The Past, Present, and Future of Ethanol

In our last 2 blogs, the past to the present of ethanol is discussed -- looking at the health origins of why its use was needed in the first place, and ethanol's continuing importance today in reducing U.S. spending on foreign oil (OPEC).

Today we will look at the future, but first let's do a quick review:

Health Benefits

War, Terrorism, China, & Oil

Origins in Health Benefits: This blog post discusses some key aspects of gasoline formulation and how a blend rate of ~10% ethanol (E-10) replaced previously used health threatening additives (lead for octane requirements, MTBE for fuel oxygenation). These health benefits from cleaner fuels (reducing rates of cancer, child autism, asthma, etc.) have been firmly established in medical science for decades.

Consequences of OPEC Oil Dependence: This blog "connects the dots" of past and continued U.S. dependence on Mid-East oil to:

Terrorism & War: From the attacks of 9/11 to now Syria, the
    dirty footprint of oil money to fund/cause these conflicts always
    emerges as a common denominator.

Financial Strength of U.S.: Over the past 30 years, the U.S. has
    reportedly now spent ~$8 trillion to protect the flow of oil in the
    Mid-East. In a context of the current debt ceiling debate, this
    would represent about one-half of all outstanding U.S. debt.

Opportunism by China in the Middle East: The biggest benefactor
    of U.S. "blood and treasure" is China, as they are now the #1
    customer of oil from Iraq and other Persian Gulf Countries.

Economic Strength of the U.S.: Historically, the two primary
    causes of the massive U.S. trade deficit has been imports of
    foreign oil and Chinese products -- resulting in the vast transfer
    of American wealth and jobs to the Middle-East and China.

Understanding the Drivers of Ethanol's Future. Of total gasoline currently consumed in the U.S., ~10% is blended with ethanol.⁽¹⁾ Ethanol at E-10 blending levels represents the lowest cost clean-fuel option to meet health standards for needed non-lead octane and oxygenate requirements -- with estimated consumer savings of ~34¢ per gallon below other available options.⁽²⁾

But with the growth rate in gasoline consumption (needing E-10) expected to remain flat (less consumer demand as a result of greater auto MPG, the economic recession, and oil prices above $100/bbl), any meaningful volume increase in ethanol use will only occur with blending rates above 10% (E-15 to E-85).

Under the Renewable Fuel Standard (RFS) "targeted" increases in ethanol use are scheduled (below graph). However, these "targets" are not "set-in-stone" mandates. The appropriateness of required yearly volume levels are reviewed each year, and must consider current market factors such as price and available biofuel supply.

Since the use of E-10 is inextricably tied to compliance with clean-fuel requirements, it is highly unlikely to inconceivable that the use of E-10 could be "eliminated or totally voluntary". Questions that anti-ethanol proponents never address are: "What would they replace it with? -- and what would be the cost?"

What is highly in doubt however, is the implementation of RFS requirements above a current 10% blending level (called the blend wall) either by the EPA (which administers the RFS Program), or through Congress (new legislation to modify or even eliminate the RFS). Since blending levels above ~10% are not required to meet current clean-fuel requirements, the argument for increased ethanol use changes -- from health benefits to primarily price and availability.

As this "blend wall" is approached, we are currently seeing this "price dynamic" being played out, with reports that the EPA will likely reduce required 2014 ethanol levels below the "targeted" RFS levels.

Understanding the basics of this "pricing dynamic" for fuel blends >10% (E-15 to E-85) is pretty easy. Per the EPA, ethanol (E-100) contains ~30% less energy content than gasoline. Thus, simply comparing the market price of ethanol versus gasoline is an un-useful "apples to oranges" comparison. An adjustment must be made for this inherent "energy content penalty" (less MPG).

The below graphic illustrates this, where ethanol (E-100) is currently 83¢ per gallon cheaper than gasoline ($2.64 minus $1.81). Applying the "energy content penalty", the price point where a consumer would be currently indifferent to gasoline or ethanol would be an ethanol cost of $1.85 per gallon ($2.64 times 70%).

