Could the Hydrogen Economy Run on Ethanol?

• Plans for a fuel cell car running on ethanol look like a clever way to circumvent the obstacles faced by other fuel cell vehicles.
• However, it is not clear that ethanol's perceived logistical benefits or emissions profile would give Nissan an edge in the competitive market for green cars.

Japan's Nissan Motor Co., Ltd. made headlines this week when it announced plans to produce a fuel-cell car that would run on ethanol, instead of hard-to-find hydrogen. As reported by Scientific American, the company expects to commercialize this approach by 2020, even though competitors like Toyota already have fuel cell cars in their showrooms. It's an interesting choice. Ethanol seems to offer logistical advantages over hydrogen, but the technical challenges involved aren't trivial, nor is ethanol without drawbacks from an energy or environmental perspective.

Fuel cells have long promised a different and potentially superior path to electrifying automobiles, compared to battery-electric vehicles (EVs) with their limited range and relatively long recharging times. One of the biggest obstacles has always been the lack of infrastructure and supply--hydrogen must first be liberated from water, methane or other compounds--and the problems of storing sufficient quantities of it on board. I've driven prototype fuel-cell vehicles (FCVs) and found the experience pretty similar to driving a regular car, as long as you have a hydrogen filling station handy.

Nissan makes the case that ethanol (chemical formula C2H6O) is much easier to source and distribute than gaseous hydrogen, and the process for making it give up its hydrogen is routine, at least under laboratory conditions. However, as the alternative energy research subsidiary of my former employer, Texaco Inc., found in pursuing a similar concept with gasoline, it's one thing to do this in a bench-scale device and quite another to do it in a size and shape that will fit easily and safely in a car and run as reliably as an internal combustion engine. I suspect Nissan's engineers have their work cut out for them for the next four years.

The bigger questions about this approach are more basic: Does it make sense from an economic, energy and environmental perspective, and can it find a large enough market? Consumers already have a wide range of green alternatives from which to choose, ranging from Prius-type hybrids (gasoline only), plug-in hybrids (gasoline + electricity) and battery EVs, not to mention the continuous improvement of non-electric cars. 

Nissan didn't include many numbers in the documents accompanying its press release, but the chemistry and math involved are pretty simple. At 100% efficiency, a gallon of ethanol could produce just under 0.8 kilograms (Kg) of hydrogen (H2) using the standard steam-reforming process. The best efficiency I could find for this ethanol-to-hydrogen conversion  was around 90%, so in the real world that gallon of ethanol would yield around 0.7 Kg of H2--enough to take Toyota's Mirai FCV about 46 miles. That's pretty good, considering that same gallon in a Chrysler 200 equipped as a flexible fuel vehicle (FFV) would drive an average of just 21 miles. Fuel cells are much more efficient than internal combustion engines.

The economics of operation don't look bad, either. If we use today's average US price for E85 (85% ethanol + 15% gasoline) of $1.87/gal. as a proxy for an ethanol retail price, that equates to around 4 ¢/mile, using the Mirai's published fuel economy data. That's about 15% cheaper than a Prius on regular gasoline at this week's US average of $2.40/gal., but it's also around 10% more expensive than a Nissan Leaf using off-peak electricity in northern California.

Emissions are trickier to assess. There's a lively and growing controversy about whether biofuels produced from crops can truly be considered carbon-neutral, even in places like Brazil where the yields from sugar cane are so high. There's much less controversy that the production of most US ethanol from corn is anything but a net-zero-emission endeavor. Corn requires fertilizer sourced from natural gas, and ethanol refineries consume gas (or coal) and electricity in their production process. In any case, when Nissan characterizes their planned ethanol FCV as having "nearly no CO2 increase whatsoever", they are either oversimplifying a very complex discussion or taking a large leap of faith. 

We can count the CO2 coming out of the tailpipe of such a car, and it would need a tailpipe because the onboard ethanol converter would emit about 12.5 lb. of CO2 for every gallon of ethanol converted to pure H2, plus some CO2 from the ethanol burned to heat the unit. My back-of-the envelope calculation gives a figure of 135 grams of CO2 per mile, or 20% lower than a Toyota Prius on gasoline. It would not be a Zero Emission Vehicle (ZEV), though of course an EV running on average grid electricity isn't really a ZEV, either, except in isolated regions or at specific times of day.

Even if there aren't any deal-killers here, I'm skeptical about Nissan's fundamental assumption that the ethanol infrastructure for their FCV would be that much easier to develop than the H2 infrastructure other FCVs require. That's because of the cost and ownership structure of the retail fuels business, which as I've argued previously helps explain why your corner gas station is unlikely to sell E15 (85% gasoline, 15% ethanol) any time soon, despite the EPA having approved it for newer cars. 

At least in the US, most gas stations are owned by small businesses, not by the oil companies whose brands they display. Margins are slim, and these folks don't have deep pockets, so adding a new fuel like pure ethanol or the ethanol-water mix that Nissan suggests, poses a difficult business decision: Do you take over an existing tank and stop selling diesel fuel, or premium gasoline with its high margins? Or do you rip up the forecourt to add a new tank, which entails being out of business for months--or even longer if you discover that one of your existing tanks is leaking? Either way, the investment costs and disruption to current customers are significant, in exchange for selling what at first would certainly be a low-volume product. When I was in the fuels supply & distribution business, we would have called that kind of decision a "no-brainer."

If Nissan can't encourage enough service stations to add ethanol or an ethanol/water blend--E85 would not work--to their product mix, do they start their own service station network? That seems unlikely. And if you buy one of these cars in a few years, should you carry a case of vodka in the trunk as an emergency range-extender? That's only half-facetious.  

I give Nissan credit for pursuing a novel option for making fuel cell cars more viable, as an alternative to today's range-limited EVs. Ethanol looks like a cost-competitive source of hydrogen, and it is at least easier to store than H2 gas or liquid H2. However, they face practical and marketing challenges that might well offset most of the advantages the company claims to see. The ethanol FCV could encounter the same chicken-and-egg dynamic as FCVs running on hydrogen, or indeed any new model requiring a fuel that is not distributed at scale today. It will be interesting to watch their progress.

EPA's Blown Call on Ethanol

• EPA's proposed revision to renewable fuel quotas achieves the appearance of compromise by cutting non-existent volumes, while still attempting to force more ethanol into the market than consumers seem to want.

Last Friday the US Environmental Protection Agency released its long-awaited proposal for untangling a broken federal Renewable Fuels Standard (RFS). Although it provides all parties with greater certainty, it fails to resolve the regulation's fundamental flaws. This is all the more disappointing for the duration of the wait involved, finalizing 2014's quotas 18 months late and leaving refiners and fuel blenders to operate for the first five months of this year on hints and guesswork about how much ethanol and biodiesel they would be required to sell in 2015.

The proposal meets at least one definition of a compromise, with most affected constituencies apparently disappointed or irate about the result. To someone unfamiliar with the situation, it might even seem that, as ethanol groups claim, the agency has leaned far in the direction of assuaging the concerns of the petroleum refining industry by cutting a total of 11 billion gallons from the 2014-16 quotas for ethanol and other biofuels. However, as EPA's accompanying analysis makes clear, the omitted volumes were unlikely ever to be purchased by end-users, given the decline in US motor fuels consumption since the statutes imposing the RFS were passed in 2005 and 2007. Nor do the facilities yet exist to produce the quantities of cellulosic biofuels that account for the lion's share of the proposed cuts.

