decision.

We believe the clear path to large ethanol consumption is to focus on moving the fleet towards E85-capable vehicles. In order to achieve the desired amount of renewable ethanol in the US gasoline pool, the solution that Brazil has embraced is the Flex-Fuel Vehicle (FFV). The FFV in Brazil has been tremendously successful in developing the ethanol fuel market in that country. It is very inexpensive to produce an FFV versus a non-FFV, so that is not an impediment. The key to unlocking the E85 market is getting the fuel dispenser infrastructure in place. There is proposed legislation to mandate the auto manufacturers to produce 90% of the fleet as FFV’s by 2013, and the legislation offers substantial federal grants for blender pump installation at gas stations.

Looking forward into 2011, the RFS mandate increases by 600 million gallons, and the small refiner exemption will be removed. These two actions will be enough to complete 100% penetration of E10 into the gasoline pool and consume all the production scheduled to come online by the end of this year. E15 is not necessary to consume all the domestically produced ethanol over the next 18 months, but the delay is having a negative impact in market psychology.