5. Ethanol and Biodiesel Provisions

A. Renewable Fuels Standards and Elimination of MTBE

Both Senate and House energy bills require a renewable fuels standard (RFS) of 5 billion gallons by 2012 in the Senate bill and by 2015 in the House bill. In addition, the Senate energy bill requires the phase-out of MTBE in four years. The Senate version of this provision is discussed below, followed by the House version.

1. Senate RFS/MTBE Ban (Senate 820, 833, 834)

Sections 820, 833, and 834 of the Senate bill contain provisions essentially identical to the Senate Energy Bill as amended (H.R.4) in the Fall of 2002. Highlights of the Senate provisions regarding the RFS and a nation-wide MTBE phase-out are listed below:          

Printer Friendly Version Year Amount 2004 2.3 billion gallons per year 2005 2.6 2006 2.9 2007 3.2 2008 3.5 2009 3.9 2010 4.3 2011 4.7 2012 5.0

1) Create a renewable fuels program requiring the use of the following volumes in the total gasoline pool:

          and for every one gallon of cellulosic biomass ethanol⁵⁹ used provide a 1.5-gallon credit

2) Eliminate the RFG oxygen requirement and require southern-grade RFG standards nation-wide (Section 834)

3) Create a renewable fuels credit trading program (Section 820)

4) Phase out the use of MTBE in four years (Section 833), but:

• Allow States to “authorize the use of” MTBE if they want to continue using MTBE;

• Provide assistance to merchant MTBE producers to convert their facilities to other gasoline blending components.⁶⁰

Impact of Senate RFS/MTBE Ban

In 2002, EIA performed a study, Renewable Motor Fuel Production Capacity Under H.R.4, of Senate bill H.R.4 on the impact of an RFS and MTBE phase-out.⁶¹ The study used the AEO2002 as a Reference Case.⁶² In the analysis, it was assumed that the Nation would use 5 billion gallons per year of renewables (mostly ethanol) in transportation fuels by 2012. Texas was assumed to seek and receive a waiver on MTBE phase-out, resulting in 87 percent of the Nation’s MTBE being phased out in four years. All other major H.R.4 provisions were also considered, including the elimination of the oxygen requirement in RFG and providing financial assistance for merchant MTBE plant conversions. The ethanol credit trading provision was not modeled;⁶³ and the tax credit for blending ethanol into gasoline was assumed to continue at $0.51 (nominal) per gallon after 2007. Because the Senate bill is essentially the same as H.R.4, the 2002 EIA study is used for this analysis, with the understanding that the phase-out of MTBE would be delayed by two years (assuming an energy bill is passed in 2004).

Figure Data

Figure Data

Figure Data

Figure 2 shows the projected impact of the Senate bill on renewables consumption, compared to a case when MTBE is banned in 17 States.⁶⁴ For 2004 and 2005, refiners are likely to provide RFG blended with ethanol for those States banning MTBE. In 2006 and 2007, the RFS volume requirements would drive the demand for renewables (mostly ethanol). In 2008, the phase-out of MTBE would briefly require more renewables than specified by the RFS. After 2008, the RFS is projected to be the driving factor for renewables demand in the Nation.

Figures 3 and 4 show the projected price impacts on RFG and average gasoline, respectively. The average RFG price increase under the Senate bill is expected to be about 3.6 cents per gallon when compared to the 17-State MTBE ban case in which about 45 percent of the MTBE would be phased out by 2004 by State legislatures. All gasoline prices are expected to be less than 1 cent per gallon higher than the 17-State MTBE ban case. The impact on RFG prices would be mainly from blending ethanol into the RFG. Because in doing so, relatively cheap gasoline blending components such as butanes and pentanes (highly volatile, yet also high in octane) must be removed to make room for ethanol (because of ethanol’s tendency to increase the gasoline vapor pressure). In addition, to make up for the volume loss due to an MTBE ban, more alkylate and reformate (petroleum-based gasoline blending components high in octane, but more expensive than either MTBE or ethanol) would need to be produced.

The current excise tax credit for ethanol blending into gasoline is $0.52 per gallon of ethanol, phased down to $0.51 per gallon for 2005 and 2006, and discontinued after 2007. This ethanol tax credit has been extended many times in the past by the U.S. Congress. Thus, EIA assumes this tax credit will continue in the Annual Energy Outlook, as well as all relevant special studies. If the ethanol tax credit is discontinued, it is expected that the price of ethanol-blended gasoline would be higher by the amount of the tax credit itself. For example, a 10-percent (by volume) ethanol-blended RFG would cost about 5.1 cents per gallon more (10 percent times $0.51 per gallon) without the tax credit than with the credit and a 5.7 percent (by volume) ethanol-blended RFG would cost 2.9 cents per gallon more (5.7 times $0.51 per gallon). Because not allgasoline would be blended with ethanol, the above estimates would be applicable only to gasoline blended with ethanol.