Currently, the price of ethanol represents a very small savings of 4¢ per gallon. But for much of 2013, ethanol's "adjusted" cost has been much higher than gasoline -- as a result of high corn feed-stock prices from drought in the Mid-West.

Certainty and Uncertainty of the Future.   It is believed that the future of ethanol and bio-fuels will likely follow one of two paths:

Low Growth -- E-10 continues to be used in almost all gasoline
    to comply with clean-fuel regulations. E-15's use is limited
    in the U.S., with market growth coming primarily from Mid-
    western States (where most U.S. ethanol is produced).

High Growth -- Demand for very high levels of ethanol (E-85
    and even E-100) increases dramatically throughout the U.S. as a
    result of technology advancements in:
      (1) Cellulosic ethanol production that significantly lowers costs;
      (2) Automotive engineering (engine turbo-charging) that
            reduces the "MPG penalty" of ethanol.

There are two areas of future technology advancements to keep an eye on. The first is in the development of cost effective enzymes to break down celluloic feedstocks (e.g., switchgrass, energycane, crop waste, etc.) into fermentable sugars for ethanol production. As the above chart on the Renewable Fuel Standard illustrates, cellulosic (non-corn feedstock) ethanol was always envisioned as the long-term future of ethanol.

One type of feed-stock source that could buy time until enzyme development reaches its full potential is the use of "bridge crops" (such as drought resistant sweet sorghum) using a hybrid approach of plant sugar (brix) extraction and also enzyme technology on the crop's waste steam (i.e., bagasse, presscake).

A second area to watch is in automotive technology advancements of the "incredible shrinking engine size". We are already seeing early glimpses of this technology being introduced into the marketplace with Ford's "Eco-boost engines". A key building block in understanding ethanol's role in engine advancements of "turbo-charging" is octane content:

Ethanol Vs. Gasoline Comparison:	Octane Rating
Ethanol (E-100)	113
Unblended Gas (E-0)	84

While our future blogs will get "Geeky" in discussing turbo-charging advancements -- The basic concept is the development of smaller engines requiring high octane levels (as found in ethanol) that generate greater power. A simplistic "Average Joe" visualization would be putting an engine the size of a Volkswagen Beetle into a large SUV, and providing the same performance to the driver.

With smaller engines having less weight and increased efficiency (e.g., running cooler), Ricardo Engines (a leader in turbo-charging) suggests that ethanol's (E-100) current "MPG penalty" could be reduced from 30% to 14%. Applying this lower "MPG penalty" to today's gasoline prices would result in current ethanol (E-100) savings of 46¢ per gallon.

Note on MPG Penalty: The highest blend of ethanol sold in retail gasoline is E-85. In AAA's daily tracking of retail gas prices, a MPG Penalty for E-85 of 24.018% is used (vs. ~30% for E-100). E-85's MPG Penalty using the potential Ricardo efficiency gains is 10.418% (vs. 14% for E-100).

---

Current Ethanol Wholesale Commodity Price
Current Gasoline Wholesale Commodity Price
Current E-85 Retail Prices by State
Current National Average Gasoline Prices

Gas Vs. Ethanol Prices -- 2012 Review

The below pink line is the commodity/wholesale price of 100% ethanol (E-100). But as a N.Y. Times story explains, ethanol gets less MPG than gasoline. The green line adjusts (increases the price) for the lower energy efficiency of ethanol, allowing an "Apples to Apples" comparison with the wholesale price of gas (blue line). The red line is the average of all U.S. retail pump prices of regular grade gasoline.A good "Rule of Thumb" for U.S. consumers in making ethanol decisions at the pump (ethanol blends above 10%, such as E-85) is that used in Brazil. In Brazil, flex-fuel drivers generally buy gasoline when the price of ethanol is more than 70% of gasoline, and buy ethanol when the comparable price is lower. For example, during the Spring, U.S. ethanol was a good deal (as low as 65% of the wholesale RBOB gasoline price). But for most of the year, ethanol has been more expensive on a MPG adjusted basis.It should be noted however, that this current "Rule of Thumb" may soon change as a result of on-going breakthroughs in engine engineering design (e.g., Ricardo Engines Turbo Boost). We will address this improving fuel efficiency of flex-fuel engines (as well as aviation bio-fuels being tested by the U.S. Military) in future blog posts.

