An Analysis of the Proposed 2017 Renewable Volume Obligations

In May 2016, the Environmental Protection Agency (EPA) proposed Renewable Volume Obligations (RVOs) for calendar year 2017 under the Renewable Fuel Standards (RFS) program. EPA set the total renewable fuel target under the assumption that nearly all gasoline would be blended with ethanol up to 10 percent by volume (E10) and that approximately 200 – 300 million gallons of motor fuel sold would be gasoline blended with 51 – 83 percent ethanol (E85) which can only be used in flex-fuel vehicles (FFVs). There currently are about 19.6 million FFVs in the

U.S. vehicle fleet, which is expected to grow to almost 21 million in 2017; and about 3,100 stations that dispense E85, concentrated primarily in the Midwest, with EPA estimating a midpoint projection of 3,700 such stations in 2017. Because E85 has less energy content per gallon than E10, most FFV drivers will use E85 only when it is priced at a discount to E10. The RFS program includes a price mechanism for valuing and trading “renewable identification numbers” (RINs) that signify a gallon of ethanol blended into fuel; the value of such RINs associated with blending E85 for retail sale can provide an additional subsidy to expand this E85 price discount
relative to the E10 price.

When the RVO implies an average concentration of ethanol in gasoline that exceeds the typical 10 percent level, the so-called “E10 blendwall” is breached. That is, additional volumes of E85 (or potentially blends such as E15 or E30) must be sold in order to displace E10 in the fuel market. For the past several years, EPA has set the RVO under the assumption that E10 would be ubiquitous and that E85 sales would be similar to levels previously observed; that is, they have avoided exceeding the blendwall with substantially expanded volumes of E85. EPA justifies this reluctance to significantly exceed the blendwall by relying on analysis that shows limited passthrough
of RIN value to retail E85 prices and limited consumer response to subsequent E85 price discounts. Because EPA considers these market phenomena to reflect constraints, they set RVOs with such limits in mind, and the RVO for 2017 appears to reflect E85 volumes in the 200 – 300 million gallon per year range.

However, EPA’s empirical analyses utilize data that reflects market conditions as they existed historically without aggressive RVO targets, providing a “rearview mirror” perspective on the future market. We re-examine these analyses using more appropriate methodologies and more informative data. We find that EPA understates the likely market responses in both areas: we estimate a higher portion of RIN value pass-through to retail prices and project a much more pronounced consumer response to E85 price discounts near the levels where the cost per unit of energy is approximately the same (the energy parity price).