4 Big Reasons to Increase Ethanol Blends

Source: By Maxx Chatsko, Motley Fool • Posted: Tuesday, February 12, 2013

The United States produced more than 13 billion gallons of corn ethanol in 2012 and is expected to produce a similar total in 2013. Where does it all go? Some is exported to Brazil and the European Union, but most goes into our fuel tanks. According to the Energy Information Administration, Americans burned 134 billion gallons of gasoline that contained 12.87 billion gallons of ethanol in 2011.

Those figures would place the average ethanol content (by volume) of a gallon of gasoline sold in the United States at about 9.6%. The good news is that the Renewable Fuel Standard, or RFS, has successfully met its goal of displacing 10% of gasoline consumption. The bad news is that the country has bumped up against the dreaded Blend Wall, or a saturated market for ethanol.

It is bluntly obvious that the current RFS cannot provide the help domestic producers urgently need. Luckily, one quick fix is at the Environmental Protection Agency’s (EPA) disposal: a simple increase in ethanol blends from 10% to 15%. In 2011 the EPA even approved E15 for use in car models from 2001 onward but failed to enact proper labeling requirements for blenders — effectively dismissing the idea. Here are four reasons action is desperately needed.

1. Economic catalyst

When the RFS became law in 2005, it was easy for critics to muffle the optimism for a future ethanol industry. Some critics viewed government involvement in biofuels as a death sentence, not to mention the “outrageous” goals of replacing any sizable amount of the country’s oil imports, which were then at an all-time high.

By the end of 2012 — a mere seven full years later — the ethanol industry evolved from a marketplace dependent on government policies into one being held back by them. Irony kills.

Renewable Fuels Association CEO Bob Dinneen spoke sharply to critics of the industry in his annual address at the National Ethanol Conference last week. According to the RFA, the ethanol industry supported more than 382,000 total jobs, contributed $43 billion to GDP, and saved American consumers $30 billion in income in 2012.

2. Capacity trumps production

Domestic producers are operating at less than 88% capacity, with few destinations — or incentives — for extra production. Given current market conditions, the operational capacity is expected to fall further, as facilities react to corn inventories decimated by last year’s drought. Leading producers such as POET and Archer Daniels Midland (NYSE: ADM ) are just two companies raising prices or idling capacity. At last count the number of idled facilities stood at 34, up from just 26 in September.

Thanks to the lack of sugar feedstock, last August was the first month since December 2009 in which the country experienced a net import of ethanol. Although net imports are expected to continue until corn production rallies this summer, the idling acts as a positive feedback that will compound the overcapacity problem. Archer Daniels Midland, POET, and BioFuel energy are all taking advantage of slower production to upgrade several facilities. The enhancements will not only allow sorghum to be used in lieu of corn but will also increase efficiency and therefore capacity.

3. Predatory overseas markets

In 2011, export revenues hovered near $1 billion — an explosive turnaround from the nearly $1.6 billion in imports in 2006. Higher sugar prices in Brazil served as a major driving force in domestic ethanol’s attractiveness, which quickly became the world’s lowest-cost biofuel in 2011. Now the American ethanol industry is in danger of losing international competitiveness that took years to build. Brazil and Europe haven’t exactly been shy about kicking Uncle Sam while he’s down, either.

Several European countries have proposed tariffs on American ethanol imports, while Brazil has fought back into the Lower 48 supply chain. In a strange reversal of fortunes, overpriced Brazilian ethanol is now more competitive than its cheaper domestic rival. What gives? Rather than institute a temporary mandate protecting domestic producers, the EPA has sat idly by, all the while qualifying Brazilian ethanol imports as advanced fuel.

Leaders at the National Ethanol Conference voiced their concerns that domestic corn ethanol wouldn’t be able to make up lost ground even when the market improves. Share prices of sugar behemoths Bunge (NYSE: BG ) and Cosan (NYSE: CZZ ) seem to agree, as each has soared in the past year on higher demand for sugar sweeteners and an improving outlook for Brazilian ethanol. If the world closes its doors to American ethanol, then producers are likely to suffer further in an even more saturated market.

4. Cellulosic capacity poised to soar

Corn ethanol production is capped at 15 billion gallons per year under the current RFS, which, given land and irrigation constraints, is a good ceiling. A problem arises when you consider that the same mandate calls for 16 billion gallons per year of cellulosic ethanol by 2022. Increasing fuel economy and engine constraints will make it impossible for the United States to consume all of the proposed 31 billion gallons of ethanol each year.

That would represent 23% of 2011 gasoline volumes, which will only increase with the new CAFE standards as American automobiles use decreasing amounts of gasoline. This, of course, means that American ethanol exports will be a major factor in international markets and serves as yet another reason for the United States to stand up to Brazil and Europe.

KiOR (NASDAQ: KIOR ) is just one company changing the ethanol landscape. To be fair, the company produces drop-in cellulosic gasoline and diesel — not ethanol. However, the company’s fuels will be blended with traditional petroleum fuels until guidelines for novel fuels are hammered out. KiOR’s first facility will reach full capacity of 11 million gallons per year in 2013, with another 35 million gallon facility scheduled for completion in 2014. Through catalyst upgrades, the two facilities could reach annual capacities of 18 million gallons and 55 million gallons, respectively.

It may not seem like much, but the company estimates that it could realize a profit of nearly $2 per gallon of fuel within a few years. How? Renewable identification numbers, or RINs, are bought and sold with renewable fuels, so the EPA can ensure that refiners are meeting their blending requirements. As long as market demand exists, RINs add value for producers such as KiOR. In total, the company estimates that the top 10 oil refiners will be required to buy $74.1 billion of renewable fuels under the current RFS.

Foolish bottom line

The industry has fallen on hard times, but it’s poised for at least another decade of tremendous growth. Since most cars in the United States can run on E15 blends, there is no excuse for inaction. Not enough to convince you? Consider: If displaced barrels of oil are taken into account, then ethanol exports provided the United States with a $54.3 billion trading surplus in 2011.

Tough to ignore when you put it like that.