Intersecting Trends of Oil and Ethanol

Oil industry consultants discuss the impact of shale oil production growth and other trends on the ethanol industry. This article appears in the May print edition of Ethanol Producer Magazine.
By Patrick C. Miller | April 21, 2017

Is the growth in shale oil production a potential boost for ethanol? The theory goes that because the light crude produced from fracked shale produces lower-octane gasoline, greater oil production from shale will translate into an increased demand for ethanol as an octane booster. However, the idea that a flood of sweet, light crude entering the market would result in an increased demand for ethanol has been around for more than two years and, thus far, remains a theory.

“Those crudes from what they call light, tight oils from shale formations do contain a very poor octane gasoline material,” says Dave Hirshfeld, co-founder and president of MathPro Inc. in Washington, D.C. “That had the effect of forcing refiners to install processes to upgrade the octane of those fractions or to sell the lightest part of it into the natural gas liquids market at a pretty stiff discount just to get rid of it.”

Hirshfeld specializes in analyzing refining economics, technologies and related areas. MathPro’s range of clients is diverse and includes oil companies, ethanol companies, state and federal agencies, government labs, automobile manufacturers and trade associations in both renewable and fossil energy.

As Hirshfeld explains, U.S. refiners took an economic hit from the increased production of sweet, light crude from shale, but quickly adapted, as did the market. “They can accommodate these things at a cost—they can overcome these challenges,” he says. “Since the end of 2015, when the ban on crude oil exports was lifted and the price of crude had begun to decline, those two factors together reduced the amount of light tight oil that’s been going into U.S. refineries.”

According to the U.S. Energy Information Administration, after the U.S. crude export ban ended, the U.S. in 2016 exported oil to 26 different countries, compared to 10 countries in 2015. In 2015, 92 percent of U.S. crude exports went to Canada, which was exempt from the restrictions. After restrictions were lifted, Canada remained the top export destination but received only 58 percent of U.S. crude exports in 2016.

The EIA also notes that in 2016, U.S. crude oil exports averaged 520,000 barrels per day, 55,000 barrels (12 percent) above the 2015 level, despite a decline in domestic crude production brought on by lower oil prices.

More can be made by selling shale oil in the export market than by selling the crude to Gulf Coast refineries, he says, “Because a number of overseas markets don’t have the demand for gasoline that we have in the U.S.,” he says, referring to the low-octane gasoline refined from shale oil. “So that hurdle is pretty much behind the refining industry.”

Hirshfeld notes that to outsiders, the refinery industry and the importing and exporting of oil and refined products can be confusing. From an economic standpoint, he relates, the international markets for crude and refined products have great flexibility in placing those products where they best belong. Some international refiners, for instance, prefer light sweet crudes more than U.S. refiners. “They have great capacity for doing that—which they’ll deny—but they do,” Hirshfeld says. “We’re still importing oil, but we’re importing half of what we did before. We’re still importing gasoline, but we’re exporting more. We’re still importing some into PADD 1, but we’re exporting twice as much out of PADD 3.” The petroleum administration district PADD 1 includes the East Coast states from Maine to Florida. PADD 3 covers the Gulf Coast from New Mexico to Alabama.

“It’s a complicated market that defies human understanding, but it does require some engagement and experience,” he adds. “People want to snap their fingers and say ‘We can replace all that.’ The increase in domestic crude has been a huge, huge boon to the producers, to the refiners and the public, but not necessarily in all the obvious ways.”

Benefits for Ethanol
John Auers, executive vice president of Turner Mason & Co.—a Dallas-based firm that provides engineering and management consulting services for the petroleum and petrochemical industries—believes the increased investment in U.S. shale oil will be of some benefit to the ethanol industry.
“It’s not a huge driving force, but it provides a little bit of tailwind,” says Auers, who leads the firm’s activities in forecasting and outlook publications. “A bigger tailwind for ethanol would be a potential future requirement for high-octane gasoline to meet the higher fuel efficiency engines that might be required.”

Both Auers and Hirshfeld agree that the ethanol industry’s future will likely be affected more by what policymakers in Washington, D.C., decide than by trends in crude production or refinery output, although they also believe market forces will play a role.

“The Trump administration looks like it might rescind the approval of the 2022-’25 stringent CAFE standards that would drive the high-octane fuel requirements,” Auers notes. “The administration is going to do its own review about what should be done for the ’22-’25 model years. That’s potentially the biggest driving force for the need for higher octane gasoline and would provide an opening for ethanol.”