Ethanol demand under the Senate bill is projected to be 3.5 billion gallons in 2006 and 3.6 billion gallons in 2007. According to the latest Renewable Fuels Association (RFA) data, the current ethanol production capacity in the Nation is 3.4 billion gallons, with an additional 0.5 billion gallons capacity under construction.⁶⁵ Additional capacity would be needed to reach the 5 billion gallons requirement assumed in this analysis, but since ethanol plants only take about two years to build, constructing them is not expected to be a problem. As a result, the supply of ethanol under the Senate bill is not expected to be an issue in terms of production capacity.

2. House RFS (House 17101 – 17104)⁶⁶

Sections 17101 to 17104 of the House bill require that 5 billion gallons of renewable transportation fuels be consumed by 2015. The House bill does not include a Federal MTBE ban, but would provide the same transition assistance for merchant MTBE plant conversions as the Senate bill. In addition, the House bill would waive the 2-percent oxygen requirement (by weight) for RFG. The following is a comparison of the main similarities and differences between the RFS/MTBE provisions of Senate bill and the House bill:

1. Create a renewable fuels program requiring:

Printer Friendly Version YEAR Amount (billion gallons per year) House Energy Bill (H.R.6.EH, Section 17101) Senate Energy Policy Act of 2003 (H.R.6.EAS, Section 820) 2004 - 2.3 2005 2.7 2.6 2006 2.7 2.9 2007 2.9 3.2 2008 2.9 3.5 2009 3.4 3.9 2010 3.4 4.3 2011 3.4 4.7 2012 4.2 5.0 2013 4.2 Renewable fuels as a fixed proportion of total annual gasoline consumption based on 2012 data. 2014 4.2 2015 5.0 2016 and beyond Renewable fuels as a fixed proportion of total annual gasoline consumption based on 2015 data.

Figure Data

Figure Data

Figure Data

2. Eliminate the RFG oxygen requirement and require southern-grade RFG standards nationwide (Section 17104), essentially the same as the Senate bill.

3. Create a renewable fuels credit trading program (Section 17101), essentially the same as the Senate bill.

4. Provide assistance to merchant MTBE producers to convert their facilities to making other gasoline blending components (Section 17103).

5. Safe Harbor provision for both renewable fuels and MTBE (Section 17102) in the House bill; but only for renewable fuels in the Senate bill.⁶⁷

Impact of House RFS

The discussion of the House RFS is based on the AEO2003 68 assumptions, in which 17 States would ban MTBE starting in 2004, with a 2-percent oxygen requirement for RFG remaining intact. Figure 5 shows the relative ethanol consumption of the two RFS schedules specified by the Senate and the House, respectively. Both RFS-only cases are compared to the Reference Case. In the Reference Case, the ethanol is blended into both RFG and oxygenated gasoline.⁶⁹ The total ethanol consumption in the Reference Case is expected to reach 3.30 billion gallons per year by 2012 and 3.48 billion gallons per year by 2015.

With the Senate RFS schedule, total ethanol consumption is projected to reach 4.90 billion gallons per year by 2012 and 5.40 billion gallons per year by 2015. Due to the 1.5-gallon credit for 1 gallon of cellulose-based ethanol, and some small amount of biodiesel supplied, the total renewable fuels consumption would be slightly less than the 5 billion gallons per year required in 2012. If the Senate bill only required an RFS without an MTBE ban, most of the additional ethanol beyond the Reference Case would be blended into conventional gasoline in the Midwest. By comparison, the House RFS requirement takes step-wise increments. In this case, the RFS would overtake the impact of 17-State MTBE bans after 2008. The difference from the Reference Case is relatively minimal before 2012; then the disparity grows larger with the total ethanol consumption reaching 4.88 billion gallons per year by 2015.

Figure 6 shows the price impact on RFG for these two RFS-only cases. Under an RFS, the average RFG price is not expected to increase more than 1.5 cents per gallon. The delay in RFS in the House version would moderate the increase in RFG prices. Between 2008 and 2014, this delay is projected to reduce the impact on RFG prices by an average of 0.5 cents per gallon. However, by 2015 the advantage of a delayed RFS schedule would be diminished and the price difference between the two cases would also become smaller (about 0.2 cents per gallon by 2015).

