Small Refinery Exemptions and Ethanol Demand Destruction

September 17, 2018

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by Scott Irwin (FarmDocDaily) Small refinery exemptions (SREs) represent the latest controversy to engulf the Renewable Fuel Standard (RFS). When the U.S. Congress first created the RFS in the Energy Policy Act of 2005 (P.L. 109-58) it included a temporary exemption for small refineries from the mandate through 2011. Under the Obama Administration, SREs were rarely granted after 2011. This changed radically under the Trump Administration, which granted a total of 48 SREs retroactively for 2016 and 2017. As detailed in this farmdoc daily article (July 12, 2018), SREs effectively reduced the conventional ethanol mandate for 2017 from 15 billion gallons to 13.9 billion gallons. This was not only a large reduction in absolute terms, but it also resulted in the conventional mandate being set below the E10 blend wall. If similar numbers of SREs are granted for 2018 and 2019, comparable reductions in the effective conventional ethanol mandate should be expected (assuming the SRE volumes are not reallocated to non-exempt obligated parties).

While there is no doubt that SREs have opened a backdoor mechanism for EPA to reduce the statutory and obligated RFS volumes, there is sharp disagreement about the impact of SREs on the physical consumption of ethanol. On one side, obligated parties, mainly refiners, argue that physical ethanol demand has been unaffected. On the other side, the corn ethanol industry argues there has been substantial destruction of demand in the physical ethanol market due to the SREs. The purpose of this article is to investigate the impact of SREs on demand for ethanol in the physical market.

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However, analysis of data on ethanol and gasoline consumption in the U.S. shows there is little if any evidence that the blend rate for ethanol has been reduced by SREs. If there has been any ethanol “demand destruction” to date it was very small, perhaps a drop in the ethanol blend rate of a tenth, which equates to only about 140 million gallons of ethanol consumption on an annual basis. The reason for this counter-intuitive result is that all but a tiny sliver of ethanol in the U.S. is consumed in the form of E10 and the price of ethanol in recent months has been very low relative to gasoline. The price competitiveness of ethanol in E10 means that the conventional ethanol mandate is non-binding up to the E10 blend wall.

This finding does not preclude SREs from having an impact on ethanol demand in the future or a demand impact on other biofuels at the present time. First, if the price of ethanol increases sharply, say, due to corn supply problems at some point in the future, then ethanol could become expensive enough relative to gasoline that the conventional mandate would become binding even for E10. SREs could result in some destruction of physical demand for ethanol under this scenario. Second, SREs have in all likelihood reduced the demand for ethanol in the form of E15 and E85. While the magnitude of this impact is very small at the present time, it also means that further expansion of the demand for higher ethanol blends is not in the cards so long as SREs are granted (and not reallocated). Third, the demand for biomass-based diesel in all likelihood has been reduced in direct proportion to the impact of SREs on total obligated gasoline and diesel gallons because the biomass-based diesel mandate is highly binding. This form of “demand destruction” from SREs will be explored in a future farmdoc daily article. READ MORE

STUDIES FIND ETHANOL DEMAND DOING FINE: (Politico's Morning Energy)

Irwin: Ethanol Demand Unharmed by SREs--University of Illinois Study Shows Exemptions Harmful to Higher Blends (DTN The Progressive Farmer)

EPA CONSIDERS PARTIAL WAIVERS: (Politico's Morning Energy)

SREs Equal Demand Destruction? Look at the Data, Both Sides Argue (OPIS)

Green Plains Partners: Volumes Officially Become A Problem (Seeking Alpha)

Ethanol consumption sinking: Refinery hardship exemptions could cost 1.6 billion bushels (AgriNews)

Ethanol Blog-- Irwin: Evidence Still Lacking for Lost Ethanol Demand from Waivers (DTN The Progressive Farmer (Dec. 2018))

Excerpt from Politico's Morning Energy: Two studies out last week showed low costs have kept ethanol in the fuel system, even as EPA has expanded refinery waivers that ethanol producers have said are undermining the Renewable Fuel Standard. University of Illinois economist Scott Irwin found that ethanol blend rates hadn't budged when accounting for seasonal changes in consumption, Eric reports, while refining giant Valero released a separate study prepared by Charles River Associates that came to a similar conclusion, arguing that as long as the price of Renewable Identification Number stayed above a certain level, fuel would be blended at the usual rates.

