COLUMN-"Blend wall" explains rising ethanol costs: Wynn

LONDON, March 21 Thu Mar 21, 2013 9:16am EDT

LONDON, March 21 (Reuters) - U.S. data suggests the percentage of ethanol in the gasoline supply is nearing the "blend wall" - the 10 percent level beyond which refiners fear to go - but perhaps not close enough to explain a sudden jump in the price of compliance credits.

Other explanations for the price rise could include new expectations that the blend wall will be reached next year; a lack of available product after a fall in U.S. ethanol output last year; speculative buying of compliance credits; or a combination of these.

It is important to resolve the cause, given concerns among lawmakers that rising ethanol compliance costs are adding to gasoline prices ahead of the summer driving season.

Two senior Republican senators on Wednesday joined the oil industry in warning that the U.S. ethanol mandate could push up gasoline prices.

Both senators who sent a letter to the Environmental Protection Agency (EPA) represented states with a large energy industry presence. Some lawmakers who represent states where grain is grown or ethanol is produced have blamed speculators for pushing up the prices of compliance credits called RINs.

WALL

The blend wall refers to the problem of exceeding 10 percent ethanol by volume in gasoline (called E10) because of the costly infrastructure development required to roll out higher blends such as E15 and E85.

Distribution of such higher blends is lagging because of concerns about their impact on the performance of older cars.

The U.S. Renewable Fuel Standard (RFS), expanded under the Energy Independence and Security Act of 2007, requires fuel producers to blend a certain percentage of biofuel into gasoline and diesel, or else buy compliance credits called Renewable Identification Numbers (RINs) in a secondary market.

Each RIN is equivalent to a gallon of biofuel.

The RFS sets extremely ambitious targets for blending bio-ethanol and biodiesel over the next decade. (See Chart 1)

Falling gasoline demand coupled with the rising renewable fuel mandate means fuel producers will almost certainly have to blend more than 10 percent ethanol in gasoline in the next two years, or else buy RINs.

The blend wall is therefore one possible explanation for a recent RIN price spike. Another is falling U.S. ethanol output last year after drought drove up the price of corn feedstock.

RIN prices stabilised this week, trading at 70 cents for 2013 credits on Wednesday. Earlier this month the credits were trading well above $1 a gallon, more than 1,000 percent above levels seen at the end of last year.

That raises the interesting possibility that the EPA may in future years either waive the ethanol target, or raise the mandated contribution from alternatives such as biodiesel, which faces no blend wall issues and currently has a manufacturing over-capacity.

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Chart 1: link.reuters.com/fux76t

Chart 2: link.reuters.com/gux76t

Chart 3: link.reuters.com/hux76t

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RATIO

A U.S. Energy Information Administration paper in October 2011 published a straightforward methodology for estimating the blend ratio of ethanol.

Applying that method to more recent survey data on supplied motor gasoline product and ethanol consumption could help confirm whether a nearing blend wall is indeed a contributing factor to rising RIN prices.

The EIA authors presented three approaches for calculating the blend ratio, in their paper, "Issues and Methods for Estimating the Share of Ethanol in the Motor Gasoline Supply".

The first compared total net inputs of ethanol with net production of gasoline blended with ethanol, and appeared to over-state the ratio and so is discarded here.

The other two compared ethanol consumption with total supplied gasoline product, with and without gasoline exports.

An approach which included gasoline exports would assume that U.S. fuel producers were adding ethanol to these.

Applying the EIA methodology to data available until December last year, it emerges that the blend percentage last year was almost identical to 2011.

The ethanol blend percentage averaged for the four months of March, June, September and December was 9.7 percent in both 2012 and 2011, excluding gasoline exports.

The corresponding figure when accounting for exports was 9.2 percent in both years. (See Chart 2)

That may suggest that the RIN price run-up had over-stated the blend wall problem.

Applying the implied corn ethanol mandates for 2013-2015 to a fixed 2012 gasoline supply, however, reveals that the blend wall will be rapidly breached unless fuel producers comply by buying RINs instead. (Chart 3)

The impending blend wall is indeed therefore one explanation for the RIN price spike.

PRODUCT

Another explanation could be falling U.S. ethanol production last year after a major drought reduced the supply of corn.

The number of conventional ethanol RINs generated last year fell to the equivalent of 12.97 billion gallons, according to EPA data, updated as of Feb. 7.

That compares with an implied corn ethanol mandate in 2012 of 13.2 billion gallons.

And it is fewer than the number of such RINs generated in the two previous years, at 13.59 billion and 13.57 billion gallons in 2011 and 2010, according to the same EPA data.

Another possible explanation for higher RIN prices is speculative buying, which is difficult to demonstrate besides referring to spikes and troughs in prices over the past few weeks.

Resolving the cause will be a central task as lawmakers grow more concerned about the impact on gasoline prices, and as the farming and oil and gas lobbies square up, for and against the renewable energy scheme. (Reporting by Gerard Wynn; Editing by Anthony Barker)

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