CME: Would RFS Waiver Affect Corn Prices?

17 August 2012, at 1:55pm

US - This week’s hot topic is whether a partial or complete waiver of the renewable fuel standard (RFS) would have any material impact on corn prices, write Steve Meyer and Len Steiner.

Several livestock groups have petitioned the EPA administrator to enact such a waiver. Those requests may or may not be answered but similar requests from at least four governors must be addressed by EPA. At least three groups of economists have weighed in on the debate and the general conclusion at this time is that a waiver may not do much to reduce the amount of corn used by ethanol manufacturers and would thus driven a relatively small reduction in prices. Let’s review the issues at hand and how they may come to bear on the market situation.

The Renewable Fuel Standard is a series of requirements in the 2007 Energy Act that mandates amounts of various biofuels that must be used each year. The standard applies to biodiesel and cellulosic biofuels but the one of interest in this debate is the category of renewable biofuels which basically includes only corn-based ethanol.

The requirements are for a calendar years’ usage — a fact that confounds usage numbers a bit already since the calendar year does no match the September-August crop year we use in the corn balance sheet. The corn ethanol mandates for 2012 and 2103 are 13.2 and 13.8 billion gallons, respectively. Weighting those proportionately gives a mandate level of 13.6 billion gallons for the ‘12-’13 crop year. At an ethanol yield of 2.8 gallons/bu., that would require 4.857 billion bushels of corn. USDA’s current estimate is 4.500 billion bushels.

But there is some flexibility built into the law. Blenders have used more ethanol than was required in past years, thus generating credits called RINs that can be used to satisfy part of this year’s mandate. No one knows just how many RINs are out there but the consensus is that there are 2 to 2.5 billion gallons (715 to 900 million bushels) worth available. In addition, ethanol stocks are still larger than normal and these stocks can be used to meet some of the RFS requirements for the rest of 2012 and 2013.

A major issue in the debate at present is just how much operational flexibility exists at the blender level. The question is whether the current use of ethanol as an octane enhancement for motor fuels will allow a reduction in its usage in the short run. Note that this is octane enhancement, not oxygenate — the use that drove ethanol prices through the roof back in 2006 when MTBE was withdrawn from the market over environmental concerns. The argument is that refineries are making gas with roughly 84 octane and changing that practice will be difficult and costly so refineries may not do it — especially if the waiver is perceived to be for only one year. If blenders either cannot or will not change this practice, then any waiver to the RFS will have little impact. This was a primary part of the discussion by Purdue researchers on the Farm Foundation’s webinar yesterday morning. We have heard from other sources, though, that octane usage and inflexibility are not as large as has been touted and that refiners would change quickly if allowed to do so. Someone needs to determine the truth on this one because it is quite critical to the outcome.

Another major driver of ethanol usage is, of course, the price of gasoline. Higher gasoline prices were a major factor that drove researchers at Iowa State’s Center for Agricultural and Rural Development (CARD) to revise a paper they published in July. Higher gas prices drive greater market demand for ethanol which, in turn, reduces the importance of the mandate and would reduce the impact of waiving all or part of the mandate. While not a month-to-month comparison like that of the CARD paper, the Purdue research implicitly recognizes this fact by identifying crude oil prices as a key variable.

They postulate that a waiver will have little or not impact if the oil price is above $120. They allow that it would have some impact if prices are below $100 and there is sufficient flexibility at the blender level. So what does this mean in dollars? The tables below show the key results of the CARD and Purdue papers. The CARD model used 500 draws from the distributions of each stochastic variable and presented the average outcome. The Purdue paper looked at various scenarios regarding ethanol usage flexibility and drought severity. We show the results for their “strong drought” and the flexibility cases that include the use of RINs.

Are these right? No one knows right now and the issue of blending flexibility is critical. Stay tuned for more!