The EPA has spoken. But what did they say?

Michael Swanson, Ph.D., Wells Fargo Chief Agricultural Economist

Given the “Sturm und Drang” of ethanol pro and con lobbying, the industry waited with baited breath for the Environmental Protection Agency’s (EPA’s) release of the 2016 Renewable Fuel Standards. Now that the standards are released, the key question is whether the EPA’s targets for blending requirements will afford higher profitability for the industry.
A higher target for blending ethanol supports better demand and higher values for the renewable identification numbers (RINs). The EPA’s targets seem to be generous for the ethanol industry, moving the blending target up from 9.5% in 2015 to 10.1% in 2016, with total renewable fuels increasing by 1.2 billion gallons.

 

 

A couple of key factors support a more aggressive growth outlook for the industry. Crude oil prices in the $40 – $50 per barrel range have led to cheaper gasoline facilitating the strongest growth rate since 1998. At the same time, payroll growth continues to expand by 1.9% year over year. This represents the best employment rate of growth since 2006, helping boost miles driven by 3.5% in 2015. However, much of this strong growth simply makes up for some of the ground that was lost during the last eight years. So, the EPA has decided to get bullish, and project even stronger growth in 2016, and this is at odds with most outlooks. The most recent monthly data indicates the year-over-year growth has started to slow from its strongest pace.

Another odd element in the EPA’s outlook involves the mismatch between what they call renewable fuel usage and the Energy Information Agency’s (EIA’s) numbers. The EIA began reporting monthly renewable fuel utilization in 2009. In 2014, they reported a net utilization of renewable fuels including ethanol to blenders and refiners of 14.2 billion gallons, substantially less than the EPA’s reported 16.3 billion gallons. Some of the mismatch comes from the different values assigned to biodiesel and second generation fuels, which makes tracking the numbers confusing. The 2015 growth rate for the EIA is at 3% through September, and closely matches the EPA’s number. This also brings up the issue of matching the EPA’s and EIA’s blending percentages. The EPA’s recent announcement set the following targets, which appear to increase the blending requirements, but they are below the renewable fuel percentages for total gasoline distributions.

 

The last piece of the puzzle comes from the exports. The stronger U.S. dollar and the much weaker Brazilian Real have altered the opportunity for sourcing ethanol in the key markets. Even some of the U.S. markets have taken advantage of this combination to pull in Brazilian sugar-based ethanol in order to qualify for a lower carbon standard. Blenders in the key California market have a challenge meeting their carbon standard goals with the corn-based ethanol as currently measured by the EPA. This serves as an excellent example of the EPA giving with one hand and taking with the other. The last couple of months have seen a seasonally divergent import of ethanol. Whether this represents a new trend or is just noise remains to be determined.

All in all, the EPA’s targets seem to be positive overall for the ethanol producers, but their growth assumption remains on the high side of most forecasts. Bottom line, it is problematic for them to try to forecast demand for ethanol in a world driven by employment and gasoline prices. Their forecasts will be wrong because all forecasts are wrong to some degree. The real question is who will have to pay for their mistakes?