Ethanol update reports $1.09/gal fuel savings

The working paper and two updates are available from here (thanks Haudy Kazemi at Prius Technical Stuff):

> The Impact of Ethanol Production on U.S. and Regional
> Gasoline Prices and on the Profitability of the
> U.S. Oil Refinery Industry
> Xiaodong Du and Dermot J. Hayes
> Working Paper 08-WP 467
> April 2008
>
> CARD: Impact of Ethanol Production on U.S. and Regional Gasoline Prices and on the Profitability of the U.S. Oil Refinery Industry, The
> http://www.card.iastate.edu/publications/dbs/pdffiles/08wp467.pdf
>
>
> May 2009 update:
> CARD: The Impact of Ethanol Production on US and Regional Gasoline Markets: An Update to May 2009
> http://www.card.iastate.edu/publications/dbs/pdffiles/11wp523.pdf
>
> May 2012 update:
> CARD: The Impact of Ethanol Production on U.S. and Regional Gasoline Markets: An Update to 2012
> http://www.card.iastate.edu/publications/dbs/pdffiles/12wp528.pdf

The 2008 working paper became a published article which is available for a fee:
ScienceDirect.com - Energy Policy - The impact of ethanol production on US and regional gasoline markets

The model that Dr. Hayes and Dr. Du developed in 2008 uses data spanning from 1995 through 2011. The two updates simply extended the original model to more current years. What woke everyone up was the model says we saved about $1.09/gallon in 2011 because of the nearly universal, E10. Needless to say, some folks took exception to the conclusion from the most recent "UPDATE" report.

This is a pretty technical set of papers and all three need to be read. They introduced two technical terms, "crack ratio" and "crack spread", that are used in refining to identify the quality of crude oil. An oil with a higher crack ratio refines into a larger fraction of gasoline versus a lower crack ratio oil. What the professors' model does is identify ethanol as improving the 'crack ratio' as it delivers more automotive fuel than existing oil supplies can provide. In effect, it upgrades the effective quality of the well-to-tank supply.

Now I can not defend their methodology because it depends upon getting a mass of data from the US Energy Information Administration (EIA), U.S. Energy Information Administration (EIA), and doing some heavy-lifting calculations. Their model is based upon seven metrics. But what I understand from the description, they used a modified least squares approach that incorporated a two-part, error correction step. They let the data from these seven metrics determine the coefficients needed to calculate the fuel savings. Then they applied the model to current data from the EIA.

Sad to say, the UPDATE papers could have been a little clearer:

• units - the coefficients and variables use to calculate the cost savings are presented without units. So we see one term is in barrels that get converted to gallons but another is not shown. In private e-mail, the second term is supposed to be in barrels(?) but we don't see the conversion. They really should have published the units.
• describe the seven variables in more detail in the UPDATE papers - the original working and published papers do a much better job.

What attracted me to this report are how many of their conclusions match observable facts:

• loss of refinery profits - the EIA reports gasoline margins are $0.10/gal while fuel oils are $0.50/gal. This helps explain the gasoline vs diesel price difference. Also, Sunoco has already idled two refineries and plans to idle another East Coast refinery in June/July.
• market concentration effect - the whole West Coast is suffering significant fuel costs because there are only a handful of refineries and one had a major fire and loss of production this winter. The others have been slow to come back online. The Sunoco refinery sale or shutdown will do to the East Coast what refinery problems have done to the West Coast.

I am by no means an expert in their methodology. I struggled through the papers and UPDATES to get some understanding. But a lot of it rings true.

Now I don't care about the energy costs of producing ethanol since natural gas, coal, and diesel are not fuels that can fill-up our Prius. Ethanol is another way to convert non-transportation fuels into Prius fuel ... I'm all for it.

I'm also not worried about the impact on food prices. As I pointed out to a hog farming operator, cheap pork won't be of any use if the customer's can't drive to the supermarket to buy it.

I would also observe that we can make ethanol plants but making crude oil is a lot harder with time-scales measured in millions of years. Furthermore, we are still at the bottom of the "S" curve and ethanol production efficiencies continue to improve. But ethanol also breaks the monopoly on Prius fuel.

I also like the fact that ethanol production includes 'fixing' CO{2} by the plants. Perhaps not as well as a bog or future oil/coal field but still less bad than releasing fossil carbon back into the atmosphere. As for carbon sequestration, it is oil marketing for gas-injection to extract more oil from a nearly depleted field.

So I've ordered an E85 kit for our Prius, the older 2003 one. If it works as expected, it will become a 'flex fuel' car. I have no idea how long it will run but know only one way to find out ... do the experiment.

Bob Wilson

 

That gives a static, today only price contribution. Using commodity prices, E10 looks to have an $0.08/gal effect. However, the Du/Hayes model incorporates these factors:

• Crude and Product Market Conditions - in effect, the commodity price spread between crude and refinery products. What ethanol does is upgrade cheaper stocks into more product, usually downstream of the refinery, at the blender. It has the effect of 'softening' the demand for crude by taking some of the demand.
• Refinery Capacity and Capacity Utilization - ethanol is typically added downstream of the refinery, reducing the demand on refinery capacity.
• Market Concentration - this is in effect the degree that a few refineries dominate a market, a defacto monopoly. In contrast, the number of ethanol plants in the midwest are counted in the hundreds and growing. This further limits the ability of a few refineries to set a higher price.
• Unexpected Supply Disruptions - part of their model, it covers such things as Gulf of Mexico storms that shutdown production. In contrast, the distributed nature of ethanol production limits, but does not eliminate, the effect of a supply disruption.
• Gasoline Imports - this is one area where their model and the EIS data shows we have become a gasoline and ethanol exporter. This in effect reverses the transportation costs of fuel.
• Ethanol Production - increased from ~1 B /yr to ~14 B /yr, so now it fully meets the production levels for E10.
• Seasonality - their model accounts for the seasonal nature of gasoline sales (and prices.)

