RFS Under Scrutiny

What many are calling the worst drought in 50 years has magnified scrutiny of the renewable fuel standard (RFS).
By Holly Jessen | September 11, 2012

The ethanol industry saw it coming long before it actually happened. Although Todd Becker, president and CEO of Green Plains Renewable Energy Inc., doesn’t believe an RFS waiver is necessary or will have the intended effect of lowering corn prices, he wasn’t surprised when official RFS waiver requests were filed with the U.S. EPA mid-August. “I think it’s a little early before we even have a corn crop harvest for somebody to say that they need relief,” he told Ethanol Producer Magazine. “Obviously blaming ethanol for all of their problems is a bit shortsighted. The drought is causing all of the problems in the United States, not the renewable fuel standard.”

In the face of tight margins and high corn prices, some ethanol producers are idling temporarily or slowing production rates. That's a sign, the industry has been quick to point out, that it is already sharing in corn rationing and that the market is naturally rebalancing. Green Plains, which reduced its production volumes this spring at two of its nine ethanol plants by about 30 percent, or about 7 percent of its total production capacity, has maintained that run rate, Becker said in mid-August. Another example is Valero Energy Corp., which temporarily idled two 120 MMgy ethanol plants this summer and cut back run rates at its remaining eight facilities, announcing in mid-August that it was producing about half of its total combined capacity of 1.2 billion gallons per year.

According to figures from the Renewable Fuels Association, about 26 ethanol plants representing 1.5 billion gallons of capacity are sitting idle, some idled recently and some that have been idle for several years. “In recent weeks, we’ve been running at a rate that is about 12 percent below the industry run rate in early June and about 15 percent below where we were running at the beginning of this year,” said Geoff Cooper, vice president of research and analysis for the Renewable Fuels Association, during an August conference call about the drought and the RFS.

That’s not to say every ethanol production facility is in danger of shutting down. In fact, in Pennsylvania, one ethanol plant actually started back up again in the midst of drought after nearly a year in hot idle. Pennsylvania Grain Processing LLC, a 110 MMgy ethanol plant located in Clearfield, started taking in corn the end of June, well after drought concerns cropped up, and began corn grind in mid-July. The former Bionol Clearfield facility was purchased at auction this spring after the former owners applied for Chapter 7 bankruptcy.

Eric Meeuwsen, general manager of the plant, acknowledged that corn supplies were going to be tight this year, but pointed out that the crop in the vicinity of this plant was looking pretty good. While the former owners of the plant purchased about 55 percent of corn supplies locally, the new company plans to increase that percentage. In addition, the facility has the advantage of location—although it’s not in the Corn Belt there is a good supply of local corn and it has the ability to sell all of its ethanol to local markets in nearby population centers, such as Pittsburgh, which is only about 100 miles away.

Green Plains previously predicted a down third quarter but still expects to pull off a profitable fourth quarter, partially due to hedging ethanol production, Becker said. The company has done a lot of things to improve profitability at its ethanol plants, including working to increase production and yield efficiencies, adding corn oil and fine grind as well as efforts to strengthen its non-ethanol operating income.

The fact remains, however, that there’s simply not going to be enough corn to go around to all corn users—rationing is expected. The Aug. 10 World Agriculture Supply and Demand Estimates report trimmed U.S. corn production to 10.8 billion bushels, the lowest since the 2006-’07 crop. The national average corn yield was projected at 123.4 bushels per acre, 22.6 bushels per acre lower than what was predicted in the previous report and 42.6 bushels lower than the projections in the June and July reports. Total corn use was estimated to decline 984.2 million bushels compared to last year, with feed use dropping 472.4 million bushels, ethanol use 500 million bushels and exports 248 million bushels.

The weekly crop progress report compiled by the National Agricultural Statistics Service, Agricultural Statistics Board and USDA also reflects a serious decline in corn quality. Looking at the average of 18 states, which make up 92 percent of the 2011 corn acreage, the Aug. 13 report pegged 51 percent of the corn crop in the poor or very poor category and only 3 percent excellent. That’s in stark contrast to the previous year, when only 15 percent of the corn crop was poor or very poor and 14 percent was excellent. Zeroing in on the Midwest states with the poorest corn crop conditions shows that more than 70 percent of the corn crop in Illinois and Indiana is poor or very poor—two states with more than 10 ethanol plants each. There are some bright spots, however. Minnesota’s corn crop is 77 percent fair or good and North Dakota is not far behind, with 72 percent in the fair or good category.

