WASHINGTON, Nov. 6, 2013 - Research from Iowa State University economists released Tuesday says the dire scenario promoted by the petroleum industry of higher fuel prices caused by increased Renewable Fuel Standard (RFS) ethanol mandates cannot occur without the formation of an illegal cartel.

Furthermore, financial opportunities created by the market for Renewable Identification Numbers (RINs) ‑ tradable credits that gasoline producers and importers use to comply with the RFS mandate – can create alternative compliance opportunities.

The oil industry is calling on Congress to modify or eliminate the RFS, asserting, among other positions, that the standard is creating a “blend wall” – the point at which ethanol blending at 10 percent of every gallon of gasoline (E10) produced is no longer sufficient to meet EPA's RFS mandate – is driving up the cost of RINs and the blending of ethanol.

However, Iowa State’s Bruce A. Babcock and Sebastien Pouliot say higher RFS ethanol requirements should encourage the vehicle fuels marketplace to innovate and create new infrastructure that allows them to reduce the cost of increasing the percentage of ethanol blended into each gallon of gasoline.

The American Petroleum Institute (API) has called the blend wall an insurmountable barrier that will cause the petroleum market to respond by reducing the overall motor fuel supply. An API study says shorting the fuel market will trigger an upward spiral in fuel prices and cost the U.S. economy up to 5 percent of current GDP.

“The problem with the API study is that it relies on the assumption that businesses have no available options to meet their RFS obligations except to cut fuel sales to make the cumulative market smaller, and thereby retreat from the blend wall,” Babcock said. “This is simply not true. There are viable options [other than] restricting supply and driving up prices.”

He said a more likely scenario is for companies obligated to comply with the RFS to evaluate available options and pursue an option that offers the greatest financial return over the longest term, even when an upfront investment is required.

The Babcock/Pouliot paper compares the financial outcomes of the API scenario of reducing domestic fuel sales to avoid mandate penalties with the alternative of providing higher ethanol blends through the installation of pumps capable of selling E85 (85 percent ethanol blend, 15 percent gasoline) to the 16 million flex fuel vehicles currently on the road.

In the latter scenario, fuel producers and blenders benefit financially above the sale of the fuel by accumulating and selling RINs. The API scenario of lower production is only plausible if oil companies act together in unison to form a cartel.

The financial benefit of moving to higher blends is immediate, according to the financial analysis presented and constructed using 2013 costs, the researchers say. Moreover, increasing quantities of high blend E85 pumps in underserved markets creates a sustainable inventory mechanism for accumulating RINs into the future.

Babcock and Pouliot write that if the federal objective is to continue to grow the amount of renewable transportation fuel in the U.S. market, setting mandates beyond the blend wall stimulates the fuel marketplace to find the least-cost way of compliance.

“A potential marketplace today exists for higher blends of ethanol with 16 million flex vehicles on the road, but these vehicles cannot easily locate pumps with higher blends,” added Babcock. “Maintaining high mandates forces industry to consider alternative pathways to compliance. One such pathway is to locate pumps where fleets of flex fuel vehicles exist and then profit greatly from the higher volume and higher revenue boosted by new RIN sales.”

Babcock and Pouliot released a related study Tuesday that identifies a bottleneck of too few fuel stations that offer the ethanol blend E85 along with price incongruity as two major factors that reduce the ability of E85 to help meet an expanding RFS.

They say flex vehicles on the road ‑ an estimated 16 million ‑ are sufficient in number to consume 3 billion gallons of ethanol if E85 was priced at parity with E10.

Virtually every gallon of gasoline sold in the United States already contains a 10-percent blend of ethanol. The researchers say that in order to increase ethanol consumption, higher blends are required. Flex vehicles are capable of burning higher blends, specifically E85.

Flex vehicles constitute 7 percent of U.S. vehicles but E85 pumps that offer high ethanol blends are in only 2 percent of fuel stations, the research shows. In addition to too few pumps, the distribution of flex vehicles does not match up well with the location of E85 pumps, resulting in the loss of potential market. Further, until recently E85 was priced at a level that increased drivers’ fuel cost versus conventional blends which was a disincentive for flex vehicle owners to purchase E85.

While the RFS mandates renewable fuel volumes in excess of 10 percent, and a flex vehicle and higher blend fuel exist that would help achieve that mandate, market conditions have not been adjusted to take advantage.

“The dilemma we attempt to answer is how much E85 would be consumed if consumers had unhindered access to the E85 fuel and if it was priced competitively with other fuel choices,” said Babcock. “When priced at parity under these conditions, with no change to fleet size, consumption of E85 could increase to 3 billion gallons.

The two studies, along with a third paper, “The Economic Role of RIN Prices,” can be found on Iowa State’s Center for Agricultural and Rural Development Web site.


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