GoodFuels

[...] Go to the author’s original blog: If EPA Grants Waivers, Repercussions Would be Swift and Painful [...]

Mr. Waterman’s point about the reactions of a jittery market that is not grounded in reality is well made, but I found his approach laced with irony that might not have been intended.
The analysis would have more credibility if Mr. Waterman disclosed how he calculated very specific numbers like $5 national gasoline, $175 crude oil, $5.75 gasoline in California in one month and $6 gasoline nationally by Sept. 30.
The levels of food and feed cost increases cited by some proponents of the Texas waiver seem to have been pulled from thin air, but until Mr. Waterman shares the sources and methodology that produced his numbers, there is little reason to think they are any more substantial.
At a time when real answers are needed, I am dismayed to find this issue and many others associated with development of alternative energy sources over simplified and clouded by sound-bite debates. We desperately need illumination that comes only from credible data, neutral and transparent sources and fully disclosed methodology.
Mr. Waterman and others on all sides of this great energy debate may feel pressured to fight fire with fire. Perhaps this is the only approach that works in a sound-bite world. I applaud him for his commitment to public engagement in a vital arena, and urge him to help to elevate the caliber of debate by making solid data and transparent methodology the minimum fee for admittance.

I agree that transparency and background are essential, but due to space limitations my post was not the complete article. It is posted on our website, and will be in the week’s issue of our publication (thought I’d give myself a plug).
For the benefit of those that question how I arrived at $5.00 gasoline, and even higher as time passes, we focused on the 2006 July gasoline market, which was “jittery” because it was less than one year removed from Hurricanes Katrina and Rita, and adequate supplies were constantly scrutinized by commodity analysts. Dire forecast of another bad hurricane season flooded the media. As a result, gasoline held a substantial premium to crude oil, and while the entire energy complex rallied, gasoline outperformed all other energy contracts. It should be noted that during that gasoline season, there were no major supply disruptions or outages. There was simply hype, much like today. The difference is, an EPA waiver would be an immediate supply disruption. That’s real and not imagined.
Here’s another excerpt from the story:

“Currently, NYMEX gasoline carries a 3.8% premium to crude oil (effective 7/2/08) when crude oil settled at $143.57 while RBOB gasoline settled at $3.5494, or $149.07 per barrel. We looked back to July 2006, a year where hype about gasoline supplies drove values disproportionately higher to crude oil. In July, 2007, the average NYMEX crude oil price was $74.46 per barrel while gasoline averaged $2.26 per gallon, or $95.04 per barrel. Gasoline carried a 27.6% premium to crude oil that month.
If the EPA grants Governor Perry the waiver, and then moves to lower the mandated amount of ethanol to be used this year, it would be logical to apply the same premium (we suspect it will be higher) that gasoline held in 2006. That would mean with crude oil at $143.57 per barrel, gasoline would be priced at $184.00 per barrel, or $4.38 per gallon.
That immediately brings retail gasoline above $5.00 per gallon, well on its way to $6.00 per gallon. In fact, we calculate the national average retail price would be about $5.37 per gallon within a few weeks. On the West Coast, the average retail price would be about $5.85 per gallon.
And that would just be the beginning. Refiners, such as Valero, that have no crude oil production and have been squeezed by tight refining margins for the past year would be emboldened to expand rising profit margins. Their incentive to eliminate ethanol wherever possible would be driven by the growing value of gasoline to crude oil. The integrated majors would be pounding ethanol producers into the ground, also eliminating ethanol wherever possible. Cheap Brazilian ethanol? That implies oil companies actually embrace using ethanol, which they do not.
As gasoline rises, crude oil would also increase, but at a slower pace. Gasoline, based on the precedent set for commodity analysts in 2006 would maintain its premium to rising crude prices. This will bring the national average retail price closer to $6.00 per gallon by year end and to the above $6.60 per gallon in California.”

Thanks for the additional information on how you arrived at the numbers in your analysis.
It would be a service to readers if GoodFuels would post the entire article, or link to the full article when space limitations won’t allow that.

I agree that it would be a Disaster for America; but, you need to rework your numbers.

We only use about 600,000 barrels of ethanol/day. We would only lose about 300,000 barrels/day; and, it would only take about 260,000 b/d gasoline to make up for that.

Bad numbers will destroy your credibility among those you most need to convince.

You are correct. When I read your comment I panicked because this post was the lead story in our newsletter this week and I thought the error had been corrected. It was corrected in the newsletter, but unfortunately not in the original text file that was used to post to the blog on Wednesday.
It does not change the analysis as we worked from the data listed here. My apologies.
In our newsletter, the sentence read:
“U.S. refiners would suddenly be faced with finding roughly between 320,000 and 350,000 barrels per day or 13.8 million gallons of gasoline per day immediately. These events are definite if the EPA acts and Congress follows by removing the tariff on Brazilian ethanol.”
I understand your logic as to “volume” and that it would take less gasoline to replace the ethanol, but that would not even be a consideration among commodity traders in my opinion. In fact, the volumes of ethanol lost could be higher. Much depends on how the oil companies react. As we noted in the story, we feel the premium gasoline would hold over crude oil would be higher than in July 2006 simply because of what has transpired in the past six months in the oil markets. It is difficult to measure how much of a premium will be established by the hype that is certain to follow any waivers from the EPA. If anyone would like to see a copy of our newsletter, drop me a line at tom@oilintel.com.

