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.