EPA E15 Decision

The EPA decision on the E15 waiver came as no surprise this week.  The EPA ruled that E15 gasoline blends were okay for 2007 and later year model vehicles in the US.  As we have stated numerous times in previous reports, a bifurcated market will not work.  For example, The National Association of Convenience Stores (NACS) told its members to exercise extreme caution on whether to sell E15 gasoline.  The NACS represents convenience stores and the petroleum retailing industry that sells an estimated 80% of the motor fuels in the US.  The NACS’s key issues with the EPA waiver is that it does not address the liability of using dispensing equipment not specifically certified to handle ethanol blends in excess of E10 and the liability exposure for engine damage and Clean Air Act emission violations caused by misfueling vehicles, even with appropriate labeling in place.  An excellent study commissioned by the American Petroleum Institute that we referenced several weeks ago sums up all the other regulatory barriers that must be dealt with before E15 can enter commerce officially.  Here is the link to that study: http://www.jordan-associates.com/Sierra%20Repor%20on%20E15%20Reg%20Hurdles_080410.pdf

The huge sticking point that is evident in the proposed rulemaking is that the 1.0 psi RVP waiver granted for E10 cannot be extended to E15 by agency rulemaking.  In 40 CFR 80.27, the law limits the waiver to gasoline containing between 9%-10% ethanol with no exception.  It can only be changed with an act of Congress.  In this week’s proposed rulemaking (here is the link - http://www.jordan-associates.com/e15-labeling-nprm.pdf), the EPA is proposing that E15-blended gasoline will not  be granted this RVP waiver, forcing the blendstock that 15% ethanol is blended with to have a reduced vapor pressure and allowing the finished blend to meet summertime gasoline RVP without a waiver.  This means a refiner will be required to produce both an E10 blendstock and an E15 blendstock.  The rulemaking goes through an elaborate process to prevent comingling of E10 blendstock with E15 blendstock in order not to violate the RVP waiver language.  It is absurd to think the gasoline industry is going to go through these contortions to deliver E15 to the consumer.  There is no economic incentive for a refiner to produce a more expensive blendstock to accommodate E15.  In our opinion, these rules are completely unworkable, and it is going to take an act of Congress (hopefully with more input from industry) to clean up this mess. 

Ethanol 4th Quarter 2010 – Is it a Train Wreck?

By the 4th quarter of this year, the industry is scheduled to bring on another 550 mln gallons of annual capacity. This represents another 36,000 bpd of new production. By October of this year, the driving gasoline demand bump with have dissipated reducing overall gasoline demand by 250,000 bpd resulting in the loss of another 26,000 bpd of ethanol demand. This assumes that ethanol blending penetration stays in the low 80’s% through the balance of the year. We think the blending penetration staying in this range as a good assumption based on the very low price for 2010 ethanol RINs tracking in the 1.5-2.0 cpg range.

Export opportunities will be limited because of certification requirements for renewable fuels into Europe go into effect in December and it is uncertain if US producers will go to the trouble of getting their supply chain certified. Brazil may be an export outlet, but with very strict ethanol specification for imports, it is difficult to produce and move significant quantities of this type of ethanol to Brazil to relieve length in the US ethanol market.

On the positive side, if we assume $4/bushel corn and $75/barrel crude oil, there will still be a 20-40 cpg blending incentive for ethanol even without renewal of the VEETC. The EPA will issue a ruling on some type of E12 or E15 waiver by September. This will be good news psychologically for the ethanol market but the higher blends could not be realistically implemented until the middle of 2011 offering no physical relief to the market in the 4th quarter. Renewal of the VEETC prior to its expiration again is psychological but will not affect demand in the 4th quarter.
The market is paying a 6.4 cpg premium for Q1-2011 swaps over prompt pricing. The market sees the E12/E15 waiver, the higher RFS2 mandate of 12.6 bln gallons, the elimination of the small refiner exemption as all changes that will kick in for Q1. It should be noted that during the 1st quarter of any year, gasoline demand falls another 250,000 bpd below demand levels experienced in the 4th quarter due to winter weather. Even though there is good news for the 2011 market, Q1 may be too soon for this good news to physically impact the market resulting in higher ethanol prices and plant margins.

The corn crush margins for Q4-2010 and Q1-2011 are in the 24-26 cpg range which are not sustainable for the industry.

With an industry at a nameplate capacity of 14 bln gallons in the 4th quarter and demand softening or at best staying flat, ethanol plant margins are going to come under strong pressure resulting in some temporary plant slowdowns or shutdowns to balance supply and demand.

More E15 News

The EPA confirmed in a status update, hidden on their website on Friday afternoon before a three-day weekend, (brave bureaucrats) that an E15 waiver for 2007 model cars and younger would be decided on in late September. For automobiles in the 2001-2006 model years, a decision will be issued in November. Assuming that, at some point in the future, some portion of the automobile fleet in the US will be able to use E15, let’s consider the confusion at the pump for the average consumer. The consumer will approach a fuel dispenser and be faced with a big ugly label indicating that it is unsafe to use E15 in cars in the appropriate model years. The consumer will then think that if E15 is unsafe for some cars, why take the risk and will decide not to use E15, even if the car in question is actually compatible with E15. The price differential will be minimal at best, so an economic incentive will not exist to motivate the consumer to make the choice of filling up with E15. A bifurcated E10/E15 gasoline market will not work. With no economic incentive to purchase E15 while E10 sits next to E15 at the same gasoline pump, E15 is going nowhere. As we suggested in last week’s newsletter, getting full E10 penetration in the gasoline market and pushing FFV’s, along with E85, is going to be the route to expanding ethanol demand. E85 will work for the consumer when he sees the lower cpg price, even though, on a miles per gallon basis, it won’t be any better; consumer self-interest will kick in. The FFV/E85 strategy faces a density of demand issue, with FFV’s scattered across the US and not concentrated enough in one area to support numerous E85 station conversions. Look for lobbying to kick into high gear to expand FFV production, as well as government (federal and state) monetary support to install E85 dispensers.

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.