Statement of Bob Slaughter, National Petrochemical and Refiners Association

Good morning, Mr. Chairman and members of the Committee. My name is Bob Slaughter. I am General Counsel of the National Petrochemical and Refiners Association. NPRA is a trade association which represents virtually all U.S. refiners and petrochemical companies who have processes similar to refiners. We appreciate this opportunity to appear before the Subcommittee to discuss the environmental effects of ethanol under the Clean Air Act and the general question of whether ethanol should be mandated.

NPRA opposes fuel mandates. Mandates eliminate competition and thus are likely to result in increased costs to consumers. They inevitably foster market protections and monopolies and often result in unanticipated side effects, such as supply curtailments and higher prices. Once in place, they are then difficult to reverse. Mandating a product signals to consumers and industry that a product is uneconomic and "can't make it on its own" without special patronage. This is often harmful to the product's reputation and adversely impacts its long-term commercial acceptability and market performance. Basically, people don't like mandates. Americans value freedom of choice. Our economy reflects that characteristic, and it has served us well. In contrast, it is a foregone conclusion that gasoline subject to an ethanol mandate will be more expensive than it would be in the absence of a mandate.

We have witnessed positive results with public policies which rely on market forces, for example, the acid rain program, but by most accounts our experiment with fuel mandates for RFG oxygenates and alternative fuels have had unsatisfactory results. Given widespread dissatisfaction with the current oxygenate mandate, proponents of continued interference with market forces in fuel policies bear a heavy burden of persuasion. We do not believe that the advocates of a new ethanol mandate under the Clean Air Act have come anywhere close to making their case.

Ethanol has a bright future as a gasoline blendstock. Why risk the negative consequences of a mandate? If MTBE use is constrained, ethanol is one way refiners can provide reliable supplies of gasoline while meeting consumers' demands for fuel performance. Studies by the U.S. Department of Energy and the California Energy Commission predict significant ethanol growth in the Northeast and California, respectively, under an MTBE phase-out without a mandate. Northeast ethanol demand is estimated to exceed 550 million gallons per year if there is withdrawal of MTBE from the market while ethanol demand in California is estimated to reach 828 million gallons. The total annual ethanol demand increase for these two regions would be almost 1.4 billion gallons--or just slightly less than a doubling of today's 1.5 billion gallon usage.

In addition, the ongoing reduction of sulfur in gasoline will lead to a significant increase in ethanol use. Many refiners will give serious consideration to ethanol as a means of replacing octane lost when sulfur is reduced. Absent a mandate, the projected increase in ethanol use will take place where it makes the most economic sense to use it. Much will depend on the price of ethanol in response to such an increase in demand. However, with total U.S. demand for ethanol in 2006 estimated possibly to double today's figure, it is clear that there should be substantial growth in ethanol use even if some demand erodes as prices rise.

The impact of an extensive, national ethanol mandate on the environment is unknown. The EPA Blue Ribbon Panel pointed out "Although ethanol is likely to biodegrade rapidly in groundwater, because ethanol is infinitely soluble in water, much more ethanol will be dissolved into water than MTBE." While the environmental track record--with respect to groundwater contamination--of using ethanol in gasoline has been good, a recent ethanol leak in the Lake Tahoe area has received considerable press and public attention. This is an indication that the environmental consequences of mandated use of this highly soluble chemical are of concern. It seems wise to proceed with a measure of caution in an area in which the public may feel that it has been recently ill-served (i.e. by the oxygenate mandate).

Air quality impacts are possible. A recent study presented by Toyota to CARB has shown that if ethanol blended at 10% replaces MTBE blended at 11% (by volume), tailpipe NOx emissions increase significantly. Also, in non-RFG regions, ethanol benefits from an EPA waiver which allows it to be blended at a higher volatility level, thus increasing evaporative emissions. Further, if ethanol blended gasoline is mixed with gasoline not containing ethanol, the ethanol causes an increase in the volatility and the evaporative emissions of the mixture. Thus, an ethanol mandate could have significant adverse impact in areas where increased ozone (smog) producing emissions are of concern.

With regard to effects on water, experience to date with ethanol blends has been relatively benign. We do know that microbes preferentially degrade ethanol present in a spill, which will retard the rate of degradation of other components.

Given the concerns expressed about MTBE, we should be cautious about new programs that would significantly increase usage of ethanol in gasoline beyond traditional volumes. The EPA Blue Ribbon Panel recommended extensive testing of gasoline constituents before widely extending their use, based upon experience with the current oxygenate mandate.

If left to the workings of the free market, ethanol has positive attributes that will promote its use. The Blue Ribbon panel described ethanol as "An effective fuel-blending component, made from domestic grain and potentially from recycled biomass, that provides high octane, carbon monoxide emission benefits, and which appears to contribute to reduction of the use of aromatics with related toxics and other air quality benefits; can be blended to maintain low fuel volatility ..."

Reliance upon a government mandate, however, could focus attention on ethanol's problematic characteristics instead. The Blue Ribbon Panel goes on to say "[ethanol]...could raise the possibility of increased ozone precursor emissions as a result of commingling in gas tanks if ethanol is not present in a majority of fuels; [ethanol] is produced currently primarily in the Midwest, requiring enhancement of infrastructure to meet broader demand; because of high biodegradability, [ethanol] may retard biodegradation and increase movement of benzene and other hydrocarbons around leaking tanks."

An ethanol mandate will make it harder for refiners to provide cleaner fuels to consumers at acceptable prices. An ethanol mandate will hinder refiners' ability to optimize the quality and volume of cleaner-burning gasoline. This will increase refining costs, impacting both gasoline supplies and price. According to the California Energy Commission, the costs of substituting ethanol-blended gasoline in that state could increase refining costs by up to 7 cents per gallon. Without a mandate, refining costs are significantly reduced, because refiners have the flexibility to economically blend gasoline in a cost-effective way that meets octane requirements while maintaining emission performance benefits.

