EPA and Ethanol in ‘14
On Friday, the Environmental Protection Agency (EPA) released its 2014 renewable fuel standard proposal that attempts to ensure “the continued growth of renewable fuels while recognizing the practical limits on ethanol blending, call the ethanol ‘blend wall’”. The total renewable fuel mandate is proposed at 15.21 billion gallons (actually a range of 15.00 to 15.52), consisting of both ethanol (13.01 billion gallons) and non-ethanol (cellulosic, biomass-based diesel and other non-ethanol advanced biofuels) at 2.20 billion gallons.
This level of corn-based ethanol is wholly consistent with prior expectations based on commentary from the EPA (see our October 11th note) as well as our own expectations, but obviously well-below the 2013 level of 13.8 billion gallons and the 2014 level (based on the original mandate) of 14.4 billion gallons.
The next step is for the EPA to take public comment for 60 days and given the large number of interested and engaged parties in this debate, there should be plenty of commentary to go around. We should hear from everyone from farmers to gas station owners, and from ethanol producers to auto manufacturers. In the end, as we argued in our original piece (July 25th), the EPA isn’t responding to political pressure in this case (though we suspect there will be a fair bit of aspersions cast at the refining industry given its historical opposition to the ethanol mandate), but rather just responding to economic reality and math. At its core, when conceived in 2005 and expanded and revised in 2007, the renewable fuel volume mandates that were laid out proved to be vastly too optimistic (or pessimistic, depending on your point of view) regarding gasoline consumption in the U.S. The EPA quite literally top-ticked gasoline consumption in the U.S. when it laid out the RFS back in ‘07. Gasoline consumption has declined every year in the U.S. since 2007. Further, the EPA’s expectations regarding adoption of higher blending levels (above E-10) and advancements in the development of cellulosic ethanol proved wildly optimistic.
Who’s happy and who isn’t?
- Happy – refiners, gasoline retailers, industries with corn as an input (other than ethanol)
- Not so much – farmers, ethanol producers, industries with leverage to farm level economics such as fertilizers and agricultural equipment.
Finally, investors need to bear in mind that this is a temporary “fix” – the principles that drove the ethanol pivot in this country are no less relevant now than they were in 2005 and 2007:
- Reduce foreign oil dependence (essentially a national security claim)
- Reduce greenhouse gas emissions (an environmental imperative) – each renewable fuel category must emit lower levels of greenhouse gases than the petroleum based fuel that it replaces.
- Increase rural economic activity in the U.S. (an economic rationale)
We happen to think that corn-based ethanol is a pretty crappy idea for a number of reasons, starting with it being energy inefficient and ending with mounting evidence that it has actually been horrible for the environment (essentially arguing against the second point above), but at this point is far too entrenched for anything other than minor tweaks in the near-term. Expect the EPA to push ahead with higher blends (E15) and to continue to pin its hopes on a breakthrough in cellulosic (don’t hold your breath). In the meantime, the realities of the blend wall will dictate yearly changes to the mandate as originally conceived, but so long as the first stop on the road to the White House requires driving through a cornfield (Iowa), corn-based ethanol is likely here to stay.