So is the real number $0.08/gal or $1.09/gal? I'm not sure. But given what ethanol does to soften the gasoline market, I'm sure it is higher than just the $0.08/gal difference between commodity prices. Long term, the limits of fossil oil means we'll have to find alternatives and today, ethanol remains the current, mass production alternative. Others may follow but this is the world we live in today.

Bob Wilson

 

I agree that it could be a lot better. Too many:

I think it needs a little more editing and possibly some supporting links to source data.

Does elasticity also have an inverse function:

• 10% increase in price -> -2.6% demand (one year interval)
• -2.6% availability -> 10% increase in price (?)

Even if we take the multi-year case, 6%, it suggests small changes in supply, especially when working near the limits, could and should have wide variations in price. Into this mix comes ethanol that serves to buffer the worst price hikes ... or so I'm thinking.

But I quite agree that a lot of their machinations are not clear. Certainly it would take a lot of time to replicate their work based upon what they've shared. If nothing else, they need a good editor to help them get their methodology on paper so others can try to replicate it.

Bob Wilson

 

No problem here.

The EIA reports the margin as lower than that of other distillates such as diesel:
Short-Term Energy Outlook - U.S. Energy Information Administration (EIA)

I am pretty sure that the EIA sees the price of oil being the major part, not "cost of equipment, people, and regulations." Regardless, there is at least a $0.19 difference between gasoline and diesel wholesale price. The EIA reports it as relative demand and Du/Hayes suggest ethanol.

Do you have any metrics on the "midwest" oil and refiners numbers?

You are right about the assumption of refinery capacity as ethanol added at the distributors is part of reducing refinery limited, demand.

That is one of the take-aways from this study. If we do exactly what you've proposed, "Prices would be higher" to the tune of perhaps $1.09/gal. Their paper proposes a model for predicting the supply-limited, demand price.

My understanding is the ethanol subsidy ended.

When we are entering an era of reduce oil production, it will be hard to find investors. Even today, Sunoco plans to sell or shutdown their largest of three refineries in Philadelphia. If building a refinery is such a great idea, how come no one is running to buy the Sunoco facility, yet. My understanding is there are two, smaller Sunoco refineries in the area ... buy them and restart?

I can't replicate their methodology, there are too many gaps in the papers. However, I am pretty sure that a shortage to meet demand can cause substantial price changes. Having seen a substantial swing just this year, I'm open to a better model. But so far, theirs seems to match what we find in the EIA data.

Bob Wilson

 

Thanks,

It reads like a great deal for the Canadians but begging the question, why don't the Canadians refine their own oil and send it east to the Great Lakes? This would give them access to the East Coast and a killing if the Sunoco refinery is shutdown.

Going back to the EIA, here is a synopsis of the Midwest and Gulf:
Supply and Disposition of Crude Oil and Petroleum Products
Supply and Disposition of Crude Oil and Petroleum Products

Oil production in the Midwest, 44,887 B, versus the Gulf, 157,397. But the slope shows the Midwest is likely to meet their fuel needs, 12,550 short, in another year on their own. Meanwhile, they have been producing a lot of ethanol and reaping the benefits described in the Du/Hayes report. For example, this is just a snapshot showing a recent distribution of prices:

Here is the mapping of ethanol production:

Notice how corn producing areas are relatively lower priced than the surrounding areas. This is the ethanol effect Du/Hayes discuss.

Du/Hayes also point out that the small number of refineries in some regions gives them exceptional control over gas prices. California, Oregon, and Washington are paying that price. But it looks like the East Coast, PADD 1, will be in the same boat when or if the Sunoco refinery closes in June/July.

The last of the higher quality, light crude oil are being burned up as fast as possible leaving the less profitable, low "crack ratio" fuels. Diluting with ethanol increases the volume so these poorer feedstocks can be stretched out.

They identified seven parameters but did a poor job of showing how they used the EIA data to generate their coefficients. It would also help to have details about how each coefficient can be used to gain insights on the price of gas. More detail is needed but since they cited them, I suspect they were used.

Bob Wilson

 

Correct but it doesn't matter. The form of energy used to make ethanol, natural gas, coal, and diesel, is not Prius fuel. Ethanol converts one form of energy, mostly solar generated corn starches and sugars with some non-Prius fuels into a Prius usable form. Turn off ethanol production and these non-Prius fuels won't power our cars.

Bob Wilson

 

I've read earlier studies but most of them do not reflect current ethanol production processes which have gone through a significant expansion.

This is a recent report from 2009:
Green Car Congress: Study Finds Recent Improvements in Corn Ethanol Production Result in 48-59% Less Direct-Effect GHG Than Gasoline

The original paper: http://onlinelibrary.wiley.com/store/10.1111/j.1530-9290.2008.00105.x/asset/j.1530-9290.2008.00105.x.pdf?v=1&t=h33t8lmq&s=da3772d9bc4fc74bc424981a1969f398827bd770

Regardless, the fuels used to make ethanol won't work in our Prius. We're looking at converting one form of energy to one that is Prius compatible. But unlike fossil fuels, we can grow more corn (and other fermentable sugars) and make ethanol.

Bob Wilson