The November 2, 2017 post, “Why mess with it?” promised to address this issue:

how not obligating blenders creates a perhaps insurmountable headwind to increasing biofuel blending volumes.

RFS’ definition of obligated party, i.e., point of obligation, inhibits increased ethanol use in transportation fuels because the folks who blend have no obligation to blend more. In fact, current exempt blenders, those not needing all their RINs for compliance, have every incentive to continue selling E10 even though the 2018 national percentage standards imply E10.47 blending for gasoline. Furthermore, Big Oil has several legal and less expensive strategies available for selling only E10 and eschewing higher blends.

Background.

EPA’s 2018 standards mandate blending 19.29 billion gallons of total renewable fuel, which includes 4.29 billion gallons of advanced biofuel, into the nation’s transportation fuel supply. This implies a 15 billion gallon mandate for “non-advanced”  conventional biofuel or corn ethanol blended into gasoline. The rule projects national gasoline consumption to be 143.22 billion gallons. If gasoline consumption contains all 15 billion gallons of ethanol, the national 2018 average blending rate will be 10.47% or E10.47. EPA projects, however, a somewhat smaller volume, 14.71 billion gallons, will actually be blended. This volume implies a national average blending rate of E10.27. More later on why there are two projected ethanol volumes.

Gasoline above E10, however, conflicts with a combination of infrastructure, market and institutional constraints known as the “blendwall”. For example, Underwriters Labs, the entity certifying most fueling equipment, will not certify older gas station equipment for blends higher than E10. This 2014 article by the National Association of Convenience Stores (“NACS”) goes into more detail. Retrofitting gas stations involves some cost – up to $200,000 per station according to the Society of Independent Gasoline Marketers of America (“SIGMA”) and NACS and a mean cost of up to $72,000 per station according to the National Renewable Energy Laboratory. There were approximately 150,000 gas stations in the United States in 2013, the last year anyone attempted to count them. Although estimates vary, $50,000 per station is in the ballpark. Take $50,000 x 150,000 stations and, as Everett Dirksen said, “pretty soon you’re talking real money” – about $7.5 billion. That’s more than sufficient incentive to avoid E15 and E85. The Renewable Fuels Association (“RFA”) says conversion costs are much lower and affordable.

In addition, some new vehicle warranties are voided by fuels containing more than 10% ethanol. Switching to higher blends on a widespread basis requires these auto manufacturers to expand their warranty coverage, and many are. The Renewable Fuels Association reports “more than 70 percent of the top selling cars are approved by the automaker for E15 usage in their 2014 vehicles”. While this is becoming less of an issue, it may still exist. Finally, EPA has not approved E15 for pre-2001 vehicles, and E85 can be used only in vehicles labeled “flex fuel”.

Expanded warranties, however, are not altering consumer choice. Higher blends are not a box office hit. As Cumberland Farms commented to EPA,

Cumberland Farms has attempted to sell E85; that experiment has largely failed, because demand is simply insufficient to support a thriving and efficient market for a boutique fuel like E85. This is attributable to factors beyond the RFS: there are not enough flex vehicles on the market, and not enough consumers who want to put E85 into their flex vehicles—because, e.g., they know that they will get fewer miles per gallon compared to E10. Similarly, our reluctance to embrace E15 has little to do with RIN pass-through. Rather, significant concerns with liability and infrastructure compatibility would make adoption of E15 far more costly than the market can presently justify.

In July 2017, RFA reported 900 stations sold E15 in the United States. In October 2017, RFA reported “more than 4,000” stations offered E85. That makes, perhaps, 5,000 stations out of about 150,000. If you’re looking for a higher ethanol blend, you may have a 3% chance of finding it. The Energy Information Administration’s (“EIA”) 2018 Annual Energy Outlook tables (rows 133 and 134) project E85 will peak in 2038 and 2039 at about 2.6% of U.S. finished gasoline energy consumption.

Whatever the reason, E15 and E85 are not big sellers. Big Oil and non-refining marketers apparently are not eager to sell these blends, and they are under no legal obligation to sell these blends.

How does one comply with an E10.47 or E10.27 obligation by selling only E10 and almost no E15 and E85?

It’s very easy, which is a main reason why the entire RFS structure is broken. First, be an exempt blender. Exempt non-refining marketers have absolutely no RFS obligation and may ignore the RFS standards and volumes with impunity. Second, be Big Oil, Inc. Big Oil blends and markets as gasoline far more BOB than it produces. Big Oil, therefore, has more RINs than it needs. For Big Oil, complying with a slightly higher standard is simply a matter of sticking with E10 and using extra RINs to fill the compliance gap; sell fewer RINs to retire more. Logic tells us these two strategies, selling E10 when the implied standard is E10.47 and selling fewer RINs, will create a RIN shortage. Merchant refiners will pay higher prices for compliance RINs without passing all of the cost through to customers. Big Oil could not have designed a better merchant refiner squeeze had it tried.

Third, export your refineries’ BOB and diesel. Exports are exempt from RFS and, therefore, reduce a refiner’s RFS obligation. Exporting is an option likely more available to Big Oil. I have already documented how Gulf Coast BOB exports have been increasing. National and Gulf Coast diesel exports have increased even more dramatically. Under RFS, a refiner’s blending obligation is defined by its combined BOB and diesel production. Exporting either, therefore, reduces the compliance requirement for both.

Fourth, blend more biodiesel or purchase biodiesel RINs. Biodiesel RINs may be used to demonstrate compliance with the BOB blending obligation. Biodiesel does not have a blendwall or, at least, one as constraining as gasoline. In fact, the RFS national standards assume more biodiesel volume will be blended in 2018 than the rule requires.

The 2018 RFS national standards mandate 2.10 billion gallons of biodiesel for blending into the national diesel supply. (See page 58523 of the final rule). The rule, however, projects actual biodiesel blending will be 2.53 billion gallons or 430 million gallons more than EPA requires. Biodiesel has 1½ times the compliance value of ethanol. The biodiesel over blending assumed in the rule, therefore, is a proxy for about 645 million gallons of blended ethanol. This 645 million gallons is about 0.45% of projected gasoline consumption or almost exactly what is needed to achieve E10.47 while selling only E10. Simply fill the BOB compliance gap with biodiesel RINs. EPA’s 2018 RFS volume mandate for biodiesel makes this possible.

So, there we have it. E10 is here to stay, and we will likely not see significant volumes of higher blends. Big Oil and non-refining marketers are under no legal compulsion to breach the blend wall or buck consumer preferences by selling higher blends. The EIA projects higher blends won’t exceed 2.6% of our gasoline supply. In fact, converting represents an expense for the nation’s gas stations. In addition, Big Oil has several options for avoiding an implied standard above E10: sell fewer RINs and raise merchant compliance costs, export more BOB and diesel, and blend more biodiesel or purchase biodiesel RINs to fill the gap. With so many available paths of lesser resistance, why blend more ethanol?

Much of this ethanol headwind, however, would be avoided by moving the point of obligation to the point of blending, which is the loading rack. Big Oil would no longer have extra RINs to enable under blending since the obligation would be based on volumes marketed rather than volumes refined. Non-refining marketers would no longer be exempt and also would have to retire RINs for what they market rather than sell every RIN and retire none. Exports and biodiesel gap-filling would still be available, but the ethanol constraining and insane expectation that squeezing obligated parties will extract compliance from exempt parties would end.

Best,

Bob