EPA's documentation repeatedly cites the "intent of Congress." This seems to refer to the Congressional sessions that bequeathed us this policy, rather than to the current Congress, which is waking up to the fact that the program has largely been superseded by reality. The RFS was designed to address two problems: US fuel scarcity and transportation-sector emissions of greenhouse gases. The former has been overcome mainly thanks to the shale revolution, transforming the US from a net importer of refined petroleum products to the world's largest exporter.

As for automobile-related emissions, they are being managed more effectively by fuel economy improvements and new vehicle technology. The RFS may even be counterproductive in its overall emissions impacts, as noted in a press release from the Environmental Working Group. Nor are emissions the only issue for which crop-based ethanol may be doing more harm than good. Evidence points to periodic impacts on global food prices. It's hard to conclude we could divert 38% of the US corn crop without causing unintended consequences somewhere.

EPA's analysis of the snarl at the core of the existing RFS is perplexing. First it describes how ethanol has effectively reached its maximum possible penetration of the US market for ordinary gasoline containing up to 10% ethanol (E10)--the so-called "blend wall." It goes on to acknowledge that sales of gasoline blends containing up to 15% or 85% ethanol, respectively, remain minuscule relative to total gasoline sales. However, it then ignores these facts and persists in the hope that by continuing to increase its ethanol quota, albeit more slowly, it can convince consumers to embrace fuels for which they had little appetite even when gasoline cost $1 more per gallon than it does today.

As the Washington Post noted, most car manufacturers still warn automobile owners that using gasoline containing more than 10% ethanol could result in engine damage not covered by their warranties. Although I was pleased to see that the car I recently purchased is warranted up to 15% ethanol, I cannot envision buying a single gallon of E15 unless it was priced at a discount to E10 gasoline, reflecting its inherently lower fuel economy and range. As for E85, in only a handful of states does the market discount meet or exceed the fuel's 27% calculated deficit in delivered energy, compared to E10. Is it any wonder that for a decade E85 has failed to take off as envisioned by the EPA and previous Congresses?

The EPA does not have a free hand to rewrite this regulation in any manner it would like, to fit the greatly altered circumstances in which the US now finds itself. The agency may well believe it has gone as far in that direction as it could, although I suspect it could have justified freezing ethanol from all sources at current levels, and allowing cellulosic ethanol gradually to displace corn-based fuel as new facilities come online. However, no adjustments that EPA seems prepared to make can repair a biofuels policy that was fundamentally broken at its inception, due to its inherent contradictions with other policies and consumer preferences.

We have reached the point at which conflicting federal biofuel quotas, emissions regulations, and  chronically weak GDP growth have rendered the original goals of the RFS not just ambitious but unattainable. The EPA has taken its best shot at addressing this and come up short. It is now up to the US Congress and the Administration to work together to fix this mess, before the consequences of inaction put a damper on one of the few bright spots of the current economy.

Is An Ethanol Compromise on the Horizon?

• The RFS ethanol mandate increasingly benefits farmers and ethanol producers at the expense of motorists, small-engine users, food producers and restaurants.
• Repeal of the RFS looks unlikely, but equitable reforms addressing the needs of all affected groups are possible, if Congress is willing to compromise.

Earlier this month, National Journal hosted an event on the “Biofuels Mandate: Defend, Reform, or Repeal” from Washington, DC. I encourage you to skim through the replay. The session highlighted a wide range of views concerning the US Renewable Fuels Standard (RFS), including those of the corn ethanol and advanced biofuels industries, poultry growers, chain restaurants, environmentalists, and small engine manufacturers. Although these broke down pretty sharply along pro- and anti-RFS lines, I thought I detected hints of the kind of compromise that might resolve this issue. I’d like to focus on the elements of such a deal, rather than rehashing the positions of all of the participants, with one necessary exception.

The most disappointing contributions to the discussion occurred during the interview with Representative Steve King (R, IA) by National Journal’s Amy Harder. If we accept Mr. King’s perspective, we should embrace the RFS as being as relevant today as when it was conceived, with no changes required. That flies in the face of the serious market distortions now manifesting in the “blend wall” at 10% ethanol content in gasoline.

Among other things, Mr. King claimed that a 2008 reduction of $0.06 per gallon in the now-expired ethanol blenders tax credit brought the expansion of the corn ethanol industry to a standstill. The industry’s own statistics tell a very different story, with US ethanol production capacity having grown by a further 86% since that point.

Rep. King also characterized “food vs. fuel” concerns as a bumper sticker issue, with no basis in fact. That issue might be controversial, but it is far too substantive to dismiss so cavalierly. The latest evidence of that is a vote by the European Parliament to cap the contribution of conventional biofuel — ethanol and biodiesel derived from food crops — at 6% of transportation energy out of a 2020 target of 10%, based on concerns about sustainability and competition with food. It seemed fairly clear that the Congressman views the RFS more as a farm support measure than an energy program.

The only one of Mr. King’s comments that seemed to find traction with the other pro-RFS panelists was his odd suggestion that without a mandate for biofuels, the only federal mandate in place would be one for petroleum-based fuels. Certainly, gasoline and diesel have advantages in terms of infrastructure, energy density and the legacy fleet, but he appeared to have something else in mind. From the way others picked up on this, perhaps it was his earlier reference to the tax benefits that conventional fuel producers have long enjoyed. This is the first and easiest element on which to compromise.

If ethanol producers and advanced biofuels developers are convinced that fossil fuels get a better deal from the federal government than the one they have under the RFS and the $1.01 per gallon producer tax credit for second-generation biofuels, it would be a simple matter to replace these programs with the same incentives received by oil and gas producers and petroleum refiners. After all, the biofuel industry already benefits from the Section 199 tax deduction that accounts for a third of budgeted federal tax benefits for the oil industry, and it shouldn’t be hard to devise an accelerated depreciation benefit analogous to “percentage depletion” and the expensing of intangible drilling expenses. Combined, the value of these tax benefits is about 1.3¢ per equivalent gallon of oil or natural gas produced this year.

Other concerns came across clearly. Despite the endorsement of 15% ethanol blends by the Environmental Protection Agency, blending more than 10% ethanol in gasoline creates serious risks for the US’s 500 million existing gasoline engines, large and small. The scale of corn diversion necessary to go beyond 10% is also distorting the US agricultural economy and food value chain, all the way to the restaurants in our communities. However, those engaged in developing new biofuels that don’t rely on edible crops, or that are fully compatible with existing infrastructure and engines, are legitimately worried that the repeal of the entire mandate would strand the significant investments in new technology that have already been made, and possibly smother their industry just as it nears its first commercial-scale deployments. All these points of view struck me as eminently reconcilable within a reformed RFS that recognizes that most of the assumptions of the 2007 mandate are no longer valid.

The starting point for reform of the RFS should be a 10% cap on ethanol from all sources in mass-market gasoline — excluding E85 — combined with measures to give ethanol from non-food sources priority within that cap over ethanol produced from corn or other food crops. The advanced biofuel targets of the RFS should also be scaled back significantly to reflect the reality that the 2007 targets were wildly optimistic. Ideally, they should be adjusted each year based on the previous year’s actual output. In return, the current producer tax credit for cellulosic and other second-generation biofuels could be extended beyond its scheduled expiration at the end of this year, and then phased out over a reasonable, predictable period, perhaps tied to cumulative output.

