US RFS2 program approaching blend wall

21 March 2013

The US Renewable Fuel Standard (RFS2) will become infeasible by 2015-2016, causing disruptions in fuel supply and substantial damage to the US economy, concludes a study by NERA Economic Consulting, commissioned by the American Petroleum Institute (API). Under the RFS2 program, fuel producers and importers must blend renewable fuels into gasoline and diesel fuels at volumes that increase every year. Within three to four years, fuel suppliers will reach the point when biofuels cannot be incorporated into fuels at the levels required by the RFS2, due to technological, infrastructure and market constraints. This point is often referred to as the “blend wall”.

Faced with the inability to meet the increasing blending obligations, fuel producers will be forced to buy renewable fuel credits and, eventually, to limit production of fuels. As a result, extreme disruptions in the fuel market would occur, with the price of gasoline increasing by about 30% and the price of diesel increasing by over 300%. The resulting disruption in the US transportation sector would ripple through the economy, causing a $770 billion decrease in the GDP, predicts the study.

The RFS2 program, enacted under the Energy Independence and Security Act of 2007 (EISA), requires blending an annual total renewable fuels volume that increases from 9.0 billion gallons in 2008 (the first year of the program) to 36.0 billions gallons in 2022. Every year, the US EPA adopts percentage RFS2 standards, calculated as the respective volume amount divided by the estimated overall sales of transportation fuels in the given year. Because the sales of transportation fuels in the United States have not been growing as once estimated (due to the improvements in vehicle’s fuel economy, the economic recession, and other factors), the percentage-based RFS2 standards are increasing faster than it was expected. For 2012, the standard was 9.23%. To meet the 2015 RFS2 total renewable fuel volume of 20.5 billions gallons, the percentage standard will have to increase to about 11%.

The enforcement of the regulation relies on Renewable Identification Numbers (RIN)—unique identifiers attached to each gallon of renewable fuel produced or imported, that can also be traded and banked. Each fuel producer and importer must accumulate a sufficient amount of RINs to meet the percentage RFS2 standards based on its fuel sales. The RINs may be accumulated by blending biofuels or else by buying them in the market.

The main mechanism to comply with the RFS2 has been through blending 10% of ethanol into gasoline (E10 blend). As long as the overall RFS2 standard remained below 10%, each gallon of E10 generated a certain RIN surplus for its manufacturer, which could be sold or banked. The sale of the surplus RINs from E10 production lowered the overall cost of producing the fuel.

Once the RFS2 requirements exceed 10%, the sale of E10 can no longer generate a RIN surplus. Rather, a RIN deficit is associated with the sale of every gallon of E10, which must be covered by purchasing RINs on the market or producing fuels of higher RIN content. E85 remains the only fuel that can produce very significant RIN surpluses for its manufacturer. However, the sales of E85 are limited by a lack of infrastructure, limited number of E85 compatible vehicles, as well as its low fuel economy. The NERA study estimates the maximum potential E85 sales in 2015 at 2.6 billion gallons—a rather limited contribution in the overall US distillate fuels market of some 180 billion gallons a year.

E15—recently allowed by the US EPA for model year 2001 and newer vehicles—could be another potential source of RINs. But E15 has been widely opposed by the fuel industry, car manufacturers, as well as by food producers and environmental organizations—with the various groups opposing it for different reasons. Oil companies seem to be wary of E15 because of the potential for failure in older moder year vehicles and the ensuing liabilities. In the coming years, the sales of E15 are expected to remain at near-zero levels.

With the limited sales of ethanol blends higher than E10, the fuels industry is now increasingly meeting the RFS2 mandates by purchasing RINs on the market. This has put an upward pressure on the price of RINs. Since the beginning of this year, the market price of RIN increased by 1400%—from pennies to more than one dollar. The rising costs of RINs are putting upward pressure on fuel prices.

Diesel fuel will be the main casualty of the rising cost of RINs. Biodiesel is the only commercially available renewable fuel that can be blended into diesel and generate RIN credits. The maximum blending level of biodiesel, however, is limited to 5% (B5) and generates 7.5% RIN (1 gal of biomass-based diesel counts as 1.5 RIN). Therefore, contrary to E10, diesel fuel always generated a RIN deficit. Even if the maximum 5% of biodiesel was blended into the fuel, the manufacturer of diesel still had to purchase RINs from E10/E85 producers to meet the RFS2 mandate.

The cost to produce fuels that require the purchase of additional RINs (such as diesel) increases, while the cost to produce fuels that generate surplus RINs (E85) declines. Furthermore, if insufficient RINs are available for purchase, a refiner must reduce domestic fuel supplies in order to comply with the mandate, creating a shortage. If the RFS2 rules remain unchanged, diesel costs would increase by 45-80% in 2014—predicts the study—followed by a further increase by over 300% in 2015. Gasoline prices would increase by 30% over the same period.

The study concludes that by 2015-2016, compliance with the RFS2 in its current form will likely be infeasible.

Source: API