Is the RFS Broken?

Prospective cellulosic ethanol producers are beginning to doubt the usefulness of the renewable fuels standard and fear the impact of lessened federal support.
By Kris Bevill | October 14, 2010
There's a growing consensus among the budding cellulosic ethanol community that the renewable fuels standard (RFS) is not doing its job. Enacted in 2005 and amended in 2007, the RFS was part of legislation designed to spur greater production of renewable fuels by ensuring demand through the establishment of mandatory blend levels for those fuels. But for the second year in a row, the EPA is proposing to drastically reduce the cellulosic biofuels volume requirement. While probably necessary due to lack of available fuel, continual lowering of the mandate brings into question the effectiveness of the program and the unintentional negative impacts it could have on the industry it was created to assist.

Procedure and Producers
Each November, the U.S. EPA is tasked with setting the RFS volume requirements for the following year. Gasoline and diesel projections from the U.S. DOE's Energy Information Administration are used to calculate the overall standard. Cellulosic standards, however, are determined based on EIA projections as well as EPA-conducted assessments of the cellulosic ethanol industry. After the EPA conducted its industry analysis in summer 2009, it reduced the cellulosic volume requirement for the first year's implementation in 2010 from 100 million gallons to only 6.5 million ethanol-equivalent gallons, which is about 5 million gallons of actual fuel. In its industry assessment, the agency relied heavily on biomass-based diesel fuel substitute producers, such as Cello Energy, to contribute to the cellulosic biofuels target. As of October, most of the anticipated producers were not known to have produced any cellulosic biofuel, and it's unlikely that the 5 million gallon cellulosic goal will be reachable by the end of the year.

Considering the fate of the 2010 mandate, it wasn't surprising that when the EPA issued its proposed 2011 RFS volumes in July, it once again slashed the cellulosic biofuels requirements. The initial 2011 target for cellulosic biofuels was 250 million gallons, but the EPA estimated a more feasible target of between 6.5 and 25.5 million ethanol-equivalent gallons (representing 5 and 17.1 million actual gallons), and will settle on an exact total by Nov. 30. Potential producers and refiners have both reacted strongly to this proposal, but for very different reasons.

A ‘Chilling Effect'
"Setting low cellulosic ethanol volumetric targets has a chilling effect on investment in cellulosic ethanol," says Mark Stowers, vice president of science and technology at Poet LLC. "EPA is sending a signal to the investment community that they don't see cellulosic ethanol developing at a rate that is consistent with the RFS. There's a lot of investment in this technology that is maturing, and it would be sad to see that shortened by lack of investment." Poet was one of the first producers to receive federal funding for its cellulosic project and has also received substantial support from the state of Iowa for its Project Liberty, and Stowers says the advancements Poet has so far made in the cellulosic arena would not have been possible without the government's financial support. Poet, like many other future cellulosic producers, is close to realizing the commercial-scale cellulosic facility, but it needs more financing in order to complete the project. "We're kind of in a stage where it's not related to technology anymore," he says. "It's really related to the ability to get financing and the overall economic climate. There's plenty of opportunity to hit those [RFS] numbers, but it requires a lot of capital. If there's no incentive based on the RINs [renewable identification numbers], it's going to be a challenge."

"It really does signal in a negative way to the market that the program isn't working as designed," says Ted Kniesche, vice president of business development at Fulcrum Bioenergy Inc. Fulcrum recently began engineering, procurement and construction activities at its 10.5 MMgy Sierra Biofuels Plant near Reno, Nev., and anticipates producing cellulosic ethanol beginning in 2012. So while his company isn't directly affected by the 2011 volumetric targets, Kniesche says it still impacts his conversations with investors and their view of the market in general. "I think that lowering the target year after year just puts a damper on biofuels in general," he says. "I think a lot of companies are in the same position we're in, which is once we prove the commercial viability of plant No. 1 we can move very fast and build a much bigger program behind that first plant. We have big ambitions for contributing to that RFS target and that's one reason why we don't want it to continually erode."

In comments filed with the EPA, DuPont Danisco Cellulosic Ethanol LLC also warned that the continued waiving and lowering of cellulosic biofuel volumes will have a negative effect on investments. "As a result, the cellulosic biofuel volumes fail to function as a true mandate, and fail to provide the consistent incentive and risk mitigation needed to drive the early market and biorefinery construction and commercial production," the company stated. Jennifer Hutchins, DDCE corporate communications director, says the company will produce its predicted share of next year's cellulosic fuel and lowering the mandate hasn't stalled DDCE's progress so far, but it is a significant issue for the industry as a whole. "The technology is proven," she says. "The technology works. There's been impressive progress in the industry and we realize that volumes were set based on projected production, but it's important to recognize that we're at a tipping point and a consistent mandate is necessary to ensure that investments continue in our industry." The RFS needs to be reevaluated to stay aligned with market realities and the overall intentions of the program but Hutchins says it will remain a vital component of the industry as deployment begins. "We fully expect to eventually be an unsubsidized industry," she says. "But we need the mandates now to ensure that we can encourage investment in this fledgling industry."