Finally, since few on the panel seemed impressed by the EPA’s exercise to date of its statutory power to adjust the RFS to fit changing circumstances, that authority should be transferred to another agency, along with clearer guidelines on when adjustments would become mandatory.

I’d be the first to admit that the reforms I’ve outlined above fall well short of the outright repeal of the RFS that many, including myself, would prefer. That’s the essence of compromise. Having just experienced a government shutdown and debt ceiling crisis brought on by the clash of two intransigent positions, this might be preferable to an impasse that leaves an unsustainable status quo untouched. And if the assessment of Representative Welch (D-VT) concerning the appetite of the Congress to take up this matter is accurate, something along these lines might just be achievable.

Reform of the RFS would leave in place for a while longer the outlines of a mechanism that one of the session's panelists accurately described as a Rube Goldberg construction. Short of a guarantee to bail out everyone who invested in biofuels production or research on the basis of the RFS that Congress put in place in 2007, should they fail in a post-repeal market, I’m not sure there’s another course that would be sufficiently equitable to all parties involved.

A different version of this posting was previously published on Energy Trends Insider. 

Crashing into the Ethanol Blend Wall

• The long-anticipated arrival of the ethanol "blend wall" for gasoline is the inevitable result of a federal policy designed for a world of expanding gasoline sales that no longer exists.
• This is not just another arbitrary crisis; it is already costing consumers at the pump, and those costs will increase unless the Renewable Fuel Standard is reformed or repealed.

The Energy and Commerce Committee of the US House of Representatives held hearings late last month on the Renewable Fuel Standard (RFS). It’s otherwise known as the ethanol mandate, although it covers biodiesel, as well. The hearings were timely, since at least two bills have been introduced to reform or repeal the RFS.  During the session on July 23rd, Rep. Waxman (D-CA) referred to the “gasoline blend wall, which may be around the corner.” In fact, a review of current gasoline sales and this year’s final ethanol target--just issued yesterday!--confirms that the ethanol “blend wall” has arrived, at least for some of the nation’s refiners. That explains the urgency of the debate about the future of the RFS.

The blend wall is simply the threshold at which the RFS requires more ethanol to be blended into US gasoline than the quantity necessary to dose essentially all of it with the maximum 10% ethanol content for which most cars on the road were designed. Because the Environmental Protection Agency, which administers the RFS, has been unwilling to exercise its flexibility under existing law, the fuels industry must now choose from a set of unattractive options: It can limit mainstream gasoline to 10% ethanol content and absorb substantial RIN costs (see below) or statutory penalties for failing to blend the required volumes of biofuel. It can produce less gasoline than the country needs, or export more of its production, to reduce its renewable fuel obligations. Or it can produce higher-ethanol blends such as E15 and risk the integrity of millions of cars and large portions of the country’s fuels infrastructure, including all but the newest gas station pumps and tanks. All of these choices affect the price consumers pay at the pump.

In order to understand why the blend wall is a serious problem, rather than another arbitrary crisis, we need to examine its two main elements. The first is fairly straightforward, relating to the mechanical integrity of the pumps and seals in automobile engines and fuel systems, as well as refueling infrastructure. While most of these function acceptably with blends of up to 10% ethanol in gasoline, there’s significant controversy about what happens above that threshold. As I noted in June, this issue has become relevant much sooner than the 2007 law anticipated, because US gasoline sales have declined instead of continuing to grow by 1-2% per year, while sales of E85 remain small and mainly regional.

As the head of the American Automobile Association (AAA) indicated in his testimony before Congress, any new product like E15, which consists of 15% ethanol and 85% petroleum gasoline, should have been tested thoroughly before release. Although the EPA conducted extensive testing before certifying E15 for use in 2001 and later model cars, as best I could tell their focus was on vehicle emissions systems, rather than mechanical integrity. Other tests conducted at the behest of the fuels industry identified problems with higher ethanol blends in vehicles not specifically designed as “flexible fuel vehicles” (FFVs) which can use up to 85% ethanol. UL previously tested existing service station product dispensers (gas pumps) and observed leaks and other failures above 10% ethanol. The uncertainties that have been raised by independent testing may not be conclusive, but they can only be resolved by a lot more testing on actual vehicles, not by rhetoric. The bottom line for consumers is that most carmakers won’t warrant any but their latest models for use with E15.

Another important but more obscure aspect of the blend wall relates to a feature of the RFS called Renewable Identification Numbers, or “RINs”. The RFS regulations created RINs for tracking purposes, to provide “the basic framework for ensuring that the statutorily required volumes of renewable fuel are used as transportation fuel in the U.S.” But they also have another purpose. RINs can be separated from the physical gallons of renewable fuel and traded in the market, effectively becoming paper ethanol. Enabling this RIN market, which includes both “obligated parties” — mainly refiners and importers of finished gasoline — and non-obligated parties such as gasoline blenders and traders, provides some flexibility in the RFS compliance system. It allows refiners that cannot blend any more ethanol into their direct fuel sales — or cover their typically larger sales of pre-ethanol product — to satisfy their legal obligations under the RFS by presenting a certificate, instead.

This worked reasonably well when the annual blending target was lower and refiners and marketers could bank RINs for future use by blending more ethanol than required, while remaining under the 10% limit. However, only 20% of the RINs generated in that manner last year could be carried over into 2013, restricting the supply just when the market approached the overall 10% blend wall. My understanding from those who follow this market is that this “bank” will become insolvent sometime next year, limiting new RINs largely to those generated from sales of E85 in the Midwest.

Now, with the blend wall a reality, the limited stock of RINs from past blending is being drawn down at prices that have spiked from a few cents per gallon-equivalent at the start of the year to well over $1.00 recently. Some refiners are spending hundreds of millions of dollars on RINs. It’s hard to determine how much of that is being passed on to consumers in fuel prices, because of the complexities of the RIN market and the agreements that various participants have made concerning the allocation of RINs. If 100% of their cost were passed on, then RINs at $1.00 would add $0.10 per gallon to the price of gasoline at the pump. The higher the annual RFS target ratchets, the higher RIN prices could go, with a recent estimate setting the potential impact on gasoline prices in 2014 at $0.19/gal, with the possibility of even larger increases in diesel prices.

Another potential outcome mirrors a comment made the hearings by the CEO of Cumberland Gulf Group, a large gasoline distributor. He characterized the functioning of the RFS and its RIN provisions as “subsidizing exports and taxing imports.” Refiners that don’t have enough RINs to cover their gasoline production will weigh current RIN prices against the profit they could generate by exporting more of their output to other countries, thus reducing the volume that must be covered by RINs. This could have an even bigger impact on the US gasoline market than merely passing through the cost of RINs. That's because gasoline prices are set by the last increments of supply and demand, and small shortfalls can translate into large price increases. That’s exactly what seems to be happening now in the artificial market the EPA has created in RINs.