I do believe that the American ethathanol industry would be destroyed if the EPA was to do this - and, not just the corn ethanol industry, but, also, the embryonic cellulosic industry. Anyone smart enough to have money to invest knows that there is no way the oil industry will distribute the product without mandates. It would be Over.

Right now, tax policies in Europe, China, and India favoring Diesel consumption have the global fuels markets discombobulated. In order to produce enough diesel they have to produce more gasoline than they want (you get approx 10 gallons of diesel, and 20 gallons of gasoline out of a barrel of oil.) This imbalance, Plus the pressure from Ethanol is pressuring the price/crack spread of gasoline seriously.

I have no doubt that the price of gasoline would “Bounce” much higher than one might first extrapolate just by looking at having to replace 300, or so, thousand barrels of ethanol. BTW, you need to contact NCGA. They’re hanging out there with those numbers, and need to get them down.

Thanks for what you do. Good Luck.

It is time for this “WELFARE MOM” industry to dissolve. The government doesn’t help anyother industry like they do this one.

That’s right, Bubba. We sent those 150,000 U.S. troops to Iraq, at a cost of $150,000,000,000.00/Yr to protect the date palm trees, and get a neat suntan.

It’s very interesting that historically, gasoline has had an almost 98% correlation to crude oil prices. In the summer of 2007 this correlation started diverging and is currently around 73%. In fact, at the higher correlation gasoline would be well over $5.00/gal. One reason this correlation has slipped to 73% is the downward pressure being exerted by ethanol in the marketplace. Reducing ethanol demand by removing the mandate should help push gasoline back to the 98% correlation.

In fact, ethanol which historically sold at a premium to gasoline (due to the blenders credit) also inverted last summer and is now selling at substantially less than gasoline. One could argue that the U.S. does not need any RFG mandate…market forces should demand that ethanol be blended to reduce gasoline prices. If Congress wants to do something constructive, they should eliminate the blenders credit; which is pocketed by the blenders, not the ethanol producers, nor the refiners. The blenders are normally middle men that should not be getting such a huge incentive to blend. The market pricing will dictate how much ethanol will be blended. As long as ethanol is significantly cheaper than gasoline, the blending should be voluntary and maximized. Reducing the ethanol tariff would help ensure that ethanol is priced lower than gasoline.

All the talk about a waiver should be put in perspective. It is highly unlikely that a waiver will be granted. Even if it were, it is likely that it would be short term, not something permanent.

Aside from that, a waiver would not mean an immediate drastic cut in ethanol blending.

I agree that it is unlikely that the EPA would grant the waiver, but I strongly disagree that it would not mean an immediate drastic cut in ethanol blending if they do.
If the EPA were to grant a waiver, it would be based on the intent of the request for it—the reduction of the amount of corn-based ethanol consumed.
Any waiver would have to include a reduction in the Reformulated Gasoline (RFG) oxygenate requirements, otherwise there would be no guarantee that less ethanol would be used. We estimate that RFG for 33% of the motor fuel pool, or about 3.1 million barrels per day, most of which has a 10% ethanol blend. That would be an immediate drop of about 155,000 bpd of ethanol consumption in RFG markets alone. That equates to 6.5 million gallons per day less ethanol used. In July, we’re estimating ethanol demand of about 682.0 million gallons, which means about 29.6% less ethanol would be used in a typical month if the EPA cut the oxygenate requirement in half.
Annually, at the rate discretionary blending is growing, and suddenly E-85 demand that is growing more rapidly than we anticipated, there is a chance that by year-end ethanol consumption could reach 9.5 billion gallons on an annualized basis.
Such a waiver would lower consumption by a minimum of 2.4 billion gallons per year, and as we stated originally, that would just be the start.
However, as you stated, it’s unlikely they will grant the waiver, and one of the major reasons will be the agency’s unwillingness to reduce the oxygenate blend requirements, because that opens a different can of worms.

[...] As we noted in an earlier post, and contrary to Verleger’s contention, a reduction in the ethanol mandate would jettison not just gasoline prices, but crude oil and therefore diesel prices as well. His notion that cutting the mandate will force refiners to ramp up production is true, but to suggest that as refiners ramp up, producing more gasoline, and diesel will lower crude oil prices is unjustifiable. Frankly, refiners are not interested in producing more gasoline. [...]

Mr. Waterman’s discussion about the Oxygenate requirement is interesting. My question is what other additives could be used to fill in or smooth this transition? Iso-octane, methanol etc are all used in the fuel supply and could perhaps fill in. Maybe the RFS does not include these, but it seems like congress might be able to mandate some other alternative (a la MTBE) that would be able to offset some of the demand issues Waterman highlights.