Tuesday, March 27, 2007

Fill 'Er Up

The Washington Post reports that when the auto industry CEOs met with President Bush yesterday, they pleaded for alternative fuel infrastructure to fill up the alternative fuel cars they are building. Despite decades of car makers and oil companies pointing fingers at each other over energy and environmental challenges, there's a lot to be said for the former worrying that the latter won't provide enough refueling opportunities to make owning a car requiring hydrogen, for example, convenient for consumers. The key question is who should pay for the installation of this infrastructure. It's not who you might think.

GM's CEO, in particular, has good reason to worry about the availability of alternative fuel. His company invested a fortune in the all-electric EV-1 in the 1990s, only to see it founder in the market, at least partly due to lack of recharging infrastructure, as I've described in detail in a previous posting. This is a big deal for hydrogen cars, as well, though they're years from the point at which refueling becomes the critical-path item. When the subject turns to ethanol and E-85, however, the argument gets considerably murkier.

By definition, cars that have been engineered to run on E-85, a mix of 85% ethanol and 15% gasoline, are "flexible fuel vehicles" (FFVs). That means they can run on gasoline with any fraction of ethanol from 0% to at least 85%. A shortage of E-85 pumps apparently didn't pose much of an impediment to selling "over 2 million" of these vehicles, as GM claims in its "Live Green, Go Yellow" campaign. The issue here is not selling more FFVs, but the risk that the government will stop counting them as alternative fuel vehicles that count towards carmakers' Corporate Average Fuel Economy quotas, because most of these vehicles have never used a gallon of E-85. That's worth serious money to Detroit.

So who should pay to make E-85 more widely available? Most people would probably say oil companies, but most of the service stations in the country aren't owned by the big oil companies; they're owned by small businesses, either individuals or local distributors. Selling retail gasoline isn't a terribly lucrative business, especially if you face competition from supermarkets and Walmart, who view fuel sales as a lure to customers, not a profit opportunity.

The problem at service stations is simple. A retail facility typically has only three underground tanks. One of them is in unleaded regular (ULR) service, one in premium (ULP) service, and the third most likely in diesel service. A dealer can't give up his ULR tank, because that's at least half of his throughput. And he won't give up his ULP tank, because he needs it to blend 89 octane mid-grade, which, along with ULP, provides his highest margin. That leaves the diesel tank. Switching that to E-85 is certainly possible, but how attractive is it? He must weigh lost diesel sales--plus any convenience store revenue that goes with them--against the chance that an FFV driver will pass his station to find one selling E-85. Absent a much bigger public outcry for E-85, I know that I wouldn't make that bet, myself.

Given these constraints, the choice comes down to an investment decision. Does a station owner rip up concrete to add another tank, putting his whole facility out of business for at least a month, in order to add a product for which the initial demand is probably only a few hundred gallons per month, versus the typical 100,000 gallons/month he sells on his other products? I don't see how you make a return on that investment, even after the $30,000 federal tax credit that's available.

What about providing more government assistance? Surely as taxpayers all of us have a vested interest in enabling sales of locally-grown ethanol that backs out imported oil. Well, even if the benefits of ethanol were large and unambiguous, the country saves exactly the same amount of foreign oil when a gallon of ethanol is sold as part of a 10% blend with gasoline (E-10), which requires no modifications to either service stations or cars, as when it's sold in E-85. Based on last year's ethanol production and current gasoline demand, ethanol output could nearly triple before it used up all its E-10 blending opportunities. The case for public support for converting stations to E-85 thus rests on political, rather than economic foundations.

The market isn't the answer to every problem, but in this case the market offers an important insight: if you want to make E-85 widely available, you should look to the parties that stand to gain the most from doing it. That brings us inevitably back to the carmakers, who have a major stake in ensuring that enough E-85 is available to preserve their CAFE ratings, along with citizens' groups that are passionate about energy security. A savvy auto firm might see some nice partnership opportunities in such alignments, which could eventually rope in an oil company interested in improving its image. In the meantime, the rest of us are no worse off if E-85 isn't available on every corner.

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