The original purpose of the RFS and the law that established it was to reduce US reliance on imported oil, along with reducing greenhouse gas emissions. Because of its lower energy content the ethanol blended into US gasoline this year displaces about 540,000 barrels per day of gasoline produced from petroleum, though with questionable environmental benefits. That’s almost exactly the average quantity of finished gasoline and gasoline blending components exported from the US in the last 12 months reported.  Although that might be at least partly coincidental, it’s a further indication of just how much our national energy situation has changed since the legislation establishing the current RFS was passed in 2007.

One of the experts appearing before Congress characterized ethanol as an additive, rather than a replacement fuel. Until and unless E85 sales grow dramatically, that seems apt. Our elected representatives should now be asking themselves whether it makes sense — in light of altered circumstances and the EPA's decision to defer any administrative adjustments in the RFS until next year — to subject the US motor fuels market and consumers to a new and entirely artificial source of price volatility for the sake of an additive that the CEO of Growth Energy, a major ethanol trade association, testified would continue to be produced and sold in the absence of the mandate. When considered together with serious questions about its impact on food supplies and prices, the case for at least reform of the Renewable Fuel Standard is compelling.

A different version of this posting was previously published on Energy Trends Insider.

The "Four-Gallon Rule": Another Unintended Consequence of Ethanol Policy

The energy field is replete with unintended consequences, and US policy promoting ethanol fuels has had more than its share.  The growing competition  between food and fuel uses of corn, amplified by the current drought, is a prime example, along with the so-called "dead zone" in the Gulf of Mexico that has been exacerbated by the extra fertilizer used to boost corn yields enough to meet the rising demands of the federal Renewable Fuel Standard (RFS).  Most of these effects occur out of the sight of average consumers, but here's a new one that could start showing up at a gas station near you, very soon: the EPA's "four-gallon" rule.  As a result of EPA's decision to allow gasoline blenders to sell fuel containing up to 15% ethanol, and in recognition of the adverse consequences of high-ethanol blends for small engines, gas stations will be required to post signs enforcing a minimum purchase of four gallons from certain pumps.  This is yet another indication that the EPA has put expediency above prudence in giving its approval to a fuel that is not ready for mass-market distribution. 

A little background is necessary to understand how we reached this point.  In 2007 the Congress passed the Energy Independence and Security Act that included the RFS, mandating dramatic increases in the quantity of ethanol blended into gasoline.  Unfortunately, its passage coincided with a sea change in the gasoline market. Prior to the financial crisis and recession, US gasoline demand had been growing by 1-2% per year for decades, and on that pace there should have been ample future gasoline demand growth to accommodate all the additional ethanol that Congress was instructing the EPA to require refiners and gasoline blenders to add, by means of the standard blend of 90% gasoline and 10% ethanol.  Instead, gasoline sales fell by more than 3% in 2008 and still haven't recovered their 2007 peak, running about on par with 2002 this year.  When you do the arithmetic, that means that instead of being able to absorb over 15 billion gallons of ethanol this year, the market can only handle around 13 billion gallons--barely enough to satisfy the 2012 mandate level and 2 billion short of the amount required in just three years.  (This ignores cellulosic ethanol requirements, which have been revised downward each year as commercial production fails to appear.)

With sales of 85% ethanol E85 trickling along at levels too low to stave off the approaching "blend wall", the ethanol industry applied in 2009 to be allowed to increase the ethanol dosage in gasoline from 10% to 15%, requiring an EPA waiver of existing regulations.  That waiver was granted in 2010 for cars made after model-year 2006 and later extended for cars made after model year 2000, in spite of continuing concerns about its impact on the engines and fuel systems of all cars not labeled as "flexible fuel vehicles", as well as testing by UL indicating that some existing gasoline dispensers failed in dangerous ways when ethanol blends above 10% were introduced. 

The four-gallon rule is part of the EPA's ongoing contortions, in the form of gas pump labeling and "misfueling mitigation plans", to make sure that E15 doesn't get into the wrong vehicles, or worse yet, into small engines--lawn mowers, string trimmers, boats, etc.--where it has been found to cause potentially serious problems.  So in addition to labels indicating that E15 is only approved for 2001 and later automobiles, the EPA is instituting a minimum sales quantity rule to prevent someone from filling a gas can for use in a small engine with E10 from a "blender pump"--one that can dispense either E10 or E15 on demand.  That's because even after the pump is switched to E10, enough higher-ethanol fuel could remain in the hose to skew the ethanol content of the first few gallons delivered. (I'd suggest that this ought to be of concern to motorists, as well.)

I'm sure the EPA sees its new four-gallon rule as a sensible measure to protect the owners of small consumer or industrial engines from damaging their equipment. Yet from my perspective outside the bureaucracy it looks like another symptom of an E15 policy that falls short of the prudence necessary when dealing with the retail distribution of motor fuels and borders on regulatory malpractice.  At some point in the process someone in EPA should have held up his or her hand and pointed out that the obvious solution was not layering increasingly impractical and downright weird regulations onto already overburdened gas station operators, but to call for a fundamental reexamination of a Renewable Fuel Standard that has been overtaken by unforeseen events.  And that's without even considering that the lower energy content of the extra ethanol equates to a new $0.07 per gallon tax on gasoline at current prices. The publicity surrounding this issue provides an ideal opportunity for one or both presidential candidates to commit to suspending the E15 program, pending a thorough review of the RFS and its implementation. 

E15's Problems Are Symptomatic of A Failing Biofuels Policy

A new report on automobile engine durability casts further doubt on the compatibility of mid-level ethanol blends such as E15 (15% ethanol, 85% gasoline) with the existing US light-duty vehicle fleet. The report was issued this week by the Coordinating Research Council (CRC) under the auspices of API, Global Automakers, and the Alliance of Automobile Manufacturers.  It found that at least some of the vehicles included in EPA's certification of E15 for use in cars manufactured since 2001 experienced excessive valve wear and other mechanical problems over the course of a simulated engine lifetime.  Together with previous research highlighting the risks of E15 for gas station pumps, the report's findings raise serious questions about the federal government's current ethanol policy and who will ultimately bear its hidden costs.

I've written extensively about the EPA's approval of E15 for use in vehicles and the underlying rationale for increasing the ethanol content of most gasoline beyond the 10% limit (E10) for which most cars on the road today were designed.  At current volumes, domestically produced corn-based ethanol accounts for roughly 10% of all US gasoline and displaces the energy equivalent of 600,000 barrels per day of imported petroleum products.  However, without increasing the amount of ethanol blended into each gallon of gasoline, and in the absence of a miraculous transformation in the public's minuscule appetite for E85 (the 85% ethanol blend sold for flexible fuel vehicles) the US ethanol strategy has hit its natural limit.  Since US gasoline consumption, which prior to the recession routinely grew at 1-2% per year, has stalled at a level comparable to what we used ten years ago, the enthusiasm of the US ethanol industry for E15 to expand its market is entirely understandable.

