Issue Analysis Summary

The summary of EIA’s responses to Sen. Bingaman’s concerns is listed below beginning with the issue that has the highest impact on supply, price, and price volatility – the proposed MTBE ban. While supply and price were not quantified in all issues, the ethanol and RFS issues that are discussed after the MTBE ban are not expected to have as much impact on supply and price as the MTBE ban. The 8 hour ozone rule is also not expected to have a large impact. The last issue, which was a proposal to establish a Federal menu of fuels to help reduce fuel proliferation was discussed qualitatively and not quantified.

MTBE Ban and Availability of Ethanol

The first three issues below relate to supply implications of MTBE bans, and the potential availability of ethanol during the next few years, both to help make up for the loss of MTBE and to meet RFS requirements, which are discussed further in subsequent issues.

The expected volumetric shortfall in fuel supplies with an effective MTBE ban in 2004

MTBE is used mainly in RFG. It has low emission properties and has good engine performance qualities such as high octane and distillation characteristics. Ethanol, which also has good gasoline properties, is expected to replace about half of the MTBE that would be removed under a ban. However, ethanol’s engine performance and air quality properties are not as good as MTBE’s, and a net volume loss of gasoline will occur as less volumes of ethanol replace MTBE and as additional petroleum components are removed to re-balance the gasoline characteristics needed to meet emissions and performance requirements.

The analysis concludes that in 2007, if a Federal MTBE ban is imposed on top of the currently proposed State MTBE bans, the combined effect will be that refiners will lose about 180,000 barrels per day of gasoline productive capacity. Depending on availability and economics, this volume loss would be replaced by more ethanol in some areas than the currently required 2 weight percent, added crude oil inputs to refineries, and/or increased product imports. This analysis assumes Gulf Coast refiners and importers provide California with additional high quality gasoline materials in 2004 when their ban is effective. However, it does not take into account additional RFG supply losses that the Mobile Source Air Toxics Rule (MSAT) could create on the East Coast when MTBE is banned.

State bans result in MTBE being banned at different times in different regions. The California State ban in 2004 affects about 40 percent of U.S. RFG supply, and the supply transition market pressure for the West Coast will appear at that time. The Gulf Coast is seen as playing an increasingly important role in resolving California’s supply loss. The East Coast States with scheduled bans in 2004 are New York and Connecticut, which represent about 26 percent of East Coast RFG.

The Mobile Source Air Toxics Rule (MSAT) locks refineries into the level of toxic emissions for gasoline that they were producing in 1998 through 2000. This is becoming a problem as MTBE bans evolve. Refiners producing a large percentage of RFG with MTBE in 1998-2000 had very low toxic emission levels. If these refiners switch to ethanol, the toxics emissions would increase in violation of MSAT without further changes, such as reducing sulfur content and/or reducing benzene and other aromatics.³ Some of these refineries have already reduced sulfur and aromatics significantly and simply may not be able to reduce these physical properties further to counter the effects of ethanol. As a result, these refineries may have to reduce their production of RFG in an MTBE-ban world. Other refineries that had higher toxic emissions in 1998-2000 may be able to fill in the volumes more economically. Also, the timing of some East Coast State MTBE bans in advance of the Tier 2 low-sulfur gasoline program may create some transition difficulties for these States, if refiners cannot advance their sulfur reduction programs for Tier 2 requirements in order to reduce toxic emissions to help meet MSAT requirements when switching to ethanol.

The loss of MTBE is expected to have the largest supply, price, and price volatility impact of all the issues covered in Senator Bingaman’s request. EIA’s analysis indicated that in a case where most of the country bans MTBE (87-percent MTBE reduction), RFG prices could be expected to increase 7.0 cents per gallon, compared to a case in which no States implement their MTBE bans. This does not consider regional or local price volatility that may occur during transitions. To eliminate MTBE from RFG, refineries and the distribution and storage system must change to accommodate the increased use of ethanol, particularly on the East and West Coasts. Historically supply problems have occurred during fuel specification transitions. Given the uncertainties associated with the transition to an MTBE ban, localized and/or regional supply problems could occur during such a transition. Market and even regulatory uncertainties will provide strong disincentives for both the domestic industry and many foreign import refiners to make many speculative investments in advance of the transition. As the market sorts itself out, it will be clearer where more investment is needed and how much time it might take to resolve potential problems.

