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Feasibility and Cost of Increasing US Ethanol Consumption Beyond E10

The proposed decision by the Environmental Protection Agency (EPA) to reduce biofuel mandates that can be met by ethanol to about 13 billion gallons is predicated in part on a finding that consumption of ethanol is largely limited to the amount that can be consumed in E10, a blended fuel containing 10 percent ethanol. One way to increase ethanol consumption beyond E10 levels is with E85, which contains up to 83 percent ethanol. Historical consumption of E85 provides a poor predictor of the level of possible consumption because the price of E85 has never been low enough to save owners of flex vehicles money. We use a new model of E85 demand to estimate the feasibility and cost of meeting higher ethanol mandate levels than those proposed by EPA. Our model shows that if existing E85 stations could sell as much E85 as demanded by consumers, and if E85 were priced at fuel-cost parity with E10, then ethanol consumption in E85 would be 1.65 billion gallons. If E85 were priced to generate a 20 percent reduction in fuel costs to consumers, then ethanol consumption would increase by 3.6 billion gallons per year. These calculations assume no growth in the number of flex vehicles above the level that existed on January 1, 2013. However, it is not realistic to assume that existing E85 stations could sell unlimited amounts of the fuel. Imposing an upper limit on monthly E85 sales of 45,000 gallons per station reduces ethanol-in-E85 consumption levels to 700 million gallons per year at parity prices, and 900 million gallons per year at a price that results in a 20 percent reduction in fuel costs. The large gap between how much E85 would be demanded by consumers and what can realistically be sold by existing stations shows that both price and the number of gasoline stations selling E85 constrain consumption. We show the impact of adding E85 sales outlets in urban areas where flex vehicles are concentrated by calculating the different combinations of new sales outlets and E85 retail prices needed to achieve a ethanol consumption targets beyond E10. An additional ethanol consumption target of 800 million gallons could be achieved with an E85 retail price of $2.32 per gallon and no new stations. If 500 new stations were added, then the required retail price increases to $2.71 per gallon. These results demonstrate that meeting a 14.4 billion gallon ethanol mandate is feasible in 2014 with no new stations, modestly lower E85 prices, and judicious use of available carryover RINs (Renewable Identification Numbers). Meeting a two billion gallon increase in consumption would require installing at least 3,000 new stations. At a cost of $130,000 per station, this would require a one-time investment of $390 million, or about 20 cents per gallon of increased ethanol consumption in one year. With 3,000 additional stations, the retail price of E85 would have to be discounted to $2.10 per gallon to generate two billion gallons of additional ethanol consumption. With a total of 3,500 new stations, the required E85 retail price increases to $2.60 per gallon. The large impact that adding new stations has on the retail price of E85 given a level of E85 sales gives EPA a powerful tool to incentivize investment in new stations that can facilitate meeting expanded ethanol consumption targets. Any gap that arises between the wholesale price of ethanol needed to support a lower retail E85 price and the cost of producing and transporting ethanol would be closed by the price of RINs. RIN prices also indicate the cost that owners of oil refineries bear to meet biofuel mandates. Thus, there exists an inverse relationship between the cost of compliance with mandates and the number of new E85 stations. This means that owners of oil refineries who bear the costs of complying with mandates can reduce their compliance costs by investing in new E85 stations. If EPA were to set the 2014 ethanol mandate at 14.4 billion gallons and the mandate was met by 13 billion gallons of ethanol in E10, 800 million gallons of ethanol in E85, and 600 million banked RINs, then the RIN price that would cover the gap between the required $2.32 per gallon price of E85 and the cost of producing and transporting ethanol would be 69 cents per RIN. With 500 additional stations, the RIN price would drop to 18 cents. This drop in RIN price represents more than a $7 billion drop in the total value of RINs that would be used for compliance in 2014. In this scenario, the cost of adding the additional stations would be $65 million. This dramatic decrease in the total cost of RINs from adding new E85 stations is what gives EPA the tool they need to incentivize the investments that would facilitate expanded ethanol mandates. EPA's proposed rule would reduce mandated volumes of biofuels in part, because of "supply concerns associated with the blendwall." We demonstrate in this paper that the important supply concern associated with the E10 blendwall pertains to the supply of stations that sell E85, not the supply of the biofuel. The lack of stations that sell the fuel results in a lack of demand for ethanol, not a lack of supply. EPA's justification for reducing ethanol mandates means that mandates will not be increased beyond E10 levels until the number of stations that sell E85 increases sufficiently. Our results demonstrate that the number of stations that sell E85 will not increase until EPA sets ethanol mandates beyond E10 levels. If increased mandates wait for the stations to be built, mandates will never increase. Our results showing that 800 million gallons of ethanol can be consumed as E85 in 2014, even with no additional investment in E85 stations can provide one way out of this policy dilemma. Combining this additional consumption of ethanol in E85 with consumption of ethanol in E10 and available banked RINs would facilitate meeting a 14.4 billion gallon mandate in 2014. Adopting a 14.4 billion gallon ethanol mandate would send a clear signal that EPA is not locked into keeping ethanol mandates below E10 levels. It would also increase RIN prices enough to incentivize investments in new E85 stations, which would give EPA the freedom to move the ethanol mandate to 15 billion gallons in 2015. Our results show that it will take at least 3,000 additional stations selling E85 to achieve a 15 billion gallon mandate without use of carryover RINs. If all 3,000 stations needed an additional tank for E85, then it will involve a one-time investment cost of approximately $390 million, or about 20 cents for each gallon of ethanol sold in E85. Because this investment cost is far below what compliance costs would be without the investment, owners of oil refineries would have a strong incentive to make the investment.

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Paper provided by Center for Agricultural and Rural Development (CARD) at Iowa State University in its series Center for Agricultural and Rural Development (CARD) Publications with number 14-pb17.

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Date of creation: Jan 2014
Date of revision:
Handle: RePEc:ias:cpaper:14-pb17
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