Waiver Effects
Official petitions to waive the RFS were first filed by Arkansas Gov. Mike Beebe and North Carolina Gov. Beverly Perdue. The waiver request opened it up for public comment which were set to close Sept. 26 but were later extended to Oct. 11. Lisa Jackson, administrator of the EPA, in consultation with the secretaries of energy and agriculture, does have the ability to waive the RFS in whole or in part, according to section 211(o)(7) of the Clean Air Act. However, to do that it must determine “that implementation of the RFS requirements would severely harm the economy or environment of a state, a region, or the United States.” A 2008 waiver request filed by Texas Gov. Rick Perry was denied, the EPA said, because the evidence didn’t support the determination that the RFS caused severe harm to the economy during the time period in question.

RFA, Growth Energy and the American Coalition for Ethanol have been working in cooperation to combat those leveraging emotions to claim a waiver is needed. “These are the same groups that have been gunning for the RFS for a number of years,” Cooper said. Notably, Tom Vilsack, secretary of agriculture, has repeatedly spoken out in continued support of biofuels and the RFS, including on the same day that the August WASDE report was released. “We don’t want to turn our backs on this industry right now,” he said at ACE’s annual conference. “We are right on the cusp of some exciting things.”

The ethanol industry has repeatedly said that a waiver is not necessary and that the corn and ethanol markets have the ability to adjust naturally to price signals. One major point is that flexibility is already built into the RFS through the ability of obligated parties to use banked renewable identification numbers (RINs) to meet possible shortfalls in the blending mandate. Because ethanol blending has been in excess of the mandate, there’s an estimated 2.5 or 2.6 billion RINs available, Cooper said. As a result, there won’t be a problem in meeting the 2012 RFS requirements. If the ethanol market gets tight, refiners can draw on ethanol stocks that have built up in the previous months and/or draw on excess RINs, he said. For these reasons, if the RFS is waived it would have little impact on corn price, no discernible impact on retail food prices and only a minor, short-term impact on ethanol output. Finally, it will send a chilling signal to investors considering the advanced biofuels industry, he added.

Two papers were recently published that examine many of those same points, one by the Center for Agricultural and Rural Development (CARD) and the second by Farm Foundation and Purdue University. The August CARD policy brief was titled “Updated Assessment of the Drought’s Impacts on Crop Prices and Biofuel Production” and was written by Bruce Babcock, a professor of economics at Iowa State University. Three Purdue University professors, Wallace Tyner, Farzad Taheripour and Chris Hurt, wrote “Potential Impacts of a Partial Waiver of the Ethanol Blending Rules.” The two papers utilized different assumptions and models to come to somewhat different conclusions on what the impact a RFS waiver would have on the price of corn.

The CARD policy brief estimated that if the RFS ethanol mandate were waived, it would have only a modest impact on the corn and ethanol markets, decreasing corn prices by only 58 cents per bushel and ethanol prices 15 cents per gallon with only a 500 million gallon drop in ethanol production. Babcock pointed to ethanol demand, stating that at average domestic consumption of 11.4 billion gallons, ethanol is at par with wholesale gasoline. “This high valuation of ethanol is consistent with the current price of ethanol relative to gasoline, and perhaps reflects a large value of ethanol in allowing refineries to produce a below-octane gasoline that when blended with 10 percent ethanol results in an 87-octane blend,” he said, cautioning that if the value of ethanol to blenders is overstated in his estimated demand curve, the effects of waiving the RFS would be larger.

Further, a 500 million gallon drop in ethanol supply could potentially increase the value of ethanol in the marketplace, supporting 11.5 billion gallons of production and maintaining high corn prices, he said. Prices are also stimulated in response to the waiver request itself. “The desire by livestock groups to see additional flexibility on ethanol mandates may not result in as large a drop in feed costs as they hope,” he said, adding that the analysis shouldn’t be interpreted as saying that ethanol prices have no impact on corn prices. Although there is no mechanism for implementing a ban on corn ethanol, banning its production would result in an average price of $2.67 per bushel of corn. The use of excess RINs to meet the RFS mandate also factored into his conclusions. Compared to the assumption that no flexibility exists in the RFS, accounting for flexibility decreases the average corn price by 91 cents per bushel and a 25-cent per-gallon drop in ethanol prices, he said.

