The Push for Ethanol
by Bob Gatty

Long before the Democrats won control of Congress in the November elections, it was clear the federal government was marching inexorably toward the day when renewable fuels would become an increasingly important ingredient in the effort to reduce America's reliance on foreign oil. Indeed, the idea of making motor fuels out of everything from corn to kitchen grease is already a reality.

Even President Bush, a former Texas oil industry executive, in his State of the Union address last January warned that Americans were "addicted to oil" and something had to be done so the nation would no longer be held hostage by oil-producing countries abroad.

That comment came only a few months after he signed the Energy Policy Act of 2005, establishing a nationwide renewable fuels standard (RFS) that nearly doubles to 7.5 billion gallons by 2012 the nation's current 4 billion gallon commitment to ethanol and biodiesel production.

Combined with tax incentives for ethanol and biodiesel, this new RFS is only the beginning of a flurry of events that could combine to overwhelm convenience store operators who sell motor fuels.

These gathering forces include:

• Political pressure in Congress and the White House in response to voter concerns about fuel dependence, with one eye already on the 2008 elections
• Incentives and requirements to encourage greater use of these fuels, both by encouraging more retailers to consider these fuels, and more auto manufacturers to create fleets that can use them
• An aggressive marketing campaign by alternative fuel producers touting the benefits to consumers
• The growth of capacity to produce both ethanol and biodiesel in supplies sufficient to make them a practical, viable and reliable source of fuel

"What's the policy and where are we headed? How do retailers respond to accommodate that policy? Those are key questions that we face today," says John Eichberger, NACS vice president of government relations.

The primary issues involve federal requirements and incentives for the development of ethanol, which is currently produced from corn but could potentially come from commodities like corn stalks and switchgrass; and biodiesel, a clean, renewable diesel fuel substitute produced from agricultural resources including soybeans or canola, or recycled restaurant cooking oil.

Both of those fuels offer opportunities and challenges for retailers who currently sell gasoline and petroleum diesel, according to industry experts who say there are extra costs and requirements involved, but also the opportunity to potentially generate higher profits while gaining competitive advantage.

"It's right for a lot of reasons: the political continuity of it, the industry's going to exist, and it's going to grow," says Mike Harrell, president and CEO of Southwest Georgia Oil Co. Inc. in Bainbridge, Georgia, which last fall became the first retailer in Florida to offer E-85. "And if nothing else, when a customer looks you in the eye and complains about the high cost of gas, it's a great way to say, 'You're right. I feel your pain, but look at what we're doing with ethanol, with biofuels. And here's why we're doing it, and we're doing it because of that very complaint. We're just as frustrated as you are.'"

But the key is for policymakers to devise an energy policy that encourages development of alternative and renewable fuels without imposing mandates that could threaten many retailers' very survival, Eichberger says.

The Question of Mandates
Currently, ethanol is blended into 46 percent of the nation's gasoline supply, most as E-10, a mixture of 90 percent gasoline and 10 percent ethanol, according to the American Coalition for Ethanol (ACE). All cars can run on E-10, and nearly all dispensers and tanks in use today are approved for E-10, ACE says.

While there are specific equipment service requirements involved for stations that sell E-10, the real challenge is with E-85, a mixture of 85 percent ethanol and 15 percent gasoline. E-85 is currently offered at only 1,000 of the approximately 167,000 stations nationwide, and cannot be used in 95 percent of vehicles currently on the road. Special separate tanks and dispensers are also required.

But advocates of E-85 say it will dramatically reduce U.S. reliance on gasoline and they have strong advocates in Congress who agree on more extensive mandates for renewable fuels production than those currently in place.

"If you want to promote it, promote it," says Eichberger. "But don't make us do this because you could put a lot of retailers out of business. If you want to help consumers, allow these products to come to market naturally, not by imposing mandates on business that would only force prices up."

ACE supports legislation introduced last year by Sens. Tom Harkin (D-IA) and Richard Lugar (R-IN) that would increase the RFS to 12 billion gallons per year by 2012, establish an eventual federal mandate of 60 billion gallons and require major oil companies to offer E-85 at half of their corporate-owned and -branded retail facilities by 2017.