The CRC's results have been criticized by both the ethanol industry and the Department of Energy.  Although I don't have the background to judge CRC's report assumption by assumption and result by result, it does appear that many of the criticisms raised by the DOE were addressed in the body of the report, including the choice of ethanol-free gasoline as the reference fuel.  As for complaints that the auto and oil producers have a vested interest in making E15 look bad, ethanol producers are at least as conflicted for their part.  Moreover, without impugning the integrity of the fine folks at the DOE, the federal government also has a significant conflict of interest in this matter: The administration and its cabinet agencies are stewards of a 2007 national biofuels policy that now depends on the adoption of mid-level ethanol blends like E15 if it is to have any chance of reaching its goal of 36 billion ethanol-equivalent gallons per year by 2022, from around 15 billion gallons per year today.  The apparent damage to some engines running on E15 under test conditions similar to those used by the car manufacturers for their own product testing highlights risks that must be addressed before consumers should be asked to put this fuel into their cars.

In addition to concerns about the safety of this fuel for the mechanical integrity of the tens of millions of vehicles for which the EPA has approved it, including both of my family's vehicles, E15 still faces substantial practical obstacles to its widespread distribution--obstacles that will likely require significant new federal funding to overcome. My industry contacts tell me that gasoline retailers considering selling E15 must install brand new gas pumps, because the nationally recognized testing laboratories like UL won't certify existing product dispensers for use with E15.  Anyone who ignores this requirement faces serious liabilities and could end up in violation of local fire codes.  So not only would retailers selling E15 instead of E10 be excluding a large portion of their existing market--at a minimum all pre-2001 cars--but they would have to make significant investments to do so.  Such investments are unlikely to be repaid by higher prices for E15 than for E10, because if anything, E15 should sell for a discount to E10.  Its nearly 2% lower energy content than E10 would translate into a requirement for roughly one extra fill-up a year for the average driver, or a penalty of about $37 per year at current prices.

There's an obvious solution for the risks that the administration is asking motorists to take on with E15 fuel.  Since neither vehicle manufacturers nor fuel retailers are prepared to accept the liability for excessive engine wear or fuel system damage from using E15 instead of E10 or purer gasoline--a position the Congress is considering granting statutory protection--the federal government should step up to this role.  The DOE and EPA claim E15 is safe for cars.  In the private sector, such claims would have to be backed up by warranties, explicit or implied.  Why should this situation be any different?  The President should therefore instruct DOE and EPA to carve out a portion of their annual budgets--after cuts--to fund a new federal warranty program for vehicles damaged by E15.  If these agencies are unwilling to stand behind their assessment of E15, then perhaps this fuel is not as ready for prime time as they suggest.  In any case, foisting this liability on consumers would represent a hidden and likely regressive new tax.

Ethanol's Future Without Subsidies

Given the remarkable longevity of the tax credit for ethanol blended into gasoline, it seems fitting that it would take a problem on the scale of the massive US deficit and $14 trillion federal debt to trigger its demise. Yet despite a widely-publicized Senate vote in June and the announcement of a key compromise among three Senators last week--two from the corn belt and one from the West Coast--it remains unclear just when and how the cancellation of this subsidy will become law. And because the fate of the subsidy is linked to that of the parallel tariff and duty on imported ethanol, the US ethanol industry faces not just the prospect of a more challenging market by year-end, but one that could include competition from foreign suppliers with special advantages under US renewable fuels regulations. Some producers may end up wishing they hadn't expanded output quite so fast.

I've followed the ethanol subsidy for much longer than I've been blogging about it. As I was reading a two-part assessment of the changing ethanol situation in Biofuels Digest it occurred to me to take the dusty report from my long-ago M.B.A. project off the shelf. Its topic was the market for "gasohol", gasoline blended with up to 10% ethanol, on the West Coast in the early 1980s. At the time, blenders received roughly the same tax credit as today's $0.45 per gallon of ethanol blended, thanks to the 1978 Federal Energy Tax Act and the Highway Tax Act of 1983. That benefit was a lot more generous in then-current dollars than now, but much smaller in aggregate. In the intervening decades, gasoline with ethanol has expanded from around 2% of the market to nearly 100%. In much of the country it is now harder to find gasoline without ethanol than it was to find gasohol back then.

That's only one indication of the tremendous success this industry has enjoyed, due almost entirely to government policies like the Volumetric Ethanol Excise Tax Credit and the national Renewable Fuels Standard (RFS) established in 2005. In fact the eventual demise of the ethanol tax credit was virtually guaranteed by the passage of an even more ambitious RFS as part of the federal Energy Independence and Security Act of 2007. Under the RFS, blending ethanol into gasoline in steadily increasing proportions became mandatory, rendering the tax credit paid to refiners and other gasoline blenders redundant. Just as importantly, it expanded the scale of ethanol blending to such an extent that the total annual cost of the so-called blenders credit grew from roughly $1.8 billion in 2005 to a projected $6 billion this year--too big to ignore.

The deal agreed by Senators Feinstein (D-CA), Klobuchar (D-MN) and Thune (R-SD) last week would reportedly result in the early termination of both the ethanol tax credit, which was due to expire at the end of 2011 but could have been renewed, and the corresponding ethanol import tariff. It would devote $1.33 billion of the unspent funds to deficit reduction, while diverting another $668 million to extend tax credits for alternative fuel refueling (or recharging) infrastructure and cellulosic biofuel tax credits. This outcome appears to have pleased at least part of the ethanol industry. However, in order for it to become law, it must still be voted on by both houses of Congress, either by itself or as a provision within another bill, perhaps even the debt ceiling extension package that could emerge from the ongoing deliberations between the House, Senate and White House.

The ultimate effect of these changes on the ethanol industry remains somewhat uncertain, though it is hard to see them as a net positive, other than the longer-term benefit of supporting infrastructure investments that could be crucial in resolving a key bottleneck in ethanol distribution. Without much higher sales of gasoline blends containing more than 10% ethanol, the market is already nearly saturated with ethanol, and that's before factoring in the additional imports that the elimination of the tariff is likely to promote. And at least in the case of ethanol derived from sugar cane, those imports will enjoy an important advantage over ethanol derived from corn: most of them are likely to qualify for the stricter designation of "Advanced Biofuel" under the RFS, a category for which the annual quota is just starting to take off, and that cannot be satisfied by corn ethanol but also seems unlikely to be filled by domestic cellulosic ethanol any time soon.

Biofuels Digest suggested that long-dated ethanol futures have already nose-dived in anticipation of the end of the tax credit. It's true that ethanol for delivery in January 2012 is trading for around $0.35/gal. less than the August 2011 ethanol futures contract, reflecting a widening of ethanol's discount to the gasoline futures contract over that interval of around $0.11/gal. However, it also seems highly relevant that corn futures have recently retreated from their early-June peak of nearly $8/bushel to $6.80, with December corn--from which January ethanol might be produced--down at $6.20/bu. That leaves ethanol producers a small but still positive margin on that January futures price. So it is hardly certain that the end of the tax credit will, by itself, stress US corn ethanol producers. If anything, refiners and consumers--who have arguably received most of the benefit of the credit in recent years--stand to lose the most from its disappearance.

Import competition could have much more serious consequences, as the fuel ethanol industry truly begins to globalize. Brazil is the big player internationally, even if the recent rise in sugar prices and a smaller-than-expected cane crop have created the bizarre situation of Brazil actually importing corn ethanol from the US. The historically fragmented Brazilian sugar cane industry is currently both expanding and consolidating, led by companies like Raizen, the new joint venture between Shell and Cosan, which has indicated plans to double its ethanol capacity to 5 billion liters per year (1.3 billion gallons per year.) Nor is Brazil the only tropical country that can grow cane and produce sugar, ethanol and electricity from modern facilities. The Brazilian model could be replicated elsewhere in Latin America, the Caribbean, and West Africa. Not all of that extra ethanol will come here, but enough of it could, helped by the RFS, to put an effective cap on US ethanol prices. I'm not aware of a similar constraint on corn prices.