In response to the Irwin report, Renewable Fuels Association Executive Vice President Geoff Cooper — the incoming CEO of the group — said the "economic incentive to expand blending that was previously shouldered by the RIN must now be shouldered primarily by the ethanol-gasoline spread. This results in artificially low ethanol prices and highly compressed margins — also known as 'economic harm' — for ethanol producers." READ MORE

Excerpt from OPIS: In its response, RFA said that only one of Irwin's measures of the blend rate was suitable -- the monthly domestic consumption of ethanol as a percent of the domestic consumption of gasoline. And it added that using that method should have given a 9.85% blend rate for the five months from February through June based on the most recent EIA figures, starting with the post-SRE period, a number that is well below the 10.17% average blend rate for the prior 12 months and the 10.37% average for the prior five months.

The ethanol industry trade group calculated this would amount to a reduction in ethanol consumption of approximately 450 million gal versus if the 12-month blend rate had been maintained and 730 million gal loss compared with the five-month blend rate.

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The consultancy (CRA) said that the key non-RFS drivers of blending ethanol are the biofuel's ability to serve as an oxygenate, enhance octane levels in motor gasoline blends and compete competing directly on price with petroleum feedstocks. If those non-RFS drivers led to an ethanol blend rate above the RFS mandate, the price of ethanol RINs would be at or near zero as they were for much of the early part of the program, CRA said.

CRA pointed to EIA monthly data that it said shows the ethanol/gasoline blend rate over the first six months of 2018 was 9.87%, above the same period in any other year since the RFS program began. CRA said historical data suggest that blend rates typically do not move with RINs prices.

The report concluded that while the SREs may have contributed to the RINs price decline, they have not impaired the incentive to blend ethanol up to the blend wall and because of that have not eroded ethanol demand.

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But RFA argued that CRA failed to take into account adjustments EIA makes in its monthly ethanol balance table needed to calculate consumption properly and calling its estimates "erroneous."

"The logic in the CRA report is convoluted, there are misstatements regarding basic RIN mechanics, and the report demonstrates a lack of understanding of ethanol/RFS economics," the organization said.

In this battle of dueling statistics, RFA has repeatedly cited an August report compiled by the University of Missouri's Food and Agricultural Policy Research Institute (FAPRI) that it said showed 4.6 billion gal of U.S. ethanol demand, valued at roughly $20 billion, could be lost to the industry if EPA continues its more relaxed policy toward granting SREs. The FAPRI report, which was published as an update to its March Baseline Outlook for Agricultural and Biofuel Markets, said that assuming no change in SRE policy, the average ethanol inclusion rate in gasoline would fall below 10% next year and steadily decline to 9.5% by 2023.

Marty Ruikka, principal analyst at ProExporter, said in an interview with OPIS that while he believes the SREs have caused significant demand destruction in RINs, the data do not suggest a substantial decline in the physical blending of ethanol.

"Everybody that's having these discussions can cherry pick their numbers," Ruikka said. "I have very close relationships with corn growers and ethanol associations, and I know there are problems [in these high numbers of demand destruction]. I have made clear to them that I agree there is demand destruction in RINs, but not in physical."

Ruikka estimated that if nothing changes this year or the next, he believes there will be even more degrading of RINs prices to a sub-10ct level. He said that since the RFS limits carryover RINs to no more than 20% in the following compliance year, the program will likely be at "full carry" in 2019. READ MORE