The proposed removal of the oxygen requirement in RFG is one provision in H.R. 4 that has potential to reduce costs to consumers. In a region banning MTBE, this proposal allows producers of RFG the option to produce a fuel without ethanol, adding flexibility to producers’ choices. However, EIA expects ethanol to be used in many areas even if the oxygen requirement is removed, since it likely will be economic in the short-run in many cases. However, removal of the oxygen requirement could reduce long-run price increases and add flexibility during the transition period, which could help reduce price volatility. This implies that removal of the oxygen requirement would be most beneficial to supply if it occurs coincident with the time of the first MTBE ban. However, because ethanol-blended fuels require complete segregation from other fuels, oxygen-free RFG must be distributed and stored separately from ethanol and gasoline blendstocks to be mixed with ethanol, creating an increase in proliferation of fuel types.

Renewable fuels production capacity, supply, and price

The renewable fuels capacity analysis projects that the ethanol industry can supply the volumes of ethanol required to phase out the use of MTBE, as passed by 17 States beginning in 2004, and meet the proposed renewable motor fuels requirement by its intended implementation date of 2004. Existing plants and those under construction will have more than the capacity needed to meet the RFS in 2004 and 2005. To meet the RFS or an 87-percent reduction⁴ in MTBE volume in 2007, if enacted, from 9 to 18 new plants (40 million gallons each) will be needed. There is sufficient time for additional plants to be constructed. As indicated above, the 87-percent ban case implies an increase in RFG prices of about 7 cents per gallon, which, when averaged with conventional gasoline results in an increase of 2.8 cents per gallon. Thus, while the increase in ethanol production required to provide adequate supply by 2004 is large, construction underway today indicates that such capacity should be in place to meet State MTBE bans and the proposed renewable fuel standard.

Inter-regional transportation issues and associated costs for renewable fuels

Probably the largest issue associated with increased ethanol use is distribution. Since EIA has not performed detailed analysis of ethanol transportation issues, the EIA transportation paper largely summarizes recent work by Downstream Alternatives, Inc., (DAI) for the U.S. Department of Energy. The DAI analysis found that expanding the market for ethanol to 5.1 billion gallons per year results in an estimated average national cost of about 8 cents per gallon of ethanol to transport it to markets. This translates to a cost of about 1 cent per gallon of gasoline when 10 percent ethanol is used. Delivery infrastructure issues requiring attention before demand reaches this level include: rail terminals able to unload more than a few cars, constraints on the Inland Waterway System, and a possible shortage of Oil Pollution Act of 1990-compliant Jones Act vessels. However, our analysis concludes that the major transportation mode for ethanol will be rail. The number of entities needing to invest to make the needed infrastructure changes is large, and breakdowns in pieces of the chain could affect ultimate supply availability. This implies that the transitions beginning in 2004, particularly the large volumes of ethanol required to flow to California, could result in some initial supply dislocations and price volatility. Even after the transition periods, coastal RFG areas dependent on ethanol, which requires a separate distribution system from gasoline that includes railcar and water transport, could experience increased price volatility if distribution becomes hampered due to events such as flooding and winter storms, as has been the case with other fuel disruptions.