The US ethanol industry has matured in the last three decades. Today's ethanol plants are much more efficient than the ones supplying the small quantities used for gasohol in the early 1980s, and they now consume around 40% of the US corn crop. The industry has expanded on a scale that would have seemed nearly impossible thirty years ago, though in my view it has in the process fallen into the classic overcapacity trap of commodity manufacturers. Whether that situation is temporary or permanent depends on the success of blends containing more than 10% ethanol--blends that the market has so far treated with indifference. But either way, when the training wheels finally come off with the end of the blenders credit and import tariff, we shouldn't be surprised to see more of the small and higher-cost producers fall by the wayside. That will have local consequences, but the ethanol industry will survive, just as it survived the bankruptcies of some ethanol producers during the financial crisis. Ethanol is here to stay, and it is about to embark on a new career as a more normal commodity.

Carbon-Neutral Gasoline

I see that Google's venture capital fund is investing in a startup company that would produce hydrocarbon fuels from cellulosic plant matter, with the added twist of sequestering carbon in soil. This is another signpost of the growing interest in non-alcohol biofuels, often referred to as "drop-in" fuels, for both oil replacement and climate mitigation. With cellulosic ethanol developers having mainly disappointed for the last several years, and with so much current policy focus on electric vehicles and their infrastructure, I find it reassuring that there are smart people out there working on alternative fuels that fit today's cars, with today's infrastructure. That's important not just for the obvious reasons, but because the end result of energy policy must create successful business models, not just neat technology.

I haven't delved deeply enough into the technology of CoolPlanetBioFuels to form an opinion about its potential, though I do have some questions about how their front-end "thermal/mechanical processor", which will apparently be produced in 1-million gallon-per-year modules, would mesh with the catalytic fuel production processes needed to turn its output into consumer-ready fuels. Those processes normally operate at scales 100 times larger than CoolPlanet's processor, and when it comes to the efficiency of industrial chemistry, smaller is rarely better. However, if their technology works as advertised, the company's pursuit of the mainstream fuel market looks like a smart business decision.

A few years ago, the main buzz in alternative fuels concerned the production of ethanol from cellulose, and companies large and small were pouring money and resources into different ways to do this, as were governments. That's still happening, despite many of the companies involved missing their early production targets so badly that the Environmental Protection Agency twice had to revise its annual Renewable Fuel Standard (RFS) mandate to compensate for the shortfalls. However, the bigger worry about cellulosic ethanol might not be its production, though that is quite challenging enough, but its ultimate market. That's because corn ethanol has effectively filled up the easiest outlet, consisting of the 10% of a gallon of ordinary gasoline that ethanol can occupy without potentially compromising the fuel systems of cars not designed as flexible fuel vehicles, as well as refueling infrastructure that appears not to be up to handling more ethanol. The EPA has approved a 15% blend, but it faces both litigation and significant practical constraints.

Then there's E85, the 85% ethanol/15% gasoline blend that was expected to provide all the market headroom that ethanol producers would need, when the RFS goals were enacted in 2007. Yet despite generous tax incentives for E85 station conversions and a price that currently averages 53¢ per gallon less than regular unleaded gasoline on a volumetric basis--though still about 50¢/gal. more on an equivalent energy basis-- E85 remains something of a dud, even in the heart of corn country. E85 sales set a record last year in Iowa, but the 9 million gallons sold through 138 outlets there accounted for just 0.7% of the gasoline sold in the state in 2010.

If you want to make money selling motor fuel--or as in the case of CoolPlanet making the hardware for making fuels--then you must come to grips with the commodity nature of its markets. After water, motor fuels are probably the world's largest commodity business. That means that volume, rather than high margins, is the main driver of revenue and profits. The major oil companies struggled with this for decades, pursuing the last penny a gallon of margin by means of additives and advertising. Many of them have left this segment entirely to franchisees, because it's typically not profitable enough to compete with their other investment opportunities. Niche markets can be attractive if they offer unusually high margins, such as those available in the 200 million gallon-per-year aviation gasoline business, which supports just a few players. However, it's not obvious that ethanol and E85 fall into that category. So if you want to develop your business based on its growth potential, and your technology gives you a choice between selling into an at least temporarily saturated ethanol market or the much larger market for fuels that don't require special infrastructure or dedicated fleets, opting for the latter looks like a no-brainer.

The extra angle CoolPlanet offers comes in the form of its sold carbon byproduct called "biochar". This is sometimes referred to as "terra preta", which was a pre-Columbian charcoal-based fertilizer used in South America. The idea is that by returning this product to the soil, rather than allowing the carbon of the biomass to decay into CO2 and enter the atmosphere, the entire process can be made carbon neutral or even carbon negative, sequestering as much or more carbon as the liquid fuels produced will emit when burned. Terra preta is something of a hot topic lately, though the logic of burying solid carbon in one location at the same time that others are mining solid carbon--a.k.a. coal--from the earth elsewhere somewhat escapes me. Nor would the gasoline produced from CoolPlanet's process be any more carbon neutral in effect than conventional gasoline produced by a company that scrupulously bought matching emissions offsets for its products, which could currently be had for a cost of around 9¢ per gal. via an organization like CarbonFund.org.

It's hard to assess the value of the climate-friendly aspects of CoolPlanet's technology in the US, given the uncertainties about pending EPA greenhouse gas regulations and Congressional legislation. However, the attractiveness of a renewable energy technology that unlike wind, solar and geothermal power could actually displace oil on a barrel-for-barrel basis, and that isn't subject to ethanol's limitations and drawbacks, is understandable. All that remains is for CoolPlanet to demonstrate that their device really works and that they can bring it to market at a price that allows the fuels it would produce to compete with commodity fuels from petroleum. That would be big news, indeed.

The Regulatory-Ethanol Complex

The US Environmental Protection Agency has a problem, and that problem is ethanol. Last Friday the EPA expanded its previous waiver on ethanol in gasoline to allow blends of up to 15% to be used in cars built in model year 2001 and later, compared to the earlier threshold of model year 2007. Because it did this just three months after granting the initial waiver, it's not clear how much additional testing was actually done, despite the agency's obligatory reference to "sound science". This step is a further indication that EPA is presiding over a failed biofuel mandate created by Congress in the expectation that a massive cellulosic biofuel industry would spring forth at their command, in parallel with a massive upsurge in sales of the 85% ethanol/15% gasoline blend, E85. None of that has happened, and for now the corn ethanol industry is the only horse that EPA has left to ride in this race. Until these waivers were issued, that horse was rapidly running out of track on which to run.

