Despite being able to feast on dirt cheap mid-continent crude oil and huge profit margins, the refining or downstream sector of the energy industry is facing a huge problem … and not it’s the dwindling WTI-Brent spread. In this case, we’re talking about something a bit more “corny.”
That would be the ethanol and biofuel mandates stemming from the Energy Policy Act of 2007.
This bill spells out the amounts of ethanol that refiners are required to blend into gasoline and costs for complying with the piece of legislation are skyrocketing — up from just pennies per gallon to more than a dollar. All in all, that’s putting a squeeze on the oil refiner’s profits.
However, the sector recently got some good news in the way of a pending Environmental Protection Agency decision to overturn or alter the rules governing just how much ethanol refiners will need to blend next year. If that ruling goes off without a hitch, investors could be treated with significant gains in the refining stocks once again.
Hitting the “Wall”
According to the Energy Policy Act, refiners are required to blend 13.8 billion gallons of corn-based ethanol and 2.75 billion gallons of advanced biofuels into our gasoline supplies this year. Those numbers rise to 14.4 billion gallons of corn-derived ethanol in 2014 and 15 billion in 2015. These requirements have been the rallying cry for investors in biofuel producers like Pacific Ethanol (PEIX).
However, there is a slight problem with those amounts, and it’s called the “blending wall.”
Unfortunately for the ethanol faithful, for whatever the reason, American’s just aren’t driving as many miles. That has significantly reduced the amount of gasoline demanded by our citizens. So in order to comply with the mandated amounts of ethanol, refiners will be forced to sell fuel blends exceeding 10% ethanol, export more gasoline to places like Brazil or purchase Renewable Identification Number credits to offset the amount of renewable fuel they did not mix with their gasoline.
The problem is that, in concentrations of more than 10%, ethanol can cause engines to corrode and break apart faster. Additionally, emissions control systems can fail if the blend is too high. Some older cars can’t handle gasoline/ethanol blends of more than 15% at all.
So most refiners have voiced that they will either go with exporting the fuel or buying credits. Both choices will result in higher costs for consumers down the line … which will offset gasoline demand and start the cycle all over again.
But, the EPA might just be throwing the downstream sector a bone on this one.