Until the administration—through the U.S. EPA and Department of Transportation—decides within the next year or so, Auers says automakers, the ethanol industry and the oil industry are in a state of limbo. “The Trump administration might go for something in between,” he says. “They could reduce the standards. If that happens and we don’t have a requirement for high-octane gasoline, that’s a negative for ethanol. The more stringent the fuel efficiency standards, the more you require high-compression engines that need higher octane fuel. That provides an opening for ethanol.”

In addition, there are questions about the Renewable Fuel Standard—a longtime target of the oil industry. However, Auers points out that Trump was friendly toward the ethanol industry when he campaigned in Iowa. In addition, his vice president, Mike Pence of Indiana, is also pro-ethanol.

“I tend to think that not much is going to happen on the Renewable Fuel Standard,” Auers says. “The 15 billion gallons of ethanol, that’s going to be there. There’s enough political push from the ag industry to keep that in place. I can’t imagine that RFS will be removed. It might become more flexible.”

Hirshfeld notes, “In the refinery industry, there are lots of things that will affect the future demand for ethanol, but those things are not going to happen inside refineries—except in response to other drivers.”

He listed the most important factors impacting future ethanol demand. The first is the demand for finished gasoline, which is likely to change based on the price of oil. Whatever the CAFE standards become, Hirshfeld says they will influence the vehicle miles traveled by consumers and the mix of cars they buy. “People will obviously be spending less per mile for gasoline and the question is: Will they just drive more?” he asks. “There’s considerable evidence that when gasoline prices go down, the demand does indeed go up.”

Hirshfeld notes that EIA’s forecast for gasoline consumption is much different in a high-price scenario than a low-price scenario. “In one case in 2040, the demand with a low oil price is around 8 million barrels a day. With a high oil price, it’s 5 million barrels a day,” he relates. Gasoline demand directly affects ethanol. “Every gallon of gasoline is going to have 10 percent ethanol in it—more gasoline, more ethanol.”

Hirshfeld says there will likely be action on the RFS by 2022. “Corn ethanol is capped at 15 billion gallons, which for the moment works out to about 10 percent of gasoline,” he says. “At some point, Congress is going to have to do something about that. They might repeal the act. They might expand the mandate. Whatever they do, it’s going to have a big effect on the ethanol industry.”

Changes in the distribution system between the refineries and gasoline retail outlets are another factor to watch, because they could result in greater use of E15, Hirshfeld says. “Very little is being used and the reason is that the distribution system is not set up to handle E10 and E15 BOBs simultaneously,” he explains. “Since E15 has more ethanol than E10 and ethanol has very high octane, the refiner wants the E15 BOB to have lower octane than the E10 BOB. Otherwise, the refiner’s giving away octane at the point of sale. That’s one reason why E15 sales have not been what the ethanol industry had hoped they would be.”

International Demand
Auers and Hirshfeld agree that international demand for ethanol could grow, but predicting how much is problematic.

“There could be changes for the better or for the worse in ethanol exports, which right now are running unusually high because of Brazil,” Hirshfeld says. “They’ve been diverting sugarcane to make sugar instead of making ethanol. The marketplace down there still needs ethanol. They’ve been importing somewhat more than they usually do from the U.S. That could change one way or the other.”

Auers points out that some countries that use lead as an octane booster are moving away from it and there’s a trend toward higher compression engines, which would also increase the demand for ethanol overseas. “At this point, it’s not defined how much of a driving force there is for premium demand internationally, but I think directionally it should grow some,” he says.

Hirshfeld allows that even if more stringent CAFE standards are eventually implemented, technical challenges remain. “Some of the octane requirements go beyond what the refiners can realistically deliver with hydrocarbons,” he says. “What midlevel ethanol blends would be authorized by EPA? E20, E25 or E30? One government lab is even looking at E40. These can get you significantly higher octane. If those fuels came into use, they would do great things for ethanol demand.”

The auto industry, the ethanol industry, EPA and the EIA are all working on potential solutions to these issues, Hirshfeld notes. “All of those factors are somehow going to coalesce in the next five, 10 or 20 years, and they will shape the demand for ethanol,” he says. “But almost none of those factors are going to happen inside the refinery gate—except as refiners need to respond. What they do will be in response to what happens; it won’t be the driver.”


Author: Patrick C. Miller
BBI International Staff Writer
pmiller@bbiinternational.com
701-738-4923