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Silver Linings in EPA Ruling for RFS

The EPA’s final blending mandates for biofuels announced Monday are already affecting corn ethanol and biodiesel credits that blenders trade with each other, roughly doubling the corn ethanol credit values in a week, those who track the industry said on Friday.

EPA’s final rule covers 2014 and most of this year retroactively, as well as 2016 and, for biodiesel only, 2017. EPA bumped up blending requirements slightly from its preliminary goals announced last June but is falling short of goals originally set by Congress for the Renewable Fuels Standard (RFS).

All in all, the agency probably won't have a big impact on the corn market and is likely to be sued both by oil industry interests who oppose granting more than about 10% market share to corn ethanol, as well as biofuels interests who could argue that the agency’s justification for not doing more — a lack of pumps and other infrastructure to sell biofuels — is illegal. Some economists think EPA’s final decision may turn out to be the start of a boom in biodiesel, pointing to a 20% increase in soybean oil prices over the past two weeks.

Higher number than expected

EPA bumped up its effective mandate for corn ethanol from 13.4 billion gallons for this year, set last June, to 14.05 billion gallons in the final rule. Its mandate for 2016 is 14.5 billion gallons, up from 14 billion gallons in June.

“It’s a higher number than a lot of people were expecting. At the same time, I don’t think it means much in outlook. The industry was already growing,” said agricultural economist Chad Hart of Iowa State University. That’s mainly because with gasoline prices cheap, consumers are using more of all kinds of fuel, “and as that happens, it’s pulling more gallons (of ethanol) into the system.”

The number that really counts for corn, Hart said, is the 2016 mandate, which coincides with most of the marketing year for the 2015 corn crop. USDA’s most recent supply demand estimate projected corn usage for ethanol at more than 5.2 billion bushels, down slightly from 5.3 billion in 2014. Hart says that slightly cheaper grain sorghum is being used by ethanol plants in Kansas, Missouri, and other southern locations.

University of Illinois agricultural economist Scott Irwin is more bullish about the effect of the ruling. Even though it falls short of what the biofuels industry would like, he sees it as a major shift in policy by EPA. He knows that biofuels groups believe EPA’s justification for lowering the mandate doesn’t follow the intent of Congress, “but I think that misses the point of how much more favorable this rule is compared to what we were looking at two years ago.”

At that point, EPA seemed unwilling to push more ethanol into the system than the so-called blend wall of about 10% of gasoline sales. Now, according to Irwin’s calculations, next year’s 14.5 billion-gallon mandate for corn ethanol will be about 900 million gallons more than the system can absorb if oil companies and retailers sell mainly E10.  On the surface, 10% of next year’s expected gasoline consumption in the U.S. would be roughly 14 billion gallons — resulting in a mandate that’s 500 million gallons bigger than the so-called blend wall. But because a small amount of gasoline without any ethanol (E0) is still sold, and because a few hundred million gallons of cellulosic ethanol and sugarcane ethanol get preference for blending, the actual mandate will be about 900 million gallons bigger than the market can absorb.

When a blender is unable or unwilling to put biofuels into the system, the blender can buy the credits, known as renewable identification numbers or RINs, from others that have a surplus. You can think of it as operating something like a futures market for biofuels. The RINs for corn ethanol went from about 40 cents a gallon to 80 cents a gallon in the first three days of this week.

Surplus of RINs

Irwin said that the industry appeared to be surprised by EPA's final rule. Due to production that has exceeded EPA mandates in recent years, a surplus of about 1.74 billion gallons of RINs has accumulated. Until last Monday, the oil industry thought “our stockpiles of RINs will get us by for years,” Irwin said. Now they realize “the EPA really was serious.”

The oil industry basically has two ways to get beyond the blend wall of E10, he said. It can either use more ethanol, by selling E15 (15% ethanol blends) or E85 (85% ethanol). Or it can use more biodiesel, which is considered an advanced biofuel.

Some economists, including Bruce Babcock at Iowa State University, see sales of E85 as the way forward.

Irwin is in the biodiesel camp. He points out that soybean oil prices have risen sharply in the past two weeks while meal has stayed flat.

“It’s hard for me not to believe that the EPA’s announcement has put 50 cents a bushel in the pockets of U.S. soybean farmers and this is through biodiesel,” Irwin said.

At the American Coalition for Ethanol in Sioux Falls, South Dakota, the group’s executive vice president, Brian Jennings, sees the increase in RIN values as “a silver lining for conventional ethanol, for corn.”

He hopes that the higher RIN values will encourage the oil industry to invest in pumps, tanks, and other infrastructure needed to sell higher blends of ethanol.

Yet, his group is among many in the biofuels industry disappointed by the EPA rule. “This is a very tough rule for cellulosic ethanol,” Jennings said.

The agency appeared to nearly double the cellulosic mandate from a modest 123 million gallons this year to 230 million in 2016. But it’s counting fuel made from biogas at landfills and other sources as the main source of cellulosic ethanol. And the agency is hinting that it may reset the mandate for cellulosic at lower levels through the end of the RFS in 2022. The industry has 60 days after the rule is published in the Federal Register, perhaps next week, to file lawsuits challenging EPA’s rule. Jennings said his group hasn’t decided if it will join any of the groups already talking of litigation. “We are still sifting through the rule,” he said.

The 2007 energy law that created the RFS allows the EPA to grant blending waivers if there isn’t enough biofuel to meet the RFS.

In its latest rule, the EPA cites “distribution constraints” to justify its waiver.

“That’s a code word for the blend wall,”  Jennings said. When the 2007 law was passed, Congress decided to leave out “distribution constraints” as a reason for granting waivers. The logic was that if the oil industry said it couldn’t find a way to distribute biofuels, higher levels would never be blended.

“We’re still very upset that the EPA continues to use the waiver language in a way that Congress didn’t intend,” Jennings said.

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