The below chart gives an illustration of just how significant these improvements in engine efficiency could be -- where the only data changed from the original chart is the use of efficiency data that Ricardo Engines' is currently achieving in field tests -- where adjusted ethanol prices are a clear winner.

Retail Gasoline Prices: The below map shows the current national average (above chart's red line) by region.

Current Retail Gasoline Prices by Region At year-end 2012, wholesale and retail gas prices were about equal to a year ago (2¢ higher) with ethanol trading 7¢ per gallon lower.

Ethanol Prices: A simple linear regression statistical analysis shows that U.S. ethanol prices can be almost entirely explained (a R² of .91) by the commodity price of #2 yellow corn (which is not used for human consumption). The extreme volatility in ethanol prices since July is the result of a series of initial over-reactions and then corrections in corn futures markets as to the actual severity of the drought in the Midwest on crop yields. As a result of this price increase, ethanol production levels have decreased up to 20% since July. With low or negative profit margins, many ethanol plants have either reduced output or temporarily shut down entirely.

As the below chart reflects, high corn feedstock costs are clearly having an adverse impact on U.S. ethanol production. The levelized (orange line) represents the theoretical monthly bio-fuel production level necessary to meet the yearly Renewable Fuel Standard's requirement of 13.95 billion gallons of bio-fuel use for 2012. In every month except January, actual production (purple line) was below the orange line.

Because of this shortfall in new bio-fuel production, the RFS was met using a combination of 3 market mechanisms: (1) Using RIN Credits from the previous year (where bio-fuel use exceeded RFS requirements); (2) Drawing down of existing bio-fuel inventories; (3) Bio-fuel imports (from Brazil).

During 2012, we agree with two studies (here and here) that ethanol use has had a negligible impact on retail gas prices. This is because the greatest use of ethanol is a 10% or less blend with gasoline (E-10). Year to date, 10% of the cumulative price differential between the wholesale price of ethanol (adjusted for efficiency) and gasoline is ~3¢ per gallon. Also recognizing that without ethanol, fuel blenders would have to substitute higher cost sources of octane additives, the price differential is probably only about 1¢ per gallon.

However long term, Supporters of ethanol must recognize a clear reality. As long as the adjusted price of ethanol (green line) is higher than the wholesale price of gasoline (blue line), ethanol use will always be criticized and lack acceptance by the U.S. Public even at low E-10 blend levels.

This lower cost can happen in two ways: (1) lowering ethanol's production cost through cheaper feedstocks and better conversion technologies (e.g., cellulosic enzymes); (2) greater auto engine efficiency utilizing ethanol's higher octane levels (smaller engines using turbo-boost).

The Renewable Fuel Standard: The recent volatility and price spikes of ethanol from the Mid-western drought is a good illustration that the future of ethanol is not from corn. Feedstock and production technology diversity is needed from other sources (sorghum, cellulosic). In passing the Renewable Fuels Standard requiring ethanol blending with gasoline, Congress recognized this point by capping the use of corn feedstocks (which current ethanol production has almost approached).

For all the criticism that ethanol use receives, what is generally lost by the general public is the amazing success story that has been so quickly achieved in accomplishing national goals for greater energy security and job creation. This achievement would not have been possible without using the existing corn industry's infrastructure in the Mid-west.

Did you know?: The Renewable Fuels Standard has resulted in a fundamental shift in gasoline formulation. The refining industry has now moved to using predominantly 84 octane "conventional" gasoline and then blending it with higher octane ethanol (around 113) to produce the 87 octane gasoline that is the most popular level with consumers. This change in refining practices is not easily reversed. While other octane enhancers could be used, ethanol's price make it the current lowest cost octane source of choice by refiners.