Brian Jennings, ACE executive vice president, says the longer-term 60 billion gallon RFS goal is needed to spur commercialization of ethanol and allow for widespread use of E-85. "A large ambitious RFS would cement ethanol as the alternative transportation fuel of choice and provide the nation with a substantial supply of homegrown, renewable fuel," he contends.

The Political Landscape
The new Congress may provide a better opportunity for the ethanol industry to achieve its objectives, with the legislature poised to consider a new farm bill in 2007.

Soon-to-be-Speaker of the House Nancy Pelosi (D-CA) has said that legislation introduced by Rep. Stephanie Herseth (D-SD) could be the foundation for the House Democratic energy policy. That bill would speed up the renewable fuel schedule to 20 percent of fuels produced by 2015, require auto manufacturers to meet prescribed model-year flexible-fuel vehicles (FFV) percentages and require the installation of E-85 pumps at retail fuel facilities when FFV penetration reaches targeted levels.

In the other chamber, as chairman of the Agriculture Committee, Sen. Harkin (D-IA) is expected to continue his aggressive push in behalf of E-85, Eichberger predicts, noting that this, combined with the intentions of House Democrats, "increases the likelihood that something pretty aggressive could pass in this Congress." He also suggests that President Bush is unlikely to veto any biofuels bill that arrives at the White House.

Meanwhile, the 2008 Presidential campaign is underway and candidates will be focusing on the ethanol-friendly state of Iowa in hopes of securing an early victory at the nation's first caucus. Recently, Iowa's Democratic Governor Tom Vilsack announced his bid for his party's nomination.

Eichberger points out that Gov. Vilsack's reputation in support of renewable fuels like ethanol and biodiesel, and his popularity in his home state, will force other candidates to increase their biofuels rhetoric in order to compete and establish momentum early in the primary season. "In the Midwest, ethanol is not a policy, it's a religion," he says. As a result, ethanol may well become an early presidential campaign issue.

Concerns Beyond Supply Issues
Aggressive ethanol mandates will only exacerbate supply issues and increase costs to consumers, Eichberger says. And distribution is a major factor, given ethanol's corrosive properties and propensity to attract water molecules.

"Production is predominantly concentrated in the Midwest and, because ethanol cannot be shipped in the pipelines, distribution is complicated and expensive. And if production does not meet demand, the price of ethanol will greatly exceed that of gasoline like it did when MTBE was removed from gasoline and the spot price of ethanol spiked to more than $200 per barrel."

ACE, however, says that supply is not a concern. With 19 states providing production incentives, there are 109 plants operating with an annual capacity of 5.2 billion gallons. Twelve plants are being expanded for an additional 560 million gallon capacity, and 48 plants are under construction to provide another 3.2 billion gallons per year. By the first quarter of 2008, ACE estimates there will be 7.45 billion gallons of annual ethanol production capacity.

But proposals to mandate E-85, like those supported by ACE, introduce a new set of challenges and costs. Because of E-85's corrosive properties, retailers must dedicate a separate underground storage tank (UST) and dispenser system for the product. The most cost-effective option is to install a new UST and dispenser system, at a cost of between $50,000 and $200,000 per location, depending on the market - an expense that Eichberger says would be difficult for many retailers to absorb. In addition, there is the need for space for the extra tank, a serious problem for many retailers.

"Such conversions will make economic sense to retailers once demand reaches a critical level," Eichberger says, "but forced conversions will serve only to penalize retailers who, on average, netted only 3 to 4 cents per gallon in pretax profit in 2005."

Meanwhile, there is a wild card that has stalled, at least temporarily, the growth of E-85. On October 23, Underwriters Laboratories Inc. (UL) said it had suspended authorization of E-85 dispenser components pending further review. The primary concern involved corrosive effects that E-85 might have on dispenser components, none of which have been certified for use with E-85.

"E-85 is at a standstill right now," says Fernando Crosa, president and CEO of Columbus, Ohio-based U.S. Tank Alliance, which manages compliance, emergency testing and cleaning services for underground storage tank clients, including convenience stores.

The 10 Percent Solution?
Given all of these developments, what should retailers do?

