The rapid increase in ethanol usage in 2006 gave many ethanol industry participants and pundits the false confidence that if the ethanol supply is available, the market will be there to use it. However, this won't be the case for the next two or more years because of facility and supply-chain constraints. Ethanol producers and marketers can help overcome these obstacles and stimulate additional demand, which is crucial in light of projections of 2 billion to 5 billion gallons per year of additional production capacity becoming available in the next two years.

Examining Current Demand
Many rely on ethanol demand information from the U.S. Energy Information Administration's (EIA) Monthly Oxygenate Report that is two months or more in arrears. Houston BioFuels Consultants has developed techniques to estimate current weekly ethanol usage by viewing ethanol demand in the United States on a weekly basis and in a contemporary time frame. Figure 1 depicts weekly U.S. ethanol demand since the beginning of 2006. From it, one can draw some valuable insights:

› U.S. ethanol demand has essentially been flat since the substitution of ethanol for methyl tertiary butyl ether (MTBE) in reformulated gasoline (RFG) in May 2006.
› The Winter Oxygenate Program in the six or so locations classified as Carbon Monoxide Non-Attainment Areas seasonally boosts demand by around 300 MMgy.
› When ethanol replaced MTBE in the spring of 2006 there was very little decrease in discretionary blending. Discretionary blending is the voluntary use of ethanol in gasoline blends, typically because the blender believes ethanol is more economic to use than other components.
› Weekly variations in ethanol demand are largely attributable to changes in gasoline demand—especially RFG—responsible for two-thirds of current ethanol demand.



Additional Ethanol Demand
The substitution of ethanol for MTBE is complete. In the spring of 2006, the replacement of MTBE in RFG increased ethanol demand by about 1.5 billion gallons per year. Unfortunately, no significant increase in RFG market demand for ethanol is expected until ethanol blends greater than 10 percent are allowed. In the meantime, the only increase in ethanol usage in RFG markets will be associated with increases in E85 and general gasoline demand. Gasoline blenders switched to ethanol at breakneck speed in 2006 because of liability concerns surrounding MTBE use after the oxygenate requirement in RFG ended. This created a gargantuan economic incentive for blenders to switch to ethanol. Ethanol was much more economical than other possible formulations considered for meeting strict RFG specifications.

Conventional gasoline, which represents two-thirds of the U.S. gasoline market, is where there is still ample room for more ethanol usage. This market currently uses 2 billion to 2.5 billion gallons of ethanol per year, with the higher end of the range attributable to seasonal ethanol usage for Winter Oxygenate Programs. Much of the current ethanol usage in conventional gasoline is in the Midwest, classified as the Petroleum Administration for Defense District No. 2, or PADD 2 (Figure 2). The remainder is mainly used in states mandating ethanol usage (Minnesota and Hawaii) and the Winter Oxygenate Program areas.


Figure 2. Petroleum Administration for Defense Districts

The Midwest is estimated to have potential demand of more than 1 billion gallons per year, which would bring the region to a 10 percent ethanol blend. Comprised of the states in the southern half of PADD 1 and portions of PADD 3, the Southeast is another potential growth area. However, this area is also a prime market area for imported ethanol from Brazil and countries participating in the Caribbean Basin Initiative.

Barriers to Additional Demand
The two main barriers to blending ethanol into unblended gasoline are the lack of facilities to receive, store and blend ethanol, and the availability of suitable gasoline blend stocks for the blenders to take full economic advantage of blending ethanol.

Some blenders will only need to make minor modifications to their terminals to handle ethanol blending. However, more than half are estimated to need from nine to 18 months to make the needed changes with capital costs that could easily reach several million dollars for each terminal. Terminals have typically been low-return businesses, and many have shut down or reduced tankage to minimize maintenance cost. Capital has been invested only for health, safety and environmental projects—not capacity expansions. Consequently, most terminals are operating with very little spare capacity in existing tankage.

Major oil companies' terminal business units have to compete for capital with upstream and refining projects, which have historically yielded much better returns. Consequently, to receive the capital needed for even modest projects to modify a terminal to blend ethanol, terminal business units need to demonstrate that the projects are economically robust. Indeed, economics can be coldhearted.

To realize full economic benefits from including ethanol in gasoline blends, blenders need to formulate to take advantage of ethanol's high octane (113 compared with regular gasoline's octane in most markets of 87). Blenders use what is called a (BOB) (blendstock for oxygenated blending) that has an octane lower than the finished gasoline they want to produce (called "suboctane"). To produce regular gasoline with an octane of 87, blenders typically use a suboctane BOB of around 84. By blending 90 percent of the suboctane BOB with 10 percent ethanol, they can produce a finished gasoline that meets the 87 octane specification. Without using a suboctane BOB, the blender is merely "splash blending" and the only economic benefit is the difference in price between finished gasoline and the delivered cost of the ethanol to the blender.

Without adding ethanol, the blender isn't able to sell the suboctane BOB as finished gasoline. As a result, once the blender has made a commitment to blend ethanol, it is unable to sell finished gasoline without blending ethanol. To do so would result in off-spec gasoline. In addition, the blender needs to establish a supply chain of the appropriate BOB to its terminal. Since most gasoline in the United States moves from refineries to terminal by pipeline, this means arranging the appropriate shipment of BOB from the pipeline company. As with capital costs for adapting facilities for ethanol, the blender needs clear economic incentives to dedicate the resources for setting up and maintaining the BOB supply chain.

Bringing About Additional Demand
Potential ethanol blenders need to perceive strong economic benefits in order for demand to increase over the next two years. Blenders need to see benefits that overshadow the costs to modify their terminals to handle ethanol and the greater costs many of them will incur maintaining an additional supply chain into their terminals. Blenders may suspect an increased ethanol blend requirement in the next three to five years, but ethanol producers and marketers can't count on them blending any earlier than mandated unless benefited economically.

In the recent past, the burden has been on refiners and blenders to seek out ethanol supply to meet their imperatives to formulate gasoline with ethanol, such as in California in 2003 and 2004, and the remaining RFG areas in 2006. Now the burden is on ethanol producers to seek potential ethanol demand to balance the enormous increase in ethanol supply expected over the next two years. Ethanol producers will feel this need most acutely, since they are the players in the industry with the most capital at risk if ethanol demand is not ramped up.

The White House has submitted the Alternative Fuel Standard (AFS) bill to Congress that calls for 10 billion gallons of renewable fuels consumption per year by 2010, ramping up to 35 billion gallons per year by 2017. Even if the implementation schedule is revised as the bill works its way into law, it is extremely doubtful that this or any other law out of Congress will stipulate an increase in the existing renewable fuels standard or AFS before 2009. This is due in part to the recognition in Washington, D.C., that to do so sooner would risk price spikes at the gasoline pump, as well as in the grocery aisles. With 2008 being a presidential election year, no politician wants to take that sort of risk for doubtful benefits since they also appreciate that it could take several years to put the supply chain in place for greater mandated volumes.

In the past, ethanol producers have been able to wave goodbye to their ethanol as it left the plant by railcar for some distant market. In the next two years, producers will find it in their interest to work closely with their marketing companies or directly with refiners to help develop additional markets for ethanol blending.

Logan Caldwell is the president of Houston BioFuels Consultants LLC. Reach him at lc@hbioc.net or (281) 360-8515.

The claims and statements made in this article belong exclusively to the author(s) and do not necessarily reflect the views of Ethanol Producer Magazine or its advertisers. All questions pertaining to this article should be directed to the author(s).