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The New War Over Ethanol, And How It Might Affect You

This article is more than 5 years old.

A seemingly small action from the Environmental Protection Agency could spark a new war between Big Oil and Big Ag that could have far-reaching effects on the U.S. agricultural, energy, and transportation industries.

Last month the EPA granted an exemption to one of the largest refiners in the United States, allowing Andeavor (NYSE: ANDV), formerly Tesoro , to no longer comply with U.S. biofuels regulations.

The EPA exemption will allow three of Andeavor’s smallest refineries to ignore the mandates of the U.S. Renewable Fuel Standard (RFS). The RFS, authorized by the Energy Policy Act of 2005, requires refiners to blend renewable fuels such as ethanol into domestic gasoline. By issuing exemptions, the EPA is authorizing refineries to produce gasoline without these renewable feedstocks.

The Andeavor exemption is the latest in recent moves by the EPA to exempt 25 small refineries (those processing less than 75,000 barrels per day).

By one estimate, the exemptions could result in a drop in ethanol demand of one billion gallons per year.

Consider how the exemption might result in wide-reaching effects for the economy:

Ethanol is produced from corn in the U.S. and, while subject to debate on the efficacy of using corn to deliver a clean and affordable transportation fuel, ethanol remains a significant market opportunity for farmers.

F. Todd Davidson

Each year, the U.S. produces approximately 15 billion bushels of corn, over 35% of which is directed towards ethanol production. One bushel of corn can produce about 2.7 gallons of ethanol. So, it takes 370 million bushels of corn to produce one billion gallons of ethanol.

If the EPA exemptions resulted in a reduction of one billion gallons of ethanol demand, overall demand for corn could fall by 2.5%.

Falling demand for corn could result in a surplus this summer, putting downward pressure on corn prices. Longer term, reduced demand could have negative implications for fertilizer companies, such as Nutrien (NYSE: NTR), formerly PotashCorp and Agrium , and equipment manufacturers such as Deere & Company (NYSE: DE).

On the other hand, falling prices for corn could be a windfall for cereal makers like General Mills (NYSE: GIS), consumers of high fructose corn syrup such as soda manufacturer PepsiCo (NASDAQ: PEP), and cattle ranchers who are dependent on corn as animal feed.

Changes in ethanol consumption also could have broad impacts for the energy industry.

F. Todd Davidson

The U.S. consumed 144 billion gallons of gasoline in 2017. Approximately 14 billion gallons of that amount was ethanol. A decrease of one billion gallons would be equivalent to more than a 7% reduction in ethanol demand.

Ethanol has a lower energy content compared to conventional gasoline. If one billion gallons of ethanol are displaced by 0.7 billion gallons of oil-derived gasoline, domestic oil consumption would rise by 35 million barrels per year, or approximately 100,000 barrels per day. This assumes that 20 gallons of gasoline are produced from every barrel of oil.

Domestic oil production recently broke 10 million barrels per day (for a total of more than 3.5 billion barrels per year.) By comparison, in 2017, domestic oil consumption was nearly 20 million barrels per day.

U.S. EIA

An increase of 100,000 barrels of oil per day would result in a 0.5% increase in domestic oil consumption. While this does not sound like a large increase, consider the history of supply and demand for oil as it relates to market prices.

From 2014—2016, prices for West Texas Intermediate (WTI) crude dropped by over 60%. At the time many attributed the decline in prices to a “rising ocean of oil” that would “swamp demand”. The global oil glut often gave the impression that the supply and demand for oil were significantly out-of-balance.

In reality, the precipitous drop in oil prices during that period resulted from global oil supply exceeding demand by less than 2%. Put in context: if you threw a party for 100 people, and ordered 102 sandwiches, would you describe the situation as having a rising ocean of sandwiches that was going to swamp demand?

F Todd Davidson & Colin M. Beal

The oil market is a finicky creature. Small changes in supply and demand can have large impacts on prices.

While the impact of the EPA exemptions for refineries shouldn’t be underestimated, it is also important to frame them within the context of current politics. Considering other monumental forces in the global economy, including discussions of trade tariffs and expansion of shale discoveries, it is likely that the impacts of the recent EPA exemptions might be dwarfed by other global affairs.

On the other hand, the recent exemptions might be a sign of other things to come.

With the looming rise of electric vehicles and existing improvements in combustion engine efficiency, we can expect the oil industry to be looking for every growth opportunity they can. That might very well involve trying to claw back gasoline market share from the ethanol industry, pitting Big Oil against Big Ag.

If that happens in earnest, a broader attempt to reverse the Renewable Fuel Standard could be in play, which could result in a rise of domestic oil demand of nearly 1 million barrels per day to displace the ethanol in gasoline. This rise would represent roughly 1% of global demand, with the potential to raise prices for oil, while putting significant downward pressure on corn prices.

Due to the Renewable Fuel Standard, our energy and food systems are now intertwined in ways that many people do not fully appreciate. Seemingly small changes in energy policy can have cascading impacts. Whether those impacts are good or bad depends on where you live, how you work, and what you eat.