Paying the Price
Of course, refiners don't view the RFS in the same light as producers. While producers are concerned that waiving down the mandate will discourage investment and drive down the market for their product, refiners are far more concerned with the money they must pay for RINs that represent those renewable fuels. A reduced mandate lessens the financial tug on refiners. The American Petroleum Institute, which represents more than 400 members of the oil and natural gas industry, commented to the EPA that it should reconsider its already low assessment and reduce next year's waiver even further than the proposed 5 million gallons. In fact, API suggested that each year's cellulosic biofuels waiver should be based on three months of continuous demonstrated production rather than "subjective projections." Patrick Kelly, API's policy advisor for downstream fuels issues, says refiners struggle to comply with federal regulations when mandates keep changing with short notice. "It's difficult for companies to plan their compliance and operations for the future year when the EPA estimates are so optimistic," he says. "The proposal for the 2010 standard was 100 million gallons. When we got the final rule, EPA estimated 5 million gallons. It was a significant jump and obligated parties did not see the final rule until they were in the compliance period. And what's the actual amount that's going to be produced this year? It's somewhere close to zero."

Kelly says the notion of requiring production before determining a mandate wouldn't have to affect cellulosic producers negatively. "We're not suggesting changing the overall cellulosic number for the dates going forward," he says. "It's just that the only way for obligated parties to have any kind of certainty in compliance is through this cellulosic waiver. If a company is to begin producing, they're still able to produce the cellulosic RINs and they still have essentially a guaranteed market for the products they produce."

Most of the companies on the EPA's 2011 list haven't produced cellulosic ethanol continuously for three months, so according to API they should be removed from the list and the waiver should be adjusted accordingly. "Because there's no certainty that any of them will be producing, they shouldn't be counted for the overall mandate," Kelly says. "Essentially, the volumes that EPA expects are likely not going to be produced. That's not to say these companies won't start production in 2011, but the EPA estimates are overly optimistic. Because the only way to accurately gauge how much they're going to be producing is to look at their demonstrated capacity, the mandate for this year should be less than a million gallons of cellulosic. The minimum number EPA set out is 5 million … it appears that for this year that number was overly optimistic and we think it's optimistic for the 2011 mandate as well."

Producers counter with the point that setting a mandate based on proven production levels would be inconsistent with the RFS' goal to increase production of alternative fuels. "This is about a 90 percent monopoly that the petroleum industry has on our liquid transportation fuels," Stowers says. "They need to comply like everybody else. They have a tremendous amount of financial resources that dwarf the size of the ethanol industry, so I don't see a concern."

Unique Situation
While cellulosic producers and the petroleum industry are not likely to agree on RFS volumes, certain refining companies find themselves in what could be an awkward middle ground. Valero Energy Corp. refines 2.8 million barrels of oil per day and is a member of API. Its subsidiary, Valero Renewable Fuels LLC, has the third largest ethanol production capacity in the U.S. The company is also invested in three cellulosic ethanol companies—ZeaChem Inc., Qteros and American Process Inc. Perhaps because of its unique position, Valero has taken a neutral stance on the RFS and is focused instead on generating revenue within the confines of the legislation. Bill Day, Valero's executive director of communications, says the company plans to continue to invest in cellulosic opportunities regardless of reduced RFS mandates. "At some point cellulosic technology will be viable on a level basis with corn ethanol, and it makes more sense to use non-food feedstocks for ethanol," Day says. "The goal for Valero is to eventually have some cellulosic production at our existing ethanol plants in addition to the corn ethanol production that we have. … We're convinced that ethanol, whether it's corn ethanol or cellulosic ethanol, is going to be an important part of American fuels, and we are a fuel company. So whether it's gasoline, corn ethanol or cellulosic ethanol, diesel fuel or jet fuel, that's the business we want to be in."

Bigger Battles
According to Day, refiners will be more affected by the overall increase in the RFS than by adjustments made to the cellulosic biofuels mandate. "In the United States, demand for refined gasoline peaked in 2007 and has been flat or declining since then," he says. "We don't expect it will ever again reach the levels it hit in 2007. Demand for refined gasoline is going to drop in this country and any incremental demand for fuel will be made up not by gasoline, but by ethanol. As more and more ethanol is required for use and, at the same time, the demand for gasoline drops, refiners like Valero will probably be looking for ways to add more ethanol into their fuel."

Fulcrum's Kneische says members of the cellulosic ethanol industry have begun discussing what measures they can take to improve the RFS so that it functions in the way it was meant to. "If they created the RFS2 to act more like a mandate, much like you see in renewable portfolio standards, where you have penalties for non-compliance and you really put the onus on the established energy industry to be stakeholders in this industry and be invested in its success, then I think you'll see a very different dynamic," he says. "You'll see investment flow a lot faster to biofuels in a way that is efficient. Right now, I think there's at best some ambivalence among the oil majors and others because as long as the cellulosic industry continues to lag, it's not really any skin off their back."

Kris Bevill is an associate editor at Ethanol Producer Magazine. Reach her at kbevill@bbiinternational.com or (701) 850-2553.