Paul Melton, vice president at Griswold Energy Partners in Woodlands, Texas, which helps retailers procure, store and blend renewable fuels, urges retailers who haven't yet embraced E-10 to consider doing so.

"You don't want to wait until it's mandated," he says. "And there are economics involved that can help lower the cost and actually improve profits."

Those economics stem both from special tax incentives provided by many states and the federal government, as well as the nature of ethanol itself.

Melton explains that ethanol can increase octane when it is blended with regular gasoline to create E-10. For example, blending 10 percent ethanol with 87 octane gasoline yields a product with 89.5 octane, that could provide a mid-grade fuel at less cost than the traditional method of blending 87 octane gasoline with straight 93 octane premium.

Thus, a retailer can choose to either sell that 89.5 octane product at the going rate for regular, providing a distinct marketing advantage over competitors, or he can use it as his mid-grade blend and benefit from the lower production costs. All that is needed, Melton says, is an extra tank for ethanol so the products can be mixed appropriately. Otherwise, the blended products can be created at the terminal. "The savings are pretty big with this 'cocktail,'" he says. "And it's hard to compete with that."

"Most tanks built after the early '90s can handle a 10 percent blend," Melton says. "Just check to make sure the manufacturer warranty covers a 10 percent blend." Make certain that tanks are UL-coded for 10 percent ethanol, he advises.

Eichberger further recommends that retailers speak with their equipment supplier to establish tank management processes that will defend against phase-separation of the fuel caused by water contamination. "It is critical that retailers prevent any water from entering their ethanol-blended tanks. Even small amounts can cause the ethanol to separate from the gasoline, resulting in an improper mixture of fuel."

But What About E-85?
Melton points out that special tanks and equipment are required for that product, which still is in its infancy. The time will come, he says, but there will need to be more flex-fuel vehicles produced before that product makes sense for most retailers to provide.

UL removed its seal of approval for E-85 components because high concentrations of ethanol are corrosive and harmful to aluminum, and most equipment in use today contains aluminum components, Melton says. "It takes a totally different pump to dispense this product, but at a 10 percent blend, everything out there is golden. Most current fueling systems at retail can handle 10 percent blending."

Making Biodiesel Work
Biodiesel, typically blended between 5 percent and 20 percent with conventional diesel fuel, since January 2005 has carried a new "biodiesel mixture credit" established by Congress to promote its use. Taxpayers are eligible for a credit of $1 per gallon for agri-biodiesel used and a credit of 50 cents per gallon for all other biodiesels. So there are some financial advantages to be gained, although Melton stresses some specific precautions must be taken.

For example, cold weather is a problem, as the product can turn into gel if care is not taken. "Once the product gets down to 35 degrees or lower in its raw form, glycerin fallout can occur. That can create all kinds of issues for someone who's blending with diesel. It clogs filters, and ultimately the trucks won't run," Melton explains.

But there are many benefits that fit with the nation's environmental efforts and need to become energy independent.

"Biodiesel reduces exhaust emissions, it is nontoxic, and it works in any diesel engine without modification," says Ed Burke, president of Dennis K. Burke Inc., a biodiesel distributor based in Chelsea, Massachusetts. While Burke acknowledges that precautions must be taken in cold weather, he says additives marketed for conventional diesel operations can be used with biodiesel, and that "fuel heaters or indoor garages will decrease the likelihood of gelling."

Biodiesel also increases both the lubricity and octane rating of diesel fuel, Melton points out. "I think the biodiesel industry is sitting on a pretty good opportunity. It's sitting on a potential boon as the government continues to push for higher end quality fuel."

Opportunities Ahead
Certainly, there are challenges ahead for retailers as they seek to take advantage of potential benefits offered by renewable fuels. There is a learning curve that needs to be addressed, as with any new undertaking. But the opportunity is there, even though there still are some uncertainties involved.

"We are working hard to oppose any new mandates," says Eichberger. "We've been speaking with all of the players involved and making efforts to educate policymakers so they understand how the retail market works and how their policies will affect the consumer. Hopefully, they will be responsive to our concerns."

Meanwhile, he advises retailers to stay abreast of developments - and to prepare their tanks to handle ethanol blends.