Thursday, February 01, 2007

Ethanol Supply Chain

Because of the problems involved in transporting ethanol in petroleum product pipelines, the key piece of infrastructure for our chosen fuel of the future is the railroad. Who would have guessed that the 21st century would owe such a debt to the 19th? Today's Wall Street Journal includes two articles describing the transportation hurdles and import barriers that ethanol will have to overcome to expand to the extent contemplated by the White House and Congress. High energy prices and environmental concerns are providing rail companies with wonderful new opportunities, but I hope their strategic planners are thinking carefully about where this could lead. Somewhere along the road to 35 billion gallons per year, the conventional wisdom about ethanol and pipelines will be challenged, perhaps in ways no one expects.

In some respects the development of ethanol is recapitulating the growth of petroleum a century ago. Although pipelines came along fairly early in the history of the oil industry, rail transport was a key supply chain link from its start in Pennsylvania, and it never went away. My first assignment after joining Texaco's Supply and Distribution department in the early 1980s involved trading LPG in tank car lots, and later I dealt with unit-trains of crude oil going from Bakersfield to Los Angeles. As interesting as all this was, I quickly discovered that trains are a lot more expensive and less reliable than pipelines, and I'm sure the ethanol industry is learning the same lessons. The incentives to shift from rail to pipeline will only grow, as ethanol volumes increase.

Besides its well-known incompatibility problems, ethanol faces other hurdles in shifting to pipelines. As crude oil production in the key ethanol producing region, including states like Illinois, Indiana, Kansas and Nebraska, declined from a million barrels per day in 1980s to less than half that today, existing oil pipelines were reversed and new ones built to supply the region's refineries with imported oil from Canada or the Gulf Coast ports. And the main petroleum product pipelines in the mid-continent flow north from the Gulf. That means that most of pipeline capacity between the Midwest, where ethanol is produced, and the Gulf Coast, where a third of America's gasoline is made, is going the wrong direction to help ethanol producers. As long as ethanol accounts for less than 2% of the country's liquid fuel supply, it can't win that battle.

As it grows, however, this impediment will turn into an opportunity, and some clever entrepreneurs will figure out that ethanol pipelines can share a right-of-way with crude and products lines going the other way. How big is the incentive? Ignoring transshipment costs and tank car rental fees, shipping ethanol from St. Louis to Houston by rail costs about 12 cents/gallon. Shipping gasoline from Houston to St. Louis on the Explorer Pipeline costs 3.5 cents. 8.5 cents per gallon would pay for a lot of pipe. And with ethanol being totally biodegradable, they might even be able to use cheaper materials to build their pipelines and the gathering systems needed to collect the ethanol from its widely dispersed sources. In any case, ethanol pipelines would face a significantly easier permitting process than anything involving oil or its refined products. If I were running a railroad, I'd enjoy those tariffs while I could, and start thinking hard about laying dedicated ethanol pipe.

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