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RFS Compliance Costs and Incentives to Invest in Ethanol Infrastructure

Bruce A. Babcock
September 2013  [13-PB 13]

At the request of the oil industry and livestock groups, Congress and the Environmental Protection Agency (EPA) are considering whether to reduce biofuel blending mandates. Livestock groups want lower corn prices and the oil industry claims that it simply cannot blend more biofuels than current levels. The oil industry argues that its only compliance option is to reduce domestic gasoline and diesel sales if mandates are not reduced; however, an alternative compliance path is to increase the demand for ethanol by investing in E85 fueling capabilities. Ethanol demand would increase by between 800 million and one billion gallons per year for each 2,500 stations with E85 fueling capabilities given the existing fleet of flex vehicles. The cost of investing in E85 at existing stations depends on whether a new tank needs to be installed or whether an existing tank can be converted. If new tanks need to be installed then the cost of 2,500 stations would be at least $325 million. If no new tanks need to be installed then the cost would be approximately $87.5 million. With the price of the tradable ethanol credits trading between $0.60 and $0.70 per gallon, and with at least 14 billion credits needed under current mandates, it seems that the reduction in compliance costs could be greater than the costs of investing in E85 infrastructure, which would create an incentive for investment. Simulation results show that this is indeed the case if EPA sets mandates that are attainable with investment. If EPA sets 2014 mandates that can be met with 13.9 billion gallons, then investment in 2,500 E85 stations would reduce oil company compliance costs from $2.84 billion to $1.09 billion. If EPA sets 2015 requirements that can be met with 14.7 billion gallons, then 2015 compliance costs would be reduced by more than $2.4 billion dollars from investment in an additional 2,500 E85 stations. Taxpayers, gas station owners, or oil companies could pay for the investment. Congress could divert farm subsidies to pay for E85 investment with a justification that an important beneficiary of ethanol is land-owning farmers. Gas station owners will have an incentive to make the investment if the wholesale price of E85 drops enough to generate fuel cost savings to drivers as well as higher wholesale-retail margins to station owners. Oil companies might find it more efficient to make the investment themselves if the required price of ethanol credits rises too high for too long.

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