Distribution of ethanol blends confronts refiners, other fuel suppliers and, ultimately, consumers with special economic burdens which a national mandate would increase. Adding more ethanol to gasoline is not just a matter of investment in new ethanol production facilities. Ethanol is added to gasoline at terminals, not at the refinery. Therefore, investment is necessary at terminals not currently using ethanol for equipment to receive ethanol by rail or truck (about $300,000 per terminal) to store ethanol in a tank ($450,000 for a new tank) at the terminal and to install blending equipment ($450,000 per terminal). In addition to environmental permitting requirements, these are sizable investment requirements for terminal operators and they should not be forced by a legislative mandate. The National Petroleum Council estimates that it ethanol blends are required at all RFG terminals outside of the Midwest, the terminal capital investment requirements would total $185 million. Total investment expenses would be higher if conventional gasoline terminals in the Southeast, Southwest and West also have to be converted for ethanol blending.

In addition, ethanol presents special logistical problems. Since alcohols like ethanol tend to adhere to water and thus separate out of an oxygenated gasoline blend, it is difficult to transport ethanol blends by pipeline. Instead, a special gasoline blendstock is made for ethanol fuels (both to ease transport and to compensate for the increase in evaporative emissions associated with ethanol's higher volatility.) The ethanol itself is shipped separately by railroad, truck or ship, and the finished gasoline is blended (using special equipment) at storage terminals near the area where it will be sold to consumers. As EIA indicates in discussing ethanol logistics and costs, "Shipments to the West Coast and elsewhere via rail have been estimated to cost an extra 14.6 to 18.7 cents a gallon for transportation."

Ethanol is already heavily subsidized by taxpayers. Ethanol has received a large federal tax subsidy since 1978. Currently, this incentive is $.54 per gallon of ethanol. The incentive is financed through diversion of moneys that would otherwise go into the Highway Trust Fund. At current ethanol usage rates, the Highway Trust Fund loses about $1 billion per year in revenues because of the reduced tax rate and diversion of some receipts to the General Fund. The only way to avoid this situation is to fund new ethanol incentives out of general revenues, which would have the negative result of assessing every taxpayer to benefit fuel ethanol. As it is, many, if not most, of those who benefit from the ethanol incentives also rely on other agricultural assistance programs for corn. As the Administration states in its most recent policy analysis: "Corn producers currently receive more in direct farm support payments than producers of any other commodity."

Proposals for a national ethanol mandate seek to make energy consumers and highway users pay even more for agriculture subsidies. Consumers already pay for corn and ethanol subsidies that are funded out of the general treasury or Highway Trust Fund. But advocates of a national ethanol mandate are proposing to take an even bigger bite out of their pocketbooks. According to the Administration, "...the potential trust fund impacts (of a national mandate), ranging between more than $0.5 billion and a little under $1 billion per year, would be on the order of 1 to 2 percent of the total fund." This means that as much as $2 billion total of revenues that would otherwise go to the Highway Trust Fund would be diverted to ethanol.

According to EIA modeling, "adding a 2 percent renewable fuels standard is projected to increase gasoline prices in the 5 cents per gallon range in 2005." As a rule of thumb, a one cent increase in gasoline prices nationwide amounts to, in the aggregate, a $1 billion additional cost to consumers. Thus, the renewable mandate will cost gasoline consumers $5 billion more in 2005 than an alternative policy option of phasing-down MTBE usage without a mandate.

The Administration's latest paper on the renewables mandate is clear in assessing the likely beneficiaries: "With 2.5 per cent of the nation's gasoline consisting of ethanol by 2010...The price of corn would be 15 cents per bushel more in 2010 than in the absence of the standard and average 11 cents per bushel more during 2002-2010...U.S. farm income would increase by $1.4 billion in 2010, and would average $750 million more per year during 2002-2010."

Ethanol credit trading pursuant to a national mandate could create regional winners and losers. Many refineries do not produce RFG, do not blend MTBE in conventional gasoline, or do not make blendstock for ethanol blending to produce gasohol. Implementation of a national renewable mandate with averaging, banking and trading could reduce investment requirements at refineries and terminals outside of the Midwest. However, a national renewable fuel mandate would segment the oil industry into winners (those in the Midwest who can offset ethanol expenses by selling excess "credits" and losers (others who would have to purchase "credits"). Consumers who purchase gasoline would benefit or be disadvantaged depending on which category their supplier fits into. Most of the winners would be located in the Midwest, with losers disproportionately located in the Northeast and West.

An ethanol mandate will make it harder for refiners to comply with priority environmental programs. Refiners are concerned with the possibility of supply disruptions as product quality specifications are changed. A renewable mandate is the same as a product specification change for refineries that do not currently use ethanol. Congress should not impose a renewable mandate burden on these facilities that already face significant new investment requirements for reducing sulfur in gasoline and diesel fuel. The industry is committed to current implementation of RFG 2 as it is to reducing sulfur in gasoline and diesel. The imposition of additional, wholly arbitrary requirements such as a nationwide ethanol mandate will further stress refiners and the refining system. This means that some of the programs may not achieve the projected environmental benefits.

"Truth in labeling" is needed to clarify, rather than confuse policy options. The intent and import of the national ethanol mandate policy option would be clearer to consumers/constituents if terms and statements made by its proponents, especially the Administration, were more reflective of the likely result. NPRA makes the following observations:

1. The "renewable fuels standard" is a national ethanol mandate and should be recognized as such. The only renewable transportation fuel likely to be used in the foreseeable future as a gