Timing for Startup of the Renewable Fuel Standard

On June 17, 2002, Senator Jeff Bingaman, Chairman of the Senate Committee on Energy and Natural Resources, requested that the Energy Information Administration (EIA) provide analysis of eight factors related to the Senate-passed fuels provisions of H.R. 4, the Energy Policy Act of 2002 (Appendix A). In response, EIA has prepared a series of analyses discussing the market impacts of each of these factors.

Because of the rapid delivery time requested by Sen. Bingaman, each requested factor related to the Senate-passed bill was analyzed separately, that is, without analyzing the interactions among the various provisions. In addition, assumptions about State actions, such as their implementation and timing of MTBE bans, influence the results. Discussions about some of these interactions have been included in order to explain the interconnected nature of such issues.

EIA’s projections are not statements of what will happen but what might happen, given known technologies, technological and demographic trends, and current laws and regulations. The Annual Energy Outlook 2002 (AEO2002) is used in these analyses to provide a policy-neutral Reference Case that can be used to analyze energy policy initiatives. EIA does not propose, advocate or speculate on future legislative or regulatory changes. Laws and regulations are assumed to remain as currently enacted or in force in the Reference Case; however, the impacts of emerging regulatory changes, when clearly defined, are reflected.

The analyses involve simplified representations of reality because of the complexity of both the issues examined and the environment in which they would occur. Projections are highly dependent on the data, methodologies, and assumptions used to develop them. Because many of the events that shape energy markets (including severe weather, technological breakthroughs, and geopolitical disruptions) are random and cannot be anticipated, energy market projections are subject to significant uncertainty. Further, future developments in technologies, demographics, and resources cannot be foreseen with any degree of certainty. These uncertainties are addressed through analysis of alternative cases in the AEO2002.

Introduction

This paper responds to Senator Bingaman’s inquiry on whether or not moving the start date of the Renewable Fuel Standard (RFS) from its currently proposed January 2004 to October 2004 would improve the chances of a smooth transition. The question recognizes that January is during the middle of the winter gasoline season and several months prior to when refiners have to begin producing summer gasoline, which is more difficult to make – particularly when using ethanol.¹ October is closer to the transition between summer and winter gasoline, and provides an entire winter season to adjust to the RFS. Concern over seasonal timing of transitions is understandable in light of the price volatility experienced in spring 2000 and 2001.

For this discussion, fuel regulatory timing issues can be considered as falling into three categories:

1) Setting implementation dates within an annual calendar. For example, should the date be set at a time when refiners are making a normal seasonal product change or during a low demand season (winter for gasoline)? The goal is to try to minimize the potential for supply problems and price surges while making the transition.

2) Synchronizing a regulatory change that has a logical connection with other regulatory changes affecting product quality requirements. An illustrative example is timing between potential MTBE bans and a waiver to the oxygenate requirement ² in reformulated gasoline (RFG). The oxygenate waiver gives refiners more flexibility to meet RFG requirements. When the use of MTBE is restricted, refiners will have to make some significant changes, and providing suppliers with as much flexibility as possible during such changes can help smooth the transition. Thus, even though most MTBE-banned RFG is expected to be made with ethanol initially, there is a rationale to having an oxygenate waiver precede or coincide with MTBE ban dates, in order to allow as much supply flexibility as possible to minimize chances of product shortfalls.

3) Timing where large changes are needed by the industry, such as large capital investment requirements. There are three dimensions to this timing area. First, adequate time must be allowed to promulgate the regulations. The time required in this case will vary with the complexity of the changes required by the legislation. Second is that adequate advance notification be provided to refiners so that they have time to plan and make the necessary investments. Third, the timing needs to be adequate for the construction and engineering sector to produce and install the equipment needed to comply with the regulations without adding excessive burden to refiners.

This particular issue deals with aspects of all three timing issues, as described below. The next subsection of the paper covers the basic elements of the RFS that could affect the timing for beginning the program. The Findings subsection discusses the issues affecting the first timing dimension, i.e., a need to start the program during a different seasonal period than mid-winter, and then discusses factors associated with the third timing issue, i.e., adequate time to implement and respond to the legislation, in order to explore if a delay beyond January 2004 might be needed. The Conclusion section then summarizes the findings.

Background on RFS and Ethanol Use

The RFS currently being proposed requires minimum volumes of renewable fuel to be used in each year beginning in 2004, as described in Appendix B. The proposed legislation directs the Environmental Protection Agency (EPA) to assign every gasoline supplier a renewable fuel volume requirement based on an estimate of the supplier’s share of the gasoline demand in the upcoming year. The proposal also allows for credit trading among suppliers, with the details to be developed in associated regulations. Due to its availability and economics, ethanol will be the renewable fuel used to meet this standard initially. (Appendix C discusses the use of ethanol in gasoline.)

The RFS requires that 2.3 billion gallons, or 150,000 barrels per day, of renewable fuels be used in 2004. In 2001, the United States used 1.7 billion gallons (113,000 barrels per day) of ethanol, which is 74 percent of the 2004 RFS requirement. During the first few years of the RFS program, volumes of ethanol used may already meet or exceed RFS requirements, as a result of increased ethanol production capacity currently under construction, partially in anticipation of State MTBE bans that are scheduled to be in place in 2004.³ (Further detail is provided in EIA’s response to the Senator’s question regarding “Renewable Motor Fuel Production Capacity Under H.R. 4.”) Regardless of the RFS, the MTBE volumes lost as a result of bans in States using reformulated gasoline⁴ (e.g., California and New York) will be replaced by ethanol, alkylate, and other materials as discussed in the response to Committee’s question on the volume impact of an MTBE ban.

Findings

Moving the start date of the RFS program from January to October has two effects. The first is to shift the date to a different part of the gasoline season from mid-winter to the transition period from summer to winter. The second effect is to delay the program 9 months from January to October.

Seasonal Startup Timing

There is not a major difference between starting the RFS program during the summer-winter transition (October) or during the middle of winter (January). A January startup separates the RFS transition from seasonal changes in gasoline specifications and allows refiners several months to adjust and prepare for the summer gasoline season. While some refiners might prefer an October startup, finding it advantageous to deal with the RFS transition at the same time as the normal seasonal summer-to-winter transition, which allows them to draw down summer-grade gasoline and replace it with winter-grade and to change gasoline types at the same time, others would prefer a mid-season transition in January. The difference in perspective between suppliers would likely depend on the types of gasoline currently marketed (conventional or RFG, and RVP specifications) and existing use of ethanol.

The seasonal choice between January or October is also not expected to be significant since the industry is not expected to have to change physical production and distribution much to meet the RFS, beyond what they would otherwise be doing. As we indicated in the response to the question on availability of ethanol (Question 2), projected ethanol production, based on added capacity of plants already under construction, will likely provide more ethanol in 2004 than required by the RFS. Thus, there would be no need for refinery or terminal changes beyond those already taking place.

The increase in ethanol production capacity has been partially driven by State MTBE bans, and it is likely that California’s ban on MTBE will result in the additional ethanol demand needed to meet the RFS target in 2004. The RFS requires that 0.6 billion gallons (39,000 barrels per day) more be used in 2004 over that used in 2001 (2.3 billion gallons RFS target minus 1.7 billion gallons used in 2001). California will likely need at least 45 thousand barrels per day, or 0.7 billion gallons, of ethanol for gasoline in 2004, to satisfy requirements given its MTBE ban.⁵ California suppliers are already beginning to remove MTBE and use ethanol. California’s consumption alone, added to current ethanol use, would meet the RFS requirement in 2004. If more California RFG than anticipated is produced without ethanol, the shortfall from the RFS is likely to be very small, and easily accommodated by Midwest gasoline suppliers that currently use ethanol.

While there may not be an immediate problem in meeting the RFS due to the impending MTBE ban in California, further compliance may be contingent on the implementation of the credit-trading program. The proposed legislation indicates that EPA will assign each supplier a renewable volume quota to meet based on the supplier’s share of the gasoline market. Some companies are likely to produce more than their quota and to have credits to sell to those companies that find it less economical to use ethanol. If the credit system does not work, gasoline suppliers that were not planning on using ethanol but on purchasing credits could be caught short of meeting their quota, even if the total RFS target is being met. The effective functioning of the credit trading system will depend on the regulations that are developed and on the eventual ability of the credit trading market to function smoothly, including the presence of an adequate number of players and volume of credits being traded in the market.

Delayed Startup

The assumption about the workings of the credit-trading program relates to the third timing issue or the potential need for a delay beyond January 2004. Senator Bingaman’s question raised an option that would add 9 months to the current proposed startup date. If the RFS legislation is passed this year, January 2004 allows about 12 months for promulgating the regulations, including a 60-day comment period, OMB review, and industry implementation. While not comparable in many dimensions, it should be noted that 3 years passed between passage of the Clean Air Act Amendments in 1990 and when the sulfur dioxide (SO 2) trading allowance rules were finalized. It then took EPA another year to finish the computer system needed to track the SO 2 allowances.⁶

While the RFS program is different than the SO 2 program, there are still complexities and uncertainties that need to be worked out. For example, EPA historically has focused fuel-quality enforcement at the refinery level of the gasoline production and distribution chain. Ethanol additions most often take place at terminals, not refineries. If EPA chooses to keep enforcement at the refinery level, for a refinery to generate RFS credits, it would need to keep records to account for each batch of gasoline that indicates those volumes must be blended with some specific amount of ethanol. If that “ethanol-tagged” gasoline is sold before blending, the buyer would be responsible for adding the appropriate ethanol volumes. While this approach should work, it will encourage production and distribution of unfinished gasolines to which ethanol is to be added at the terminal, not for normal market reasons, but because of a regulation. This is a change from today where ethanol is added to finished conventional gasoline in many cases. Since this process would not be tracked under current reporting practices, it could discourage some ethanol blending decisions being made today at the terminal. For example, in some cases, marketers determine how much mid-grade gasoline to make on an as-needed basis at the terminal, and they add ethanol to regular gasoline to produce the higher octane midgrade. Such blending would not be “counted” towards the RFS program under an enforcement process directed at the refineries, even though ethanol is being used. It is not known if these examples would make a large difference in the marketplace. They illustrate why EPA will need time to determine the role of blenders in the credit-trading program, and how best to establish the program both from an enforcement perspective as well as from a market perspective to avoid inadvertently introducing any significant market barriers or inefficiencies. On the industry side, once the players and basic rules of the credit trading system are known, companies must set up their supply/trading strategies and computer systems to comply.

If the RFS is delayed, the second timing issue of synchronizing with other regulations will be important to consider. The oxygenate waiver is currently tied to the RFS. If that remains the case, a delay in the RFS means there will be a delay in the oxygenate waiver, and that will mean some States may begin their MTBE bans before refiners are allowed to produce RFG without oxygenates. RFG can be produced without oxygenates by adding clean-burning, high-octane materials such as alkylate or iso-octane. Since even ethanol-blended RFG will require more alkylate than is being used today, there could be insufficient economic supply of such materials initially to produce much, if any, non-oxygenated RFG. While EIA expects that most volumes of RFG will be made with ethanol when MTBE is banned, some refiners may find it beneficial to include some RFG without oxygenates. The oxygenate waiver provides production flexibility, and flexibility is needed the most during major fuel-change transitions such as MTBE bans.

Conclusion

A shift of the RFS startup date from the currently proposed mid-winter date (January) to the time when the seasonal change in gasoline from summer to winter occurs (October) will probably not matter to the transition, mainly because the State MTBE bans that are planned to go into effect in 2004 would result in sufficient ethanol use to meet the RFS target in that year. Construction is already underway on enough additional ethanol capacity to meet 2004 and 2005 requirements. However, it is important to ensure that the administrative aspects of the program can be developed with sufficient time between promulgation and implementation to give companies adequate time to respond.

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Appendix A: Request Letter from Senator Bingaman
Appendix B: Selected RFS Requirements
Appendix C: Using Ethanol in Gasoline
Notes and Sources
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