The results of the Purdue paper were discussed during a webinar Aug. 17. Tyner pointed out that the economic harm is a result of the drought and that the EPA can’t change that—it can only redistribute it among the effected parties. An RFS waiver would help livestock producers, he said, but would also penalize ethanol and corn producers and could have longer-term implications that were not examined in the paper. A waiver is not a “stroke of the pen” solution, as it was characterized in a New York Times editorial published the end of July, he said. The EPA must consider many complicated factors when weighing whether to waive the RFS, including oil prices, corn prices, final corn production numbers, the flexibility of oil refiners and blenders and the potential use of RINs.

The Purdue professors clearly state in the paper that they do not believe the EPA will issue a waiver for 2012 and that the more important question is whether a partial waiver will be put in place in 2013, when the ethanol blending obligation increases to 13.8 billion gallons. Typically, the EPA issues a decision on the blending levels of the RFS in November of the year before the mandates are applied, giving the agency until October to gather information on whether the RFS would cause economic harm. “EPA will have to determine what impact a waiver actually would have given the way the market functions,” it concluded. “The most likely technical outcome is that refiners and blenders could and probably would reduce ethanol use to some extent, but how much is uncertain for 2013.”

Whether oil refiners and blenders would utilize RINs was considered at length. There are no financial incentives for blenders to use RINs to meet RFS obligations if the ethanol price is below that of reformulated blendstock for oxygenated blending (RBOB) and RINs will not be used until they have the economic incentive to do so, it said. Like the CARD policy brief, it referenced refiners’ use of ethanol to increase the octane level of 84 octane gas to 87 octane gas, necessary for retail sale. “In other words, for technical and economic reasons, the waiver could have little or no near-term impact, but it is hard to predict how refineries and blenders would respond,” the paper said, adding that if refiners and blenders have limited flexibility in the near term the impact of a waiver would be small or nonexistent.

If the full RFS is left in place and no prior-year RINs are used, the corn price could range between $7.02 and $8.57, depending on the ultimate outcome of the drought. However, in a scenario where no waiver is approved, but RINs are carried forward, ethanol blending could be reduced to 11.8 billion gallons, potentially dropping corn prices about 67 cents a bushel. With flexibility to reduce ethanol usage in the short term, use of RINs credits and/or a waiver could reduce corn prices from 47 cents a bushel for a modest waiver and $1.30 for a large waiver. “The waiver decision clearly depends to a large degree on the flexibility of refiners,” Tyner said.

Although it wasn’t examined in depth, the paper did point out that if exports are reduced, it could lead to some reduction in corn prices. In addition, as corn prices continue to increase, bringing the ethanol price with it, ethanol production rates have already been falling. “This shows that markets can and do adjust, with less corn being used for ethanol,” it said.

Author: Holly Jessen
Features Editor of Ethanol Producer Magazine
(701) 738-4946
hjessen@bbiinternational.com

 

How Bad is the Drought?
This year’s drought has been such a constant topic of conversation that it’s easy to lose sight of the basic facts in the midst of information overload. Here’s a snapshot of relevant weather conditions across the U.S.

July was the all-time warmest month on record, according to the National Oceanic and Atmospheric Administration’s National Climatic Data Center. The average temperature was 77.6 degrees, 3.3 degrees higher than the previous record set in July 1936. Hot and dry conditions in most of the central U.S. expanded the drought to 63 percent of the nation in July, NOAA said. The nationally averaged precipitation total was drier than average and Nebraska, Iowa and Missouri’s precipitation totals ranked among the states’ ten driest months on record.

By the time the heat began to let up and some rain fell in some areas, it was already too late for many drought-stricken corn fields. The USDA announced Aug. 15 that a total of 1,792 counties had been declared disaster areas—1,670 due to drought. In addition to other measures intended to take the pressure off food and livestock producers impacted by drought, the agency announced it would purchase up to $170 million of pork, lamb, chicken and catfish for federal food nutrition assistance programs.