Renewable Fuel Standard (RFS)-Related Issues

The next three issues are associated with supply concerns relating to the proposed Renewable Fuel Standard. Two of the concerns focus on timing of the start of the program. The RFS is currently scheduled to begin in 2004, which is when some significant State MTBE bans are scheduled to begin and right before the low-sulfur gasoline and ultra-low-sulfur diesel fuel programs are scheduled to begin in 2005 and 2006 respectively. The third RFS issue looks at the supply implications of allowing States to opt out of the 1-pound RVP waiver currently allowed for conventional gasoline using 10 percent ethanol. None of these RFS issues are expected to have large supply or price impacts. However, any changes required on top of the ambitious low-sulfur programs already being pursued can create further transition complications. Still, compared to the MTBE-ban issues, the RFS impacts on supply in the early part of the program are small.

The potential effect of operating the renewable fuel mandate on a fiscal year (i.e. beginning in October) vs. calendar year basis

The EIA paper examines whether changing the start of the RFS program from the middle of winter to the normal seasonal transition for gasoline at the end of the summer would help ease the transition. The RFS program is currently scheduled to start in January 2004, which is several months ahead of the transition period to the summer gasoline season. Starting in the middle of winter should allow adequate time for adjustments prior to the summer transition. Because the ethanol industry is expected to have production capacity that exceeds the RFS target for 2004, and because 17 States have already banned MTBE from future use, the petroleum industry is expected to be using ethanol in volumes that exceed the RFS target in 2004. Thus, additional shifts in physical production and distribution to accommodate the start of the program should be minimal. While total RFS volumes will likely be met, refiners must still meet their individual quotas based on gasoline market shares that EPA is directed to assign. This requires that the administrative aspects of the program (e.g. credit trading) function adequately at the onset of the program.

The impact of the simultaneous implementation of the low sulfur and Mobile Source Air Toxic (MSAT) gasoline regulations and a national ethanol mandate

EIA examined whether shifting the close relative start dates for the RFS (January 2004), low-sulfur gasoline (January 2005⁵), and ultra-low-sulfur diesel (June 2006) programs could ease the supply impacts of those transitions. The close proximity of the RFS and low-sulfur gasoline start dates does not seem to be a problem. EIA expects the 2004 RFS target to be met since the industry is likely to be using at least this amount of ethanol in 2004 due to the State MTBE bans. However, the close proximity of the low-sulfur gasoline program and the ultra-low-sulfur diesel program remains a concern, as expressed earlier in a previous EIA study.⁶ The magnitude of changes required for both the gasoline and diesel fuel programs and the outstanding issues that will affect diesel fuel production plans, such as requirements for off-road diesel fuel, need to be studied to ensure adequate supply during the transition. However, any proposal to change the timing of the ultra-low-sulfur diesel fuel introduction must take into account synchronization with the heavy-duty vehicle changes required in model year 2007. (MSAT’s relationship to low-sulfur programs is discussed under the MTBE ban issue.)

The potential cost and supply impacts associated with individual States seeking to protect air quality through the removal of the one-pound vapor pressure waiver for gasoline blended with ethanol

EIA examined the supply impacts of allowing States to be exempt from the 1-pound RVP waiver when ethanol is added to conventional gasoline to produce a 10-percent blend. When ethanol is added to gasoline, it increases RVP. The waiver allows refiners to add ethanol and make few if any changes to the underlying petroleum base. When the waiver is removed, refiners must remove light, high-RVP materials to counter ethanol’s RVP increase. In some cases, the driveability index is affected, and refiners may have to remove even more materials. There are two volume impacts of removing the waiver. The first is the impact on total gasoline volumes. The analysis indicates that making up the lost conventional volumes in aggregate if the waiver is removed should not be difficult, since conventional gasoline supply does not face the same production challenges as RFG. While local supply issues could still arise, the proposed legislation requires EPA to study any potential supply impacts when a State petitions for waiver exemption. The second volume impact of not using the waiver is from the perspective of the contribution of renewables to gasoline supply. The analysis shows that removal of the waiver could reduce renewables contribution to supply by 30 to 40 percent. While this provision could add to the fuel proliferation problem and might potentially result in some local problems, it does not appear to have major overall supply impacts.

Notes and Sources