Impact of Renewable Fuels Standard/MTBE Provisions of S. 1766
Uncertainty
State MTBE Restrictions
In this analysis, the S. 1766 and RFS/No MTBE Ban Cases are compared to a Reference Case that does not include the implementation of MTBE bans or restrictions in 13 States in the 2003 to 2004 time period. Although MTBE legislation or executive orders have already been passed in these States, there is considerable uncertainty as to when or if these requirements will be implemented. It has been well publicized that California officials have been considering postponing the 2003 ban on MTBE, since EPA officially denied California's oxygen waiver request, and given the high transitional costs reported in a recent study conducted by Stillwater Associates for the CEC. The California Energy Commission highlights the possibility of short-term supply shortfalls and associated price spikes if MTBE is banned without adequate lead-time.22
The long-run equilibrium analysis in this report is based on an assumption of sufficient lead-time for investments and an assumption of perfect foresight for investors. In other words, investment decisions are based on a certainty that a given policy change will occur in a given number of years. In reality, some market participants may respond to uncertainty by delaying investment decisions, increasing the likelihood of supply imbalances and price spikes during transition.
Ethanol tax exemption
Ethanol currently receives a Federal excise tax exemption of 53 cents per gallon, which is scheduled to decline to 52 cents in 2003 and 51 cents in 2005. Legal authority for the Federal tax exemption expires in 2007 and poses considerable uncertainty for this analysis. The exemption has been renewed several times since it was initiated in 1978 and is assumed to be extended at the 51-cent (nominal) level through 2020, in all cases of this analysis. The costs associated with the S. 1766 and RFS/No MTBE Ban Cases are highly dependent on this assumption. Without this tax exemption, ethanol-blended gasoline would cost consumers an additional 5.1 cents per gallon for a 10 percent blend of ethanol, and 2.9 cents per gallon for 5.6 percent RFG blends. Regardless of this higher ethanol cost, the RFS requirement leaves little flexibility to reduce ethanol blending. If the tax exemption is assumed to expire in 2007, the S. 1766 average price differential for all gasoline between 2006 and 2020 is projected to be 4.5 cents per gallon, compared to 4.0 cents per gallon when the exemption is assumed to continue. The average projected differential for RFG is 12.0 cents per gallon without the exemption in comparison to 10.0 cents per gallon with the continuation of the exemption.
Structure of credit trading
This analysis does not reflect any representation of the credit program mentioned in S. 1766 because of the lack of specific information about the structure of the program. For instance, it is not clear whether trading would occur nationally or only between regions, or how credits would be allocated to individual refineries. A credit program would be expected to provide flexibility to refineries that are unable to meet individual targets; however, it would not be expected to modify the aggregate results of this analysis except possibly to dampen the market demand for ethanol in the S. 1766 Case in those years that it rises above the level specified by the RFS. Given the specifics of the proposed credit program, the extent to which market demand for ethanol could be reduced by credit trading could not be quantified without an in-depth analysis of State tax incentives for ethanol blending.
The DI and Removal of the Rvp Waiver
Due to the rapid delivery schedule for results for this study, this analysis does not explicitly model the impact of either the reduction to 1200 DI or the removal of the 1 psi waiver for ethanol-blended conventional gasoline east of the Mississippi River, as specified in S. 1766. Both of these changes would tend to make it more difficult to blend gasoline with ethanol, at the same time more ethanol blending is being required by the RFS. Although the magnitude of the impact on the cost of gasoline blending is unknown, these changes would tend to increase costs relative to those reflected in this analysis. A report by the National Petroleum Council provided a wide range of cost estimates for reducing DI based on different assumptions.23 The NPC analysis was based on a proposal by the Alliance of Automobile Manufacturers which advocated a 1200 DI maximum at the retail level, in contrast to the current standard of 1250 at the refinery gate. Note that the S. 1766 provision would require 1200 at the refinery gate. The analysis assumed that gasoline would need to meet an 1100 DI at the refinery gate in order to meet 1200 at retail, and resulted in an estimated cost increase of about 7 cents per gallon. Sensitivity cases included in the NPC study that resulted in costs as low as one-half cent per gallon a 1150 at the refinery gate requirement is assumed and refineries are allowed the greatest flexibility in reallocating naptha streams.24
States’ Ability to Waive the Oxygen Requirement on RFG
S. 1766 grants Governors the ability to waive the oxygen requirement on RFG in their States but toxic emissions benefits must be maintained. The follow-up letter from Senator Murkowski of February 6, 2002 directed EIA to assume that States on the East and West Coast waive the oxygen requirement. This assumption makes sense because the RFG areas currently using MTBE are predominantly on the East Coast and in California, and would be the most likely to want a waiver. However, the feasibility of getting a waiver given the requirement of maintaining air toxic emissions is uncertain. Air toxic emissions from RFG are assumed to be maintained at current levels on average. In reality some refineries might require further investments to achieve this goal while others might not, resulting in more disparate impacts than reflected in this analysis.
Biodiesel Market Penetration
The biodiesel projections in this analysis reflect offline estimates of the amount of biodiesel that will be used to meet EPAct requirements. All cases of this analysis reflect growth in biodiesel from 5.4 million gallons in 2001 to 7.3 million gallons in 2020. In order to quantify the uncertainty associated with biodiesel, EIA developed "high biodiesel penetration" estimates that assume biodiesel becomes widely used as a lubricating agent for ultra-low-sulfur-diesel. The "high biodiesel penetration" estimates resulted in 139 million gallons of additional biodiesel and less ethanol used to meet the RFS requirement for 2006, 347 million gallons for 2012, and 625 million gallons for 2020.
Return On Investment
Investment decisions are based on an assumed return on investment (ROI) of 10 percent with a 10 percent hurdle rate. Although the assumed ROI is standard to refining industry analysis, returns have historically fallen below these levels. Based on EIA’s Financial Reporting Survey System the average estimated after-tax ROI for refiners between 1977 and 2000 was closer to 6 percent. A lower ROI/hurdle rate assumption would tend to make investment decisions less favorable and lower capacity expansion. Because the Reference, S. 1766, and RFS/No MTBE Ban Cases use the same investment assumptions, the impact of a lower ROI would be similar in all cases.