Department of Energy Analyses in Support of the EPA Evaluation of Waivers of the Renewable Fuel Standard November 2012 Ethanol Demand Curve for 2012 and 2013 In support of EPA analyses of the 2012 RFS waiver requests, DOE developed an ethanol demand curve (Figure 1) to be used as an input assumption for stochastic modeling and assessment of ethanol demand, corn supply and demand and economic impacts. The approach in developing the demand curve follows the same approach adopted in support of a RFS waiver request from the State of Texas in 2008; the ethanol demand curve is developed based on the price ratio of ethanol vs. gasoline (E/G Price Ratio). The differences between the constructions of the 2008 vs. 2012 ethanol demand year reflect the following factors: the relative levels of ethanol blending into gasoline, the expected markets for ethanol blending after the ethanol low level blend wall is encountered, and the expectation that any waiver of the RFS program would be for only one year. The ethanol demand curve was developed by analyzing the value of ethanol as a blending component relative to other gasoline blending components in the refinery linear program (LP). The refinery LP contains detailed representation of refinery processing units, raw material inputs costs and qualities, and variable and fixed operating costs and detailed gasoline blending representation to capture both product environmental and performance specifications for the winter and summer gasoline seasons. 1 Additionally, DOE assessed the capability of refiners, terminal operators, and pipeline companies to change the transportation, distribution, and terminal blending infrastructure facilities to reduce or increase the amount of ethanol use in the short term. Refinery Blending Economics DOE conducted a detailed analysis of the gasoline blending economics of ethanol relative to other high octane blending components available within refinery. The analysis was done for both the winter and summer gasoline seasons, and for refineries that produce either a mix of reformulated, sub-specification gasoline blendstocks for ethanol blending (CBOB) and conventional gasoline for ethanol splash blending, or produce only conventional gasoline and conventional gasoline blendstocks for ethanol blending. The refinery LP model indicated that for a typical cracking refiner that produces both winter and summer conventional and CBOB gasoline, the ethanol value is about equivalent to the octane replacement costs from refinery feedstocks. The marginal cost of production of the primary octane replacement is almost equivalent to an E/G ratio of 1.1. The refinery LP analysis also indicates that the ethanol value to a refinery is higher at lower ethanol consumption levels than it is when ethanol reaches the low level gasoline ethanol blend wall. 1 See Appendix A for more information on analysis conducted using the refinery linear program.
E10 Refueling Infrastructure Issues The analysis below describes how the gasoline supply infrastructure can limit refiners and blenders capability to quickly change the proportion of ethanol blended gasoline they produce and market. Refiners and gasoline blenders have increased their production of 10 percent ethanol gasoline blends (E10) over the last eight years for several reasons. First, the ethanol value as a blending component has increased as the crude oil price has increased and, subsequently, the gasoline price, and as significant volumes of new ethanol production capacity came online in response to the renewable fuel standard (RFS) enacted in the EPACT 2005 and were increased in the EISA 2007. Further ethanol production also came online as the ethanol excise tax exemption made blending ethanol into gasoline a valuable gasoline blendstock relative to gasoline blendstock derived from crude oil. Second, refiners gained experience handling ethanol when in 2006, they chose to replace MTBE as a blending component to address concerns with MTBE causing water quality issues in areas where gasoline leaked from underground fuel storage tanks. This MTBE-to-ethanol transition resulted in some retail operators having to drain storage tanks to remove excess amount of water and replace refueling equipment filters that swelled due to water contamination. Third, refiners and blenders in 2008 exercised discretionary blending of ethanol at levels significantly above the RFS mandate level due to good economics. When the price of ethanol rose to a level where it became uneconomic for refiners they reduced the amount of ethanol they blended with gasoline. During this transition, some refiners and blenders learned that some of their terminals and ethanol blending equipment were not sophisticated enough for optimized blending or blending at multiple sub-specification grades, which allows varying the demand for E10. Finally, when refiners and blenders chose to reintroduce ethanol blended gasoline to retail stations that had stopped selling ethanol blended grades, some storage tanks had to be drained completely to remove water and some refueling equipment required the changing of filters. Ethanol Supply Contracts Another issue limiting refiners and blenders ability to quickly change the quantity of ethanol they blend into gasoline is the structure of their contracts with ethanol suppliers. Many of these contracts are long-term with a predetermined price and volume over a given period of time. That is, the contracts require the purchaser of ethanol to pay for contracted delivery of ethanol whether or not market conditions have changed. 2