It's not that EPA loves corn ethanol. In fact, the first draft of its RFS2 renewable fuel standard incorporated an emissions-measurement basis that was distinctly unfavorable to older conventional ethanol facilities. That was subsequently toned down, after reinterpreting the science relating to "indirect land use impacts". Unfortunately for EPA, however, corn ethanol is the only avenue for continuing to comply with the annually escalating biofuel mandate set in the Energy Independence and Security Act of 2007, unless they want to flood the US with Brazilian cane ethanol. Oilseed-based biodiesel remains a niche product, and the US biodiesel industry is half-dead after the EU imposed anti-dumping tariffs as punishment for biodiesel exports to Europe that were subsidized by a $1.00 per gallon US biodiesel tax credit--a credit that lapsed at the end of 2009 but was reinstated retroactively as part of the Lame Duck Congress's tax deal.

The central problem relates to the so-called blend wall, the annual quantity of ethanol that can be accommodated in gasoline under the previous 10% blending limit. With US gasoline sales having dropped in 2008, rather than continuing on their path of 1-2% annual increases, and still not recovered to their former level, the entire US gasoline pool can only absorb 13.9 billion gallons per year of ethanol. As a practical matter, the blend wall is probably a billion gallons lower than that, given the challenges of getting ethanol to the remotest corners of the country. By coincidence, the RFS target for 2011 after backing out the renewable diesel requirement is roughly 13 billion gallons. The production capacity of the US corn ethanol industry already stands at 14 billion gallons per year, with more ethanol plants under construction or expansion.

Accommodating all that extra ethanol would have been easy if E85 had taken off as planned. However, if Minnesota's E85 statistics are any indication, E85 sales appear to have declined since 2008. In the absence of E85 demand, the EPA's waivers have the effect of moving the blend wall and giving the ethanol industry more headroom to grow. In theory, this would also have been needed to make room for cellulosic ethanol, but so little of that is being produced that EPA has had to scale back its quota for that category two years in a row, with a further adjustment in 2012 a virtual certainty.

Expanding the waiver to cover earlier car model years was crucial to making it useful. The first round didn't encompass enough cars--and thus enough annual fuel volume-to make it likely that refiners, distributors and retailers would incur the cost and risks of introducing it into the market. Going back to 2001 adds roughly another 90 million cars and light trucks and includes some of the highest car-sales years in US history. As a result, the broader waiver now probably covers about half of the 240 million light-duty vehicles on the road in the US.

The consequence for consumers will be higher taxes, in several forms. First, there's the tax associated with paying for fuel that has less value, due to ethanol's lower energy content, yet carries the same pump price. At current gasoline prices a gallon of E15 is worth about 5.5 ¢ less than the E10 blend most of us are buying today. Then there's the indirect tax associated with the higher maintenance and repair expenses that some motorists are likely to experience. Despite the EPA's reassurances about having tested E15, the focus of their testing was explicitly on emissions, not on performance and longevity. And finally there's the tax or debt we'll incur for the ethanol blenders credit that will be paid out on the incremental ethanol volumes facilitated by the waiver. That could eventually amount to an extra $3.2 billion per year, unless the current Congress finally ends this redundant subsidy that has been in place for more than thirty years.

Although it is probably best viewed as a marriage of convenience, for now the EPA and the corn ethanol industry are joined at the hip, forming a sort of regulatory-industrial complex. For political reasons EPA can't afford to abandon its partner, because the administration is fully committed to the RFS2 biofuel targets as part of its broader approach to energy security and emissions--even though corn ethanol does little or nothing to reduce the latter. Until and unless E85 takes off, the only real alternative to the E15 waivers would be to admit that the 2007 biofuel standards were unrealistically ambitious and must be suspended pending the arrival of so-called drop-in fuels--synthetic hydrocarbons derived from biomass sources such as algae, cellulose or sugar cane. Drop-ins could provide the same renewables energy benefits as ethanol, but without the latter's blending, fuel economy and logistical disadvantages. In the meantime, I will not knowingly fuel either of my family's 2004 model cars with E15, as long as I have a choice.

UL Study Raises New Questions About E15

One of the energy stories I've followed with great interest all year concerns efforts to increase the proportion of ethanol blended into ordinary US gasoline. This began last year when Growth Energy, an ethanol trade association, asked the Environmental Protection Agency for a waiver to increase the allowed percentage of ethanol in gasoline from 10% to 15%. In October EPA issued a partial approval of the request, but only for vehicles built in model year 2007 or later. However, a new report from Underwriters Laboratories (UL) indirectly casts doubt, not only EPA's ruling, but on whether the agency was assessing all the relevant issues.

I ran across the UL report on the compatibility of mid-level ethanol/gasoline blends in gasoline dispensing equipment--the pumps, hoses and tanks in gas stations--in a posting on API's EnergyTomorrow blog. It cited the UL study, which had been commissioned by the Department of Energy, as evidence that E15, the 15% blend of ethanol and gasoline that the EPA just approved for use in newer cars, could result in serious failures of gas pumps. Yet when I read the report, I immediately encountered its innocuous-sounding conclusion stating, "The overall results of the program were not conclusive insofar as no clear trends in the overall performance of all equipment could be established." It went on to say that the equipment "generally performed well." If I had stopped reading there, I'd have concluded that API was blowing the whole story out of proportion.

When I read the data included in the report, however, a different story emerged. Of the new and used gasoline dispensers and associated equipment tested, very few exhibited no problems on the 17% ethanol test fuel used. In fact, in UL's long-term exposure test, many hoses, nozzles and swivels leaked. 100% of the meter, manifold and valve assemblies tested leaked or failed to shut off. Perhaps most worryingly, two-thirds of the breakaway couplings tested leaked, failed their pressure tests, or required more than the recommended pull to separate. (A breakaway is designed to pop the hose off the dispenser when a customer forgets to remove the nozzle from his car's gas intake and attempts to drive off. This happens a surprising number of times a year, and before the deployment of breakaways such incidents imposed significant repair costs on dealers, even when the resulting spills didn't cause fires.)

The common denominator in these failures was what the report refers to as "nonmetals", gaskets, seals and parts made from various polymers. From that I would draw two conclusions: First, it ought to be possible to design new dispensers and retrofit existing dispensers with new gaskets, seals and plastic parts designed to withstand higher concentrations of ethanol, just as the fuel systems in flexible fuel vehicles are designed to tolerate blends of up to 85% ethanol. However, considering that the US has between 90,000 and 160,000 gas stations, depending how you count them, the number of dispensers that would have to be modified is at least in the high tens of thousands, if not well into the hundreds of thousands. To my knowledge the ethanol industry has not offered to defray the cost of these conversions for a retail fuel industry that operates with extremely lean margins. Nor is it obvious that dealers would qualify for federal assistance, as they do when they add E85 capability.

My second conclusion--really more of a suspicion--has nothing to do with gas pumps or gas stations, and everything to do with cars. After reading the UL report I went back and reread portions of the EPA's official waiver response, which ran to 58 pages in the Federal Register. From what I can tell, EPA wasn't really looking at whether cars would suffer damage from operating on a higher percentage of ethanol than the fuel for which they were designed. The waiver was granted on the basis of those cars not emitting more pollutants than on the fuel for which they were designed. Quoting from the EPA document:

"For MY 2007 and newer light-duty motor vehicles, the DOE Catalyst Study and other information before EPA adequately demonstrates that the impact of E15 on overall emissions, including both immediate and durability related emissions, will not cause or contribute to violations of the emissions standards for these motor vehicles. Likewise, the data and information adequately show that E15 will not lead to violations of the evaporative emissions standards, so long as the fuel does not exceed a Reid Vapor Pressure (RVP) of 9.0 psi in the summertime control season. The information on materials compatibility and drivability also supports this conclusion."

