By John Kingston
What the grain industry has long hoped for is about to happen: expansion of ethanol into a new petroleum market. It should get prepared for a rough ride, because ethanol is likely to be on a lot of people’s lips, and the words may not warm everyone’s heart.
The market is California, and ethanol consumption there will rise in 2003 in preparation for a January 2004 ban on Methyl Tertiary Butyl Ether (MTBE), ethanol’s competing oxygenated chemical of the petroleum industry; most of the state’s refiners have vowed to eliminate MTBE and substitute ethanol as an oxygenate by the start of 2003, so the date the ban takes effect becomes largely moot.
The irony is that the MTBE ban, driven by discovery of the compound in groundwater, initially was scheduled to go into effect in January 2003, but California’s Governor, Gray Davis, announced last March that the state would delay the ban for a year. Most of the state’s oil refiners said that with the preparations they had made already, they would go ahead with the switch in early 2003.
Three of the state’s biggest refiners — BP, ExxonMobil and ConocoPhillips — said that they would begin blending ethanol into gasoline in 2003. Others, such as ChevronTexaco, were not so forthright but are expected to begin using mostly ethanol as an oxygenate beginning in 2003. Only two significant-sized refiners, Valero and Tesoro, are holding back and still plan on using MTBE during 2003.
California already has acknowledged implicitly that there might be a problem with the no-MTBE policy. Soon after announcing the ban in 1999, California quickly asked the U.S. Environmental Protection Agency for a waiver of the requirement that most of the state use an oxygenate in its gasoline. But the waiver was denied in June 2001, as expected by many. In the furor over MTBE in groundwater, the concern of including ethanol in gasoline became moot.
All of this will be a welcome development to ethanol marketers. But in California, it is difficult to find a single gasoline trader who does not believe that the introduction of ethanol into the gasoline pool will be anything but a fiasco.
One aspect that won’t be a problem is ethanol supply. While there are no statistics to support the idea that demand will be met, these same informal conversations fail to turn up anyone who sees a true shortage of ethanol. A form of transportation rarely used in the oil industry — rail — is coming to the rescue. So-called "unit trains," pulling nothing but a long line of ethanol-laden tank cars, will give the state what it needs for blending, as California produces virtually no ethanol.
But what all the planning and a large federal tax break cannot overcome is the chemistry of ethanol, and therein lies the basis for trader forecasts of delivery bottlenecks and price spikes. A preview of what might happen in California was on display in the country’s heartland in spring 2000 and spring 2001.
Midwest refiners have long blended ethanol into gasoline. But in spring 2000, producers of reformulated gasoline — the cleaner blend that is required in many parts of the U.S. as it is mandated to contain an oxygenate — faced tougher new specifications. In particular, were more stringent rules on Reid Vapor Pressure (RVP), which is difficult as ethanol carries such a high RVP level.
It was not much of a problem before 2000, because the RVP specifications were not overly stringent. Reformulated gasoline was introduced in the mid-90s, blended with ethanol as an oxygenate. The rollout of RFG went smoothly everywhere, despite projections of disaster.
But in spring 2000, the tighter RVP requirements, when combined with ethanol blending in the Midwest, proved challenging. (RVP specifications become tighter as the weather gets warmer; that’s why the Midwest spikes hit in spring, as the industry began switching to summer RVP levels).
Here’s how it works: if you need to get high-RVP ethanol into the gasoline blend, you need to get something else in to offset those high RVP levels. Therefore, something also needs to come out. What needs to go in is something like alkylate, because that petroleum product carries a low RVP. The combination of the low RVP alkylate and the high RVP ethanol allows the finished gasoline product to meet the tighter RVP specifications. But as a result of that, what needs to come out are pentanes, and the process for doing that reduces the yield in gasoline. The chemical algebra of alkylate plus ethanol minus pentanes does not produce a gasoline yield equivalent to the standard formula of pentanes plus MTBE.