If the ethanol tax credit is discontinued, it is expected that the price of ethanol-blended gasoline would be higher by the amount of the tax credit itself. For example, a 10-percent (by volume) ethanol-blended RFG would cost about 5.1 cents per gallon more (10 percent times $0.51 per gallon) without the tax credit than with the credit and a 5.7 percent (by volume) ethanol-blended RFG would cost 2.9 cents per gallon more (5.7 times $0.51 per gallon). Because not allgasoline would be blended with ethanol, the above estimates would be applicable only to gasoline blended with ethanol.

Figure 7 shows the price impact on average gasoline. An RFS is not expected to increase the average gasoline price by more than 0.5 cents per gallon. If the ethanol tax credit were not extended, the national average gasoline prices would be an additional 1 to 1.5 cents per gallon higher under an RFS. However, the increase in the national average price would be lower in magnitude then the RFG price increase. Again, the delay in RFS in the House version would moderate the increase in average gasoline prices. The difference remains relatively uniform after 2008 at about 0.1 to 0.2 cents per gallon. This is due largely to the fact that most of the additional ethanol required would be blended into the conventional gasoline, which accounts for about two-thirds of the market.

B. Biodiesel Credits

1. Biodiesel Credit Expansion (Senate 817)

The Energy Policy Act of 1992 (EPAct) requires certain Federal, State, and alternative fuel provider-owned light-duty-vehicle fleets to gradually switch to alternative-fueled vehicles. Seventy-five percent of new light-duty vehicles purchased by Federal and State fleets must be capable of running on alternative fuels. Ninety percent of new light-duty vehicles purchased by alternative fuel providers must be capable of running on alternative fuels. The Energy Conservation and Reauthorization Act of 1998 gave fleet operators the option of using biodiesel credits to offset vehicle purchase requirements. A biodiesel credit is obtained by using 450 gallons of biodiesel blended into petroleum diesel at 20 percent or less of total volume. Previously, up to half of a fleet’s alternative-fueled vehicle purchase requirement could be satisfied using biodiesel credits. Section 817 of the Senate bill allows EPAct fleets to use biodiesel credits to offset all required alternative-fueled vehicle purchases through 2005.

Impact of Biodiesel Credit Expansion

Federal fleets covered under EPAct purchased 20,799 light-duty vehicles in fiscal year 2000. Three-quarters of these vehicles, or 15,600, must be capable of running on alternative fuels. To offset this number of vehicle purchases with biodiesel credits, about seven million gallons of neat biodiesel would be required. Another 6.5 million gallons of neat biodiesel would be needed to fully offset 14,453 alternative-fueled vehicle purchases required of State and alternative fuel provider fleets in model year 2001. It is difficult to forecast incremental biodiesel demand under Section 817 of the Senate bill, because the vehicle purchases of such a small group are not likely to follow a smooth trend. For example, State fleets and fleets owned by alternative-fuel providers purchased 22 percent fewer light-duty vehicles in model year 2001 than in model year 2000.

Another consideration is that the EPAct’s vehicle-purchase requirements have never been satisfied by all covered fleets. Most of the covered fleets belong to the Federal or State governments. Costs for alternative fuels and alternative-fueled vehicles are higher than costs for conventional fuels and vehicles, yet no funding is appropriated specifically to defray the added costs. Compliance with the EPAct would therefore reduce funding available to carry out the agencies’ functions. In addition, the EPAct has never been rigorously enforced, so it is not surprising that many fleets are not in compliance.

C. Federal Purchasing Requirements

1. Federal Agency Purchasing Requirement for Ethanol and Biodiesel (Senate 820A)

Section 820A of the Senate bill requires Federal agencies to purchase gasoline with 10-percent ethanol, if supplies are “reasonably available” at a “generally competitive price”. This provision also requires Federal agencies to purchase biodiesel blends of at least 2 percent by volume for diesel vehicles that are centrally fueled, beginning five years after the bill is enacted. The required minimum volume percentage of biodiesel increases to 20 percent ten years after the bill is enacted.

Impact of Federal Agency Purchasing Requirements

The ethanol blend purchase requirement is not likely to have much of an effect, due to limited availability of 10-percent ethanol blend gasoline and due to the small size of the civilian Federal vehicle fleet. The choice between 10-percent ethanol blend and gasoline without ethanol is offered only in geographic areas that use conventional gasoline. Conventional gasolines with and without ethanol are fungible, and consumers are assumed to be indifferent between the two. If Federal agencies increase their consumption of gasoline with ethanol, other entities will decrease their consumption by a corresponding amount. In some geographic locations, all gasoline is required to contain ethanol, though not all at fractions of 10 percent by volume. RFG in the Midwest is blended with 10-percent ethanol. California Air Resource Board gasoline, however, is effectively limited to 5.8-percent ethanol, and RFG in the Northeast is expected to be 5.8-percent ethanol as well. There is obviously no gasoline choice for agency administrators to make in these regions.