Data Sources:
Per numerous Sources (DOE, EPA), E-10 (10% ethanol) has ~3% less efficiency than E-0 (zero ethanol). Ethanol on a "net basis" has less BTU content, but higher octane.

-- Wholesale Ethanol prices are from the Chicago Board of Exchange.
-- Wholesale Gasoline prices are from the Chicago Board of Exchange.
-- Retail Gasoline prices are from Bloomberg's survey of national gas prices.
-- Corn Feedstock costs are calculated from Chicago Board of Exchange.
-- Distiller's Dried Grains (DDG) Futures (100 short tons) from CBOE.

-- Wholesale Gasoline Real Time Daily Trading Data.
-- Wholesale Ethanol Real Time Daily Trading Data.

Current Gas Vs. Ethanol Prices (Oct. 19, 2012)

The below pink line is the commodity/wholesale price of 100% ethanol (E-100). But as a N.Y. Times story explains, ethanol gets less MPG than gasoline. The green line adjusts (increases the price) for the lower energy efficiency of ethanol, allowing an "Apples to Apples" comparison with the wholesale price of gas (blue line). The red line is the average of all U.S. retail pump prices of gasoline.Retail Gasoline Prices: As the below map shows, the current national average (above chart's red line) is skewed upward by spikes in Western prices caused by current refinery problems in California (fires, questionable maintenance).

Current Retail Gasoline Prices by Region The good news is that for most of the U.S., each October marks the annual date where gasoline refiners start switching production to cheaper fuel blends for cooler weather. During summer months, higher cost blends are used to reduce air pollution (e.g., smog). Thus excluding any unforeseen major market event (e.g., war in the Middle East) consumers should expect to see a decrease in pump prices through next Spring.

Ethanol Prices: A simple linear regression statistical analysis shows that U.S. ethanol prices can be almost entirely explained (a R² of .91) by the commodity price of #2 yellow corn (which is not used for human consumption). The extreme volatility in ethanol prices since July is the result of a series of initial over-reactions and then corrections in corn futures markets as to the actual severity of the drought in the Midwest on crop yields. As a result of this price increase, ethanol production levels have decreased ~20% since July. With low or negative profit margins, many ethanol plants have either reduced output or temporarily shut down entirely.

During 2012, we agree with two studies (here and here) that ethanol use has had a negligible impact on retail gas prices. This is because the greatest use of ethanol is a 10% or less blend with gasoline (E-10). Year to date, 10% of the cumulative price differential between the wholesale price of ethanol (adjusted for efficiency) and gasoline is less than 3¢ per gallon. Also recognizing that without ethanol, fuel blenders would have to substitute higher cost sources of octane additives, the price differential is probably only about 1¢ per gallon.

However long term, Supporters of ethanol must recognize a clear reality. As long as the adjusted price of ethanol (green line) is higher than the wholesale price of gasoline (blue line), ethanol use will always be criticized and lack acceptance by the U.S. Public even at low E-10 blend levels.

This lower cost can happen in two ways: (1) lowering ethanol's production cost through cheaper feedstocks and better conversion technologies (e.g., cellulosic enzymes); (2) greater auto engine efficiency utilizing ethanol's higher octane levels (smaller engines using turbo-boost).

The Renewable Fuel Standard: The recent volatility and price spikes of ethanol from the Mid-western drought is a good illustration that the future of ethanol is not from corn. Feedstock and production technology diversity is needed from other sources (sorghum, cellulosic). In passing the Renewable Fuels Standard requiring ethanol blending with gasoline, Congress recognized this point by capping the use of corn feedstocks (which current ethanol production has almost approached).

For all the criticism that ethanol use receives, what is generally lost by the general public is the amazing success story that has been so quickly achieved in accomplishing national goals for greater energy security and job creation. This achievement would not have been possible without using the existing corn industry's infrastructure in the Mid-west.

Did you know?: The Renewable Fuels Standard has resulted in a fundamental shift in gasoline formulation. The refining industry has now moved to using predominantly 84 octane "conventional" gasoline and then blending it with higher octane ethanol (around 113) to produce the 87 octane gasoline that is the most popular level with consumers. This change in refining practices is not easily reversed. While other octane enhancers could be used, ethanol's price make it the current lowest cost octane source of choice by refiners.

