August 23rd, 2012

Ethanol futures, the best-performing energy commodity this year, is cheaper than gasoline, encouraging refiners to use the biofuel even if President Barack Obama’s administration ends a requirement to do so.

A 48 cent-per-gallon discount to gasoline provides companies including Exxon Mobil Corp. and Valero Energy Corp. (VLO) an opportunity to profit by blending the corn-based additive into fuel, while easing prices at the pump for consumers. Marketers may use ethanol as they look for the cheapest way to boost engine performance and reduce pollution.

The most severe U.S. drought in 56 years has prompted lawmakers from both parties to ask the Obama administration to suspend the mandate because of the potential impact on food costs. Ethanol will consume 42 percent of this year’s corn crop, according to government estimates, up from 41 percent last year. The biofuel has been blended into more gasoline than ever this year, Energy Department data show.

“It’s just ingrained in the supply and distribution and it’s having a moderating effect on pump prices,” John Kilduff, a partner at Again Capital LLC, a New York-based hedge fund that focuses on energy, said by phone. “As long as they were still allowed to use it, most would. The lower price and just the logistics of taking it out, most would still use it.”

Denatured ethanol for September delivery slipped 2.7 cents, or 1 percent, to $2.637 a gallon at 12:28 p.m. on the Chicago Board of Trade. It’s climbed 20 percent this year, more than the 16 percent gain for gasoline on the New York Mercantile Exchange.

Ethanol: Cheaper Than Gasoline

Still, the biofuel is 16 percent cheaper than gasoline with which it’s mixed, known as RBOB, or reformulated blendstock for oxygenate blending. Nymex gasoline extended a 16-week high, rising 1.73 cents to $3.1215 a gallon.

A 2007 U.S. law enacted under President George W. Bush, known as the Renewable Fuels Standard, or RFS, requires refiners to mix 13.2 billion gallons of renewable fuels, such as ethanol, with gasoline in 2012 and 15 billion gallons by 2015.

On an annualized basis, production has averaged 13.6 billion gallons so far this year, above the target. Output has fallen 15 percent from a record 963,000 barrels a day, or a 14.8 billion gallon pace, as of Dec. 30.

The U.S. had the hottest July ever, the government said Aug. 8. Just 23 percent of the corn crop was in good or excellent condition on Aug. 19, the worst assessment for this time of year since 1988, the Agriculture Department said Aug. 20. One bushel of corn makes at least 2.75 gallons of ethanol.

Ethanol: Waiver Requests

Twelve Republican and 13 Democratic senators asked Environmental Protection Agency Administrator Lisa Jackson, who enforces the program, to suspend or reduce the country’s ethanol targets in an Aug. 7 letter because of the drought.

That followed an Aug. 2 letter in which a bipartisan group of 156 U.S. lawmakers, led by Republican Representative Bob Goodlatte of Virginia, asked the EPA to cut the requirements. Governors of North Carolina, Arkansas, Maryland, Delaware and Georgia have also called on Obama to halt the RFS.

The EPA asked Aug. 20 for public comments on the waiver requests, and said it has 90 days to make a decision.

“This notice is in keeping with EPA’s commitment to an open and transparent process to evaluate requests the agency receives under the Clean Air Act and does not indicate any predisposition to a specific decision,” the agency said in the Aug. 20 statement.

Alisha Johnson, an EPA spokeswoman, said yesterday that the statement stands.

Ethanol: Economical Fuel

“From the ethanol blending perspective, it puts ethanol back on the footing that it’s a fuel used only if it’s economical,” said Sander Cohan, a global transportation fuels analyst and principal with Energy Security Analysis Inc. in Wakefield, Massachusetts. “It wouldn’t be a complete crash. If you’re an ethanol producer, you’re a little nervous right now.”

The profit for making ethanol has tumbled as corn prices surged to $8.49 a bushel Aug. 10. The so-called crush spread, or profit from making ethanol from corn, for September contracts was minus 32 cents today from 17 cents in May.

Producers including Valero have idled or slowed at least four plants since June. Ethanol stockpiles have fallen 8.9 percent from then to 18.5 million barrels as of Aug. 17.

Gasoline output that includes ethanol increased to 92 percent so far in 2012 from 88 percent last year, according to Energy Department data.

Gasoline Infrastructure

It would be “extremely difficult” to eliminate ethanol, because it is so entrenched in the gasoline mix and infrastructure, Valero Chief Executive Officer Bill Klesse said on a July 31 conference call with analysts and investors. Valero is the largest independent U.S. refiner and third-biggest ethanol producer.

In addition to meeting the government mandate, it’s combined with gasoline to boost octane, a measure of engine performance, allowing refiners to spend less on the crude-oil refining process, Klesse said.

Alternatives to ethanol for boosting octane include alkylate and toluene. Toluene cost $4.205 a gallon on the U.S. Gulf Coast as of Aug. 17, according to data compiled by Bloomberg.

“U.S. blenders have an undeniable economic incentive to maximize the amount of ethanol in U.S. gasoline,” Vincent Andrews and Hussein Allidina, analysts at Morgan Stanley, wrote in an Aug. 7 report.

Political Pressure

Obama is facing pressure to waive the mandate as gasoline has jumped 15 percent since the end of June, reviving Republican accusations that he hasn’t done enough to rein in fuel costs at a time when unemployment remains above 8 percent.

Ethanol is blended into gasoline in some regions of the country as an oxygenate, which allows the fuel to burn more thoroughly, reducing emissions. It emerged as the primary oxygenate as the U.S. phased out use of methyl tertiary butyl ether, or MTBE, which leaks into groundwater and may pose health risks, according to the EPA.

The industry last year decided not to fight to keep a 45- cent tax credit that refiners received for each gallon of the fuel blended into gasoline, saying the mandate would be sufficient.

Companies don’t have to produce all the ethanol required under the rule. Each gallon of ethanol made is assigned a Renewable Identification Number, or RIN, which helps the agency track whether obligated parties, or refiners, are complying with the blending rules.

Buying Credits

Refiners can buy RINs in lieu of blending a physical gallon of ethanol and because of the over-production over the past two years there are ample supplies from which refiners can draw, Geoff Cooper, vice president of research and analysis at the Renewable Fuels Association, a Washington-based trade organization, said in an interview in Bloomberg’s Chicago bureau.

Ethanol companies have produced beyond the government mandates each year that it’s been in effect, squeezing margins from time to time with gluts, while also dumping excess RINs into the market, Cooper said.

The value of a RIN jumped to 5 cents on July 25 from 1.15 cents on June 19, according to data compiled by Bloomberg. The cost has since slipped to 3.65 cents.

“You’re not going to stop blending ethanol,” said Ian Horowitz, an analyst at Topeka Capital Markets Inc. in New York. “If ethanol’s under gasoline, people are going to blend it anyway. They’re not going to leave money on the table.”

- Mario Parker in Chicago at Bloomberg.