These transition issues surrounding the proposition of introducing ethanol blended gasoline into retail markets, removing ethanol blended gasoline from the market, and then reintroducing it increases transition costs. The result is that refiners and blenders are unlikely to switch between providing ethanol blended grades of gasoline and non-ethanol grades of gasoline in markets in the short run. The only exceptions would be during the transition from winter to summer specification grades of gasoline or from summer to winter gasoline when stocks of gasoline are brought down to accommodate the seasonal gasoline specification changes. RFS Compliance Beyond 2013 The ability of refiners and blenders to comply with the RFS requirements beyond the 2012 and 2013 compliance years will likely play an important role in how they comply with the RFS requirements in 2012 and 2013, even if the 2012 or 2013 RFS requirements are changed as a result of the RFS waiver request. This is because the low level ethanol gasoline blend wall may soon limit, the incremental volumes of ethanol that refiners and blenders can blend into gasoline. Other RFS compliance strategies would increase the blending of biomass-based diesel and increase the volume of ethanol sold as E85 or possibly introduce E15 blends for use in 2001 model year or newer vehicles. Widespread adoption of E15 blends that would significantly increase ethanol demand in the next year is not considered feasible or evaluated as a possible compliance strategy due to issues that still need to be resolved. Assuming the only viable compliance strategy for 2014 in generating incremental RINs is either blending non-ethanol renewable fuels such as biomass-based diesel or selling incremental volumes of E85, the value of RINs could easily approach $1.00 or more per ethanol-equivalent gallon. This is because E85 compliance would require ethanol to sell at a price that is reflective of its lower energy content, plus an additional discount to compensate for consumers need to refuel more often. This discount could be on the order of $1.00 or more per gallon assuming spot gasoline prices are in the $2.50 to $3.00 per gallon range and ethanol production costs are in the $2.20 to $2.80/gallon range. Given the issues outlined above, the ethanol demand curve between the E/G ration of 1.0 to 1.5 was reduced to a level at which refiners would begin to remove ethanol from markets where they are currently splash blending ethanol on top of finished gasoline. Refiners would limit removing ethanol from markets where there is optimized blending for octane compliance. The demand curve incrementally backs out ethanol demand as ethanol prices rise above gasoline to a maximum of 3 billion gallons, which accounts for all the splash-blended ethanol market and a small portion of the optimized-blended ethanol markets. 3
E85 Retail Economics Marketing E85 to flexible-fuel vehicle owners will require retailers to adjust the price of fuel to account for both ethanol s lower energy content relative gasoline and the reduced number of miles a tank of E85 will achieve relative to gasoline or E10 blends. A gallon of E85 provides about 75 percent of the energy a gallon of gasoline provides and a tank of E85 will only take a consumer 225 miles while a tank of gasoline would provide 300 miles of travel. Consumers will notice this difference and will require the price of E85 to be lower to make up the difference. Additionally, many consumers will likely want an additional incentive to account for the more frequent refueling that E85 requires. In the end, E85 may need to be priced at a greater discount than it would be based on the energy content differential between E85 and gasoline alone. Additionally, retailers that make investments in E85 refueling tanks and pumps will likely require that the retail margins for E85 be higher than those for gasoline because sales volumes will likely be lower than what could be achieved with investments in gasoline refueling infrastructure. DOE incorporated the E85 retail economics into a short-term ethanol demand curve for the RFS waiver request analysis using the following assumptions. First, the RFS waiver analysis is being performed over the 2012 to 2013 motor fuel demand time frame, it was assumed that incremental E85 sales would only take place at existing E85 retail outlets. Second, it was assumed that incremental investments in E85 refueling infrastructure would not change appreciably over the next 12 months. Third, the demand curve for ethanol was expanded to accommodate the incremental quantity of E85 that could be sold at existing retail E85 stations as the price of ethanol drops relative to gasoline. The maximum volume was limited to retailers refueling their E85 tanks (assumed to be about 5000 gallons) from the current once per month refill rate to about a once per week refill rate, which is the approximately average refill rate of retail gasoline storage tanks in the U.S. This would result in the potential demand increase for E85 from approximately 125 million gallons annually to 600 million gallons annually. 4
E/G Price Ratio Ethanol Demand Curve for 2012 and 2013 Compliance Years Only Bgal vs E/G Price Ratio 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 16.00 B gallons /Yr Figure 1 Ethanol Demand Curve 5
Appendix: Refining Economics of Reducing Ethanol with Rising Ethanol Prices Introduction As a result of the Renewable Fuel Standard (RFS), industry made the necessary investments to blend ethanol into gasoline, and most gasoline today contains 10- percent ethanol (by volume). With the drought this past growing season, the price of corn, the major feedstock for fuel ethanol, increased, and thus the price of ethanol increased. The Environmental Protection Agency (EPA) was asked to consider waiving the RFS, with the underlying assumption being that fuel demand for ethanol would decline, thus lowering both corn demand and the price of corn. The price of ethanol relative to gasoline is a key measure of when refiners might find it economic to back ethanol out of gasoline, should such a waiver be issued, and setting aside the hurdles and economics of transporting and storing additional gasoline types. 2 As a result, DOE s Office of Policy and International Affairs sponsored an analysis to explore the economics of reducing ethanol use at a refinery as the cost of ethanol rises relative to gasoline. Many refiners have changed their operations to make use of ethanol s high octane. They produce a sub-octane blending component that, when blended with 10-percent ethanol, produces a finished gasoline with the appropriate octane and other driveability and emission properties. For these refiners, there is a cost to change back to producing a gasoline without ethanol. It was assumed that reformulated gasoline (RFG) would continue to be produced with ethanol, as it is easier and less expensive to remove ethanol from conventional gasoline. The study focused on Gulf Coast refineries 3. Gulf Coast refineries represent about half of U.S. refinery capacity, and they produce mainly conventional gasoline, which represented almost 83% of the gasoline and blending component output in 2012. These refiners supply the Gulf Coast area as well as East Coast and Midwest consumers with gasoline, and thus represent a large potential for ethanol reduction. 2 We recognize that the distribution system is where the largest challenge may lie in changing the level of ethanol content in gasoline, but we also need to understand the costs at the refining level. 3 Gulf Coast for this memo is Petroleum Administration for Defense District (PADD) 3. 6