The chaos of spring 2000 was followed by a chaos in spring 2001, but of shorter duration. Refiners attributed the less-volatile market that year to having learned much about the trifecta of RVP, RFG and summer.
A MOVING STORY
Having learned lessons from the Midwest, shouldn’t the transition in California go much smoother? That’s possible. But there are significant differences between California and the Midwest.
Logistics leads the list. Ethanol cannot be moved in a pipeline as it is an ether and attracts water, sweeping up any water in the pipeline, unlike petroleum. Hence, gasoline-containing MTBE can move through a pipeline, gasoline-containing ethanol can’t. Refiners therefore manufacture a product called RBOB, Reformulated Blendstock for Oxygenate Blending. RBOB is basically gasoline lacking ethanol as an oxygenate.
The RBOB comes out of a refinery, and moves toward market on a pipeline, or a boat, or possibly a truck. It is taken to the gasoline rack, the wholesale distribution point where trucks load it for delivery to the corner gas station. As the gasoline comes into the truck, so does the ethanol, essentially combining the two at the step just before gasoline goes to the retail outlet.
And that’s what has much of the California gasoline industry concerned. Even as fears of adequate ethanol supplies have dissipated, there’s an all-new logistics system to worry about: unit trains, RBOB production, reduced yields due to pentane reduction and ethanol being hauled around to racks on trucks.
There’s also the problem that with MTBE gone, it can’t be looked to as a potential enhancement to the gasoline pool. To reach the required level of an oxygen blend of 2% by weight, according to Bob Cunningham, senior vice-president of the refinery engineering firm, Turner Mason & Co., about 5.6% to 5.7% ethanol is expected to be blended into the gasoline. But if gasoline supplies are tight, the yield problems with blending ethanol create a barrier to blending more ethanol into the process.
The inclusion of more ethanol resumes the requirement to back out pentanes. MTBE, by contrast, has been blended into the gasoline pool to constitute as much as 15% of the total pool. That produces far more oxygen than needed to meet federal mandates, but it helps deepen the gasoline supply line. Such an option, however, will disappear in California and soon in other parts of the country — MTBE is slated to disappear in New York and Connecticut in 2004.
However, the Renewable Fuels Association, the Washington-based trade group representing the ethanol industry, disputes the 5.6% limit. Monte Shaw, the group’s spokesman, notes that the Midwest generally blends 10% ethanol into its gasoline without any difficulty. The 5.6% limit in California, according to Shaw, comes from a model that California used when it was requesting the oxygenate waiver.
"Their predictions of NOX (nitrous oxide) increases from using ethanol have not been borne out," Shaw said. "You could add another 4% volume to the gasoline market. They have been unwilling to revisit the model."
Shaw inevitably comes back to the RFA’s best anti-MTBE argument: groundwater infiltration. The decision by companies to move from MTBE earlier than required, he said, is because "ethanol is a better deal than MTBE, and their liability exposure (in groundwater-related suits) continues to go through the roof. This is a bottom-line business decision."
By the end of 2002, the transition to ethanol in California had begun, without any significant signs of disruption. But that was occurring against a backdrop of looser RVP standards. The warm weather test had not yet faced the industry.
In spring 2001, Tom O’Malley, then the CEO of independent refiner Tosco Corp., spoke at a meeting on gasoline quality issues. He mentioned Tosco’s difficulties working with ethanol in 2000 and announced that the MTBE ban "would turn into a disaster."
Fast-forward to late 2002. Tosco was acquired by Phillips Petroleum, which then merged with Conoco to form ConocoPhillips. In the mid-2002, the company announced that it had become "all ethanol." The California market showed no signs of shortage from this move; there were no indications from ConocoPhillips traders, or from their customers, that the company was having difficulty supplying MTBE-free gasoline. When a company spokesman was asked in late 2002 whether it had seen a decline in refinery output with the most recent move to ethanol, he declined comment.
The same thing will be asked of many companies in coming months. The market, as always, will reveal the answer.