The biodiesel purchase requirement would take effect in 2008, at the earliest. A 2-percent biodiesel blend currently sells for about 2 cents per gallon more than diesel; a 20-percent biodiesel blend sells for about 18 cents per gallon more than diesel. It is unlikely that an 18-cent-per-gallon premium would be considered “generally competitive.” Some agencies might be willing to pay the premium for 2-percent biodiesel, but the more diesel that the agency consumes, the more price-conscious it is likely to be. And agencies might already plan to use 20-percent biodiesel blend to satisfy EPAct requirements. For these reasons, the biodiesel purchasing requirement is also not likely to have much effect.

D. Ethanol From MSW

1. Commercial Byproducts from Municipal Solid Waste Loan Guarantee Program (Senate 820B and House 17108)

Section 820B of the Senate bill and Section 17108 of the House bill direct the Secretary of Energy to establish loan guarantees for the construction of facilities to convert municipal solid waste into ethanol or other commercial products.

Impact of Loan Guarantee Program

A subsidiary of Masada Resource Group is awaiting final approval to construct such a facility in Orange County, New York. While the economics appear to be favorable, Masada has encountered local opposition to its permitted emissions levels that has successfully delayed construction for the past several years.⁷⁰ Construction is expected to finally begin this year, and the plant is expected to begin operation in 2005.⁷¹

The Federal loan guarantee serves to eliminate the risk premium that might be required to finance new technology. But this effect is only temporary. The risk of investment in municipal solid waste-to-ethanol technology will be reduced several years after Masada begins operating, in that the economics of the technology will be known to a much greater degree. Once the profitability of municipal solid waste-to-ethanol is known, there will be no risk premium assessed for new technology, and the loan guarantees will have little or no effect.

E. Biodiesel Incentives

1. Incentives for Biodiesel (Senate 2008)

Section 2008 of the Senate bill establishes income tax credits of $1.00 per gallon and $0.50 per gallon (nominal dollars), respectively, for producers of biodiesel from virgin oil and nonvirgin oil. Producers of biodiesel from virgin oil can take an excise tax exemption of $1 per gallon (nominal dollars) of biodiesel for blends up to 20 percent by volume instead of the income tax credit. These credits expire after 2005.

Impact of Biodiesel Incentives

The excise tax exemption in conjunction with the Department of Agriculture’s Commodity Credit Corporation (CCC) grants (available through fiscal year 2006) could result in large increases in biodiesel production for the fiscal years 2004 to 2006. In May 2003, Agriculture issued revised rules for the CCC bioenergy program. Although the funding formula changed, the payments for increased virgin oil biodiesel production remained about the same as under the previous rules. The payment for nonvirgin oil biodiesel is new under the revised rules. Another new benefit from the bioenergy program is base payments for biodiesel production.

The National Biodiesel Board⁷² claims that dedicated biodiesel plants with capacity of 60 to 80 million gallons have already been built.⁷³ In addition, 200 million gallons of capacity are available from oleochemical producers, such as Proctor and Gamble. These firms make methyl esters of fats and oils for use in consumer products such as soaps and detergents. The virgin feedstock of choice is soybean oil. The nonvirgin feedstock of choice is yellow grease, consisting mostly of used cooking oil and rendered animal fats. This analysis assumes that the competing uses for yellow grease limit output of biodiesel from this source to 100 million gallons per year.

From fiscal years 2004 through 2006, soybean oil biodiesel receives an income tax credit or excise tax exemption of 90 to 94 cents per gallon; yellow grease biodiesel receives an income tax credit of 45 to 47 cents (2001 cents). In addition, the CCC payments for expansion of biodiesel production are $1.43 to $1.46 for soybean oil biodiesel and 88 to 90 cents for yellow grease biodiesel. The Commodity Credit Corporation payments and the proposed income tax credit or excise tax exemption effectively reduce the variable cost of additional soybean oil and yellow grease biodiesel to 21 and 30 cents per gallon, respectively, in fiscal year 2004 (see Tables 17 and 18). But additional units produced in fiscal 2004 become base units in fiscal 2005 and 2006 and, as such, are eligible only for much smaller, and declining, base production payments. Because the Commodity Credit Corporation subsidies and the tax exemptions under Section 2008 are temporary, they are likely to result in large but unsustainable increases in biodiesel production. In the absence of any further policy changes, EIA projects biodiesel production of about 33 million gallons in calendar year 2004.

Ethanol and Biodiesel Provisions - Tables

Notes and Sources