Analysis The purpose of the study was to obtain a rough estimate of the level of cost changes refiners might see when reducing ethanol, which could then be used to explore relative ethanol price levels necessary to provide incentives to reduce ethanol volumes. A representative Gulf Coast refinery was analyzed using a detailed refinery linear programming model (LP) developed by Jacobs Consultancy for the Department of Energy (DOE). The representative refinery runs a moderately heavy, high sulfur crude mix, and is equipped with fluid catalytic cracking (FCC), alkylation, coking, reforming, and full desulfurization units to accommodate the streams produced from the crude oil feed. Ethanol has a very high octane number, which adds to its value as a gasoline blend stock; however, it has a high vapor pressure and lower energy content than most other gasoline blend components. These properties impact how and at what cost refineries are impacted with reduction in ethanol use. The analysis examined the economics when refineries switch a portion of their production from conventional gasoline blend stock for oxygenate blending (CBOB), which is a sub-octane blend that will only meet all finished gasoline quality requirements when ethanol is added at the terminal in the sales region, to finished conventional gasoline that will meet quality specifications without ethanol being added. Crude oil was priced at $107 per barrel, gasoline was $123 per barrel, and ultralow sulfur diesel (ULSD) $128 per barrel, with typical summer/winter variations. Ethanol was priced equal to gasoline to isolate the added refinery variable cost resulting when ethanol volume is reduced. The base LP model run made 100% CBOB, meaning 10% ethanol would be added to every gallon of CBOB produced at the refinery. Then ethanol use was progressively reduced in subsequent cases. Three reduction cases were explored: 1) CBOB production at 67% of total gasoline and 33% conventional, 2) 33% CBOB and 67% conventional, and 3) 100% conventional with no ethanol use. When the high-octane ethanol volume is reduced, the refinery compensates by finding more octane in other streams, primarily in reformate. Reformate is the gasoline blending component made in the reformer where molecules in the lowoctane naphtha feed are reformed into higher-octane aromatic molecules. The refiner can increase the aromatic content of the product, increasing the product octane, but in doing so the volume of reformate product decreases, and the volumes of light lower-priced refinery gases increase. The result is an increase in operating costs and a decrease on refinery margins both as operating costs increase and volumes of higher margin product decline. But if a refinery must pay a higher price for ethanol, it may be more economical to reduce ethanol and 7
increase reformate octane (with its associated loss of volume for the gasoline pool). Table 1 summarizes the economics for this Gulf Coast refiner. The table shows that as the refiner reduces ethanol use, the compensating cost increases from 1.1 cents per gallon at the 33% conventional gasoline level to 3.7 cents per gallon when all the ethanol is removed. The model runs kept ethanol priced equal to gasoline, but we can calculate a break-even price, above which it is more economic for the refiner to reduce ethanol volumes and alternatively produce more octane within the refinery. As the table shows for the 33% conventional case with its 33% reduction in ethanol use, if ethanol prices rose 26.4 cents per gallon above the price of gasoline, then ethanol volume reduction becomes attractive. The table shows the increasing variable margin penalty and the increase in ethanol prices required to make ethanol reduction economic. Table 1. Summary Economic Results for Three Ethanol Reduction Cases Ethanol Reduction Base Moderate Large Full Percent CBOB 100 67 33 0 Percent Conventional (No Ethanol) 0 33 67 100 Average Percent Ethanol in Gasoline Pool 10 7 3 0 Added Variable Cost/Gallon of Gasoline (cpg) 1.1 2.4 3.7 Breakeven Ethanol Price Increase (cpg) 26.4 29.8 32.8 Ethanol/Gasoline Price Ratio 1.09 1.10 1.11 Note: cpg cents per gallon Additional model runs were made for a Gulf Coast refinery making 20% RFG and the balance CBOB in the base case. The results showed only a small change compared to the table above. Based on conversations with several refiners, it seems likely many would experience results similar to those shown in the table. Some, however, will have more challenging economics for ethanol reduction. For example, refiners with poor gasoline octane pools and those who bring in large volumes of low-octane blending material such as pentanes plus streams would see less attractive economics. 8
Conclusion Our assessment based on analysis at the refinery level only is that, if the distribution system were able to handle variations on ethanol blends and if there was a waiver of the RFS program beyond one year, substantial ethanol could potentially be removed from U.S. refineries (mainly Gulf Coast). For reductions in ethanol blending to be profitable to refiners, however, the price of ethanol would have to increase significantly; more than 26 cents per gallon of ethanol to incentivize an ethanol reduction of 33% and increasing ethanol costs to further reduced ethanol blending. 9