That's good as far as it goes, but from my perspective this finding reflects a necessary but hardly sufficient standard for putting a new fuel into the marketplace, particularly when the failures of the dispensers in the UL study point to the possibility of similar failures of "nonmetals" in the fuel systems of cars or other devices not designed to run on more than 10% ethanol. Even if the leaks found in the testing of product dispensers didn't result in safety hazards, they would at a minimum increase the evaporative emissions from infrastructure, aside from the automotive impact on which EPA apparently focused. I also find it interesting that a bill was introduced in Congress this summer, as EPA was considering the waiver request, that would appear to make it more difficult for consumers to recover the cost of damages resulting from compatibility problems in approved vehicles or misfueling of non-approved vehicles.

As I've noted in my previous postings on this topic, I'm sympathetic to the box into which altered circumstances have placed both the ethanol industry and the federal government with regard to ethanol blending. US gasoline sales, which stagnated after the financial crisis and are only growing by a historically modest 0.7% this year (through November) according to API's latest statistics, are not expanding fast enough to accommodate the output of all the ethanol plants that have been built or are under now construction. When the Renewable Fuels Standard was enacted as part of the Energy Independence and Security Act of 2007, the bill's architects presumably expected that E85 sales would take up any slack. The fact that that hasn't happened does not justify creating a new outlet for additional ethanol in automobiles not designed to accommodate it, any more than it would justify running a new fuel through infrastructure that has been shown not to be up to the challenge. If EPA doesn't revisit the more comprehensive aspects of this question as part of its deferred decision on allowing E15 for cars made before 2007, then perhaps it's time for another government agency with a broader charter to take over this issue.

Splitting the Baby on E15

I've been going over the EPA's ruling yesterday partially granting the waiver request from Growth Energy, an ethanol trade association, to allow gasoline with up to 15% ethanol to be used in cars not specifically designed as flexible fuel vehicles. The request had created a serious dilemma for the EPA, because granting it could jeopardize the integrity of millions of consumers' car engines and fuel systems, but turning it down would call the entire national renewable fuels strategy into question. What looks like the agency's attempt to find a middle ground that could satisfy all parties might turn out to have little practical impact on the ethanol market for some time, while still unleashing a potentially very disruptive shock wave on the entire motor fuels industry in this country.

If that sounds contradictory, you have to look at the specifics of what the EPA has agreed to here, and overlay them on the highly-competitive, relatively low-return network of gasoline blending, distribution and sales infrastructure through which it must eventually feed. Instead of approving E15, a blend of 15% ethanol and 85% gasoline for all vehicles, or even just for vehicles produced since 2001--as many had speculated they would--the agency has only given the green light for putting this fuel into cars made in the last four years. I might note that this interval includes some of the lowest US car sales rates in recent memory, so yesterday's ruling affects just a fifth or so of the total US light-duty vehicle fleet. The decision for another tranche of cars built between 2001-2006 is to be made after further study, perhaps by the end of the year.

In essence this means that no fuel producer can afford to stop supplying the E10 (or less) fuel that is compatible with all those pre-2007 cars, and precious few retailers are likely to take a bet on switching one of their tanks to a new fuel that only a fraction of their customers can take advantage of, once all the other legalities of introducing E15 into the market have been satisfied. So while this decision might seem to be about promoting the use of more home-grown, renewable fuel in preference to petroleum products that depend on deepwater wells and foreign suppliers, its implementation hinges on a very lopsided business decision for a group of mainly independent fuel retailers and distributors, rather than the major oil companies whose brands we see on filling station polesigns.

A retail gas station has a finite number of product dispensers drawing on an even smaller number of underground storage tanks. In order for a retailer to introduce a new fuel without ripping up the forecourt (which entails being out of business for several months and possibly longer, should he have the misfortune to discover a leak in the process) then he must do the math on how many gallons per month of the new product he might sell, and at what margin, against how many gallons and how much margin he'd lose from the discontinued product. This is the dynamic that has contributed to the excruciatingly slow lift-off of E85, which is at the heart of why E15 even became an issue. It was never supposed to be necessary, because the extra ethanol mandated under the federal Renewable Fuel Standard (RFS) was intended to be sold in big, 85% at-a-time chunks, not little 10-15% slices, and into a gasoline market that was still growing at its historical 1-2% per year clip.

So as a retailer--a small and not very lucrative business--do you give up premium unleaded? Seems an obvious choice, since it's probably your lowest-volume offering. But unless you have a dedicated mid-grade tank, you need premium to blend in the pump to make mid-grade, which accounts for more of your sales. Worse yet, your margin per gallon on premium is your best, followed by your margin on mid-grade. Or you could give up diesel, though if you do, you'll never see those customers again: not on the forecourt, and not in your store, where you make much of your monthly profit. The alternative is an expensive investment in a new tank and dispenser, against a highly questionable return. By now it should be obvious this is a losing game for retailers, who as far as I can see would choose to continue to sell E10 to everyone, including post-2006 cars affected by the E15 ruling, and just ignore the EPA.

The folks who won't be able to ignore the EPA will be the refiners and major fuel blenders. That's because they continue to fall under the authority of the steadily increasing RFS mandates, requiring them to sell a higher percentage of biofuel every year until 2022, or pay large penalties. And while the EPA was kind enough to reduce the mandate for cellulosic ethanol last year and this year--for the very good reason that it isn't yet available in the expected quantities--the chances of getting a waiver in the future because a company has run out of room to blend ethanol into E10 look pretty low, when the EPA can just insist that you make E15 or E85, both now legal. This sets up a situation in which suppliers will shortly need to induce their retailers to take on one or both of these products and make it worth their while, further depressing the margins in this part of the business and making an exit strategy even more attractive.

It's hard to gauge exactly what this could mean for consumers. At a minimum, it might lead to drivers of older cars pulling into some gas stations only to find that the unleaded fuel advertised on the sign is actually not compatible with their particular car. (The EPA as part of yesterday's ruling has promised pump labeling sufficiently clear that no one will fill up with E15 by mistake.) Or in a bigger station, all the E10 pumps might be over on one side of the convenience store, and all the E15 pumps on the other. And of course this raises the awkward question of why consumers would ever consciously choose to fill up with a fuel containing at least 2% fewer BTUs and thus offering 2% lower mpg and range, unless it's going to be cheaper for them--which is inconsistent with E15 carrying sufficiently higher margins to make it worth the retailer's effort to sell.

The result looks like a dog's breakfast, although I can't honestly say I'd have ruled much differently if I were running the EPA and only charged with upholding the RFS and making this ruling on the basis of whether it would increase the overall pollution from the affected vehicles, rather than on whether its policy and ostensible environmental benefits outweigh its costs and risks for vehicle longevity and consumer value. The EPA's supporting documents included evidence that a significant proportion of E10 already approaches 11% ethanol, so E15 means routinely exposing engines and fuel systems to a mix of 16% or more ethanol, even if they were only designed with 10% in mind. Who will bear the liability for the expensive repairs that some cars will require? There are few aspects of this situation that offer consumers any upside, but I see ample downside, if only from having to bear the additional costs that will be passed on by retailers who are in no position to absorb them.