Data Sources:
Per numerous Sources (DOE, EPA), E-10 (10% ethanol) has ~3% less efficiency than E-0 (zero ethanol). Ethanol on a "net basis" has less BTU content, but higher octane.

-- Wholesale Ethanol prices are from the Chicago Board of Exchange.
-- Wholesale Gasoline prices are from the Chicago Board of Exchange.
-- Retail Gasoline prices are from Bloomberg's survey of national gas prices.
-- Corn Feedstock costs are calculated from Chicago Board of Exchange.
-- Distiller's Dried Grains (DDG) Futures (100 short tons) from CBOE.

-- Real Time Daily Trading Data on energy products.

Current Ethanol Vs. Gas Prices (July 6, 2012)

The below pink line is the commodity/wholesale price of ethanol. But as a N.Y. Times story explains, ethanol gets less MPG than gasoline. The green line adjusts (increases the price) for the lower energy efficiency of ethanol, allowing an "Apples to Apples" comparison with the wholesale price of gas (blue line). The red line is the average U.S. retail pump price of gasoline.Current Retail Gasoline Prices by Region The Bad News: On July 6 -- the price of ethanol (green line) was a whopping ~71¢ per gallon higher than gas on a wholesale price comparison (blue line). Incredibly, this price is higher than the retail price of gas (which includes taxes, transportation costs).

Not as Bad News: Most gasoline contains 10% or less ethanol (E-10). Thus, as this high cost ethanol is blended with gasoline, most people could be paying ~7¢ per gallon more when they fill up.

Better News: The current "price premium" between wholesale ethanol and gasoline has not existed for the entire year. From March to May, ethanol prices (green line) were less than gas. On a year-to-date basis, the price premium for E-10 is ~1.5¢ per gallon.

Hopeful Consumer News: U.S. ethanol inventories remain at near record high levels (excess supply). If inventories remain high, the current price premium may never fully make it to consumer's pocketbooks. Rather, ethanol companies may have to "eat" some of this higher cost, reducing their margin and profit levels to sell product.

What's Going On?: Prior to June, ethanol prices were trending lower in expectations of reduced ethanol feedstock costs from the largest corn crop planted in the U.S. since 1937. However, recent drought conditions in many mid Western States have caused commodity corn futures prices to skyrocket.

Currently, almost all ethanol in the U.S. is produced from corn feedstock. Until the Industry transforms itself to next generation feedstocks (e.g., sugar cane, sweet sorghum, cellulosic sources as is being done in Florida), ethanol prices will be highly dependent on the market price of corn. ^{(1) (2)}

⁽¹⁾ A simple linear regression of corn (x) and ethanol (y) prices using 2012 data resulted in a correlation R² of .8378 with a dependent variable value of y= 0.8893x + 0.7536.
⁽²⁾ "Corn Feedstock Cost" is the estimated "Net Costs" reflecting co-product of DDGS (Distiller Grains). The calculation methodology is simplistic, using 70% of commodity corn prices.

Data Sources:
Per numerous Sources (DOE, EPA), E-10 (10% ethanol) has ~3% less efficiency than E-0 (zero ethanol). Ethanol on a "net basis" has less BTU content, but higher octane.

-- Wholesale Ethanol prices (pink line) are from the Chicago Board of Exchange.
-- Wholesale Gasoline prices (blue line) are from the Chicgo Board of Exchange.
-- Retail Gasoline prices (red line) are from Bloomberg's survey of national gas prices.
-- Corn Feedstock costs (orange line) are calculated from Chicago Board of Exchange.
-- Dried Distillers Grains data from Chicago Board of Exchange.

-- Real Time Daily Trading Data on energy products.

Current Ethanol Vs. Gas Prices (May 25, 2012)

Tracking gasoline prices versus ethanol prices. The pink line is the commodity price of ethanol (which has less efficiency than gas, E-0). The green line line adjusts for this lower efficiency, allowing an "Apples to Apples" comparison with the commodity RBOB price of gas (the blue line). The red line is the average retail price of gasoline in U.S.

As of May 25, 2012 -- ethanol (adjusted for efficiency) is 8¢ per gallon higher than gasoline on a wholesale price comparison. However, since most gasoline contains only 10% or less ethanol (E-10), this price differential at the pump is currently eight tenths of a penny (.8¢).

Current Retail Gasoline Prices by Region Data Sources:
Per numerous Sources (DOE, EPA), E-10 (10% ethanol) has ~3% less efficiency than E-0 (zero ethanol). Ethanol on a "net basis" has less BTU content, but higher octane.

-- Wholesale Ethanol prices (pink line) are from the Chicago Board of Exchange.
-- Wholesale Gasoline prices (blue line) are from the Chicgo Board of Exchange.
-- Retail Gasoline prices (red line) are from Bloomberg's survey of national gas prices.

-- Real Time Daily Trading Data on energy products.

Current Ethanol Vs. Gas Prices (May 11, 2012)

Tracking gasoline prices versus ethanol prices. The pink line is commodity price of ethanol (which has less efficiency than gas, E-0). The green line line adjusts for this lower efficiency, allowing an "Apples to Apples" comparison with the commodity RBOB price of gas (the blue line). The red line is the average retail price of gasoline in U.S.

As of May 11, 2012 -- ethanol (adjusted for efficiency) and gasoline are exactly equal ($3.00) on a wholesale price comparison.

Data Sources:
Per numerous Sources (DOE, EPA), E-10 (10% ethanol) has ~3% less efficiency than E-0 (zero ethanol). Ethanol on a "net basis" has less BTU content, but higher octane.

-- Wholesale Ethanol prices (pink line) are from the Chicago Board of Exchange.
-- Wholesale Gasoline prices (blue line) are from the Chicgo Board of Exchange.
-- Retail Gasoline prices (red line) are from Bloomberg's survey of national gas prices.

-- Real Time Daily Trading Data on energy products.

Current Ethanol Vs. Gas Prices (5/04/12)

Tracking gasoline prices versus ethanol prices. The pink line is commodity price of ethanol (which has less efficiency than gas, E-0). The green line line adjusts for this lower efficiency, allowing an "Apples to Apples" comparison with the commodity RBOB price of gas (the blue line). The red line is the average retail price of gasoline in U.S.

As of May 4, 2012 -- ethanol is about 16¢ per gallon more expensive than gasoline on a wholesale price comparison.

Data Sources:
Per numerous Sources (DOE, EPA), E-10 (10% ethanol) has ~3% less efficiency than E-0 (zero ethanol). Ethanol on a "net basis" has less BTU content, but higher octane.

-- Wholesale Ethanol prices (pink line) are from the Chicago Board of Exchange.
-- Wholesale Gasoline prices (blue line) are from the Chicgo Board of Exchange.
-- Retail Gasoline prices (red line) are from Bloomberg's survey of national gas prices.

Current Ethanol Vs. Gas Prices (4/20/2012)

Tracking gasoline prices versus ethanol prices. The pink line is commodity price of ethanol (which has less efficiency than gas, E-0). The green line line adjusts for this lower efficiency, allowing an "Apples to Apples" comparison with the commodity RBOB price of gas (the blue line). The red line is the average retail price of gasoline in U.S.

As of April 20, 2012 -- ethanol is about 8¢ per gallon cheaper than gasoline on a wholesale price comparison.

Data Sources:
Per numerous Sources (DOE, EPA), E-10 (10% ethanol) has ~3% less efficiency than E-0 (zero ethanol). Ethanol on a "net basis" has less BTU content, but higher octane.

-- Wholesale Ethanol prices (pink line) are from the Chicago Board of Exchange.
-- Wholesale Gasoline prices (blue line) are from the Chicgo Board of Exchange.
-- Retail Gasoline prices (red line) are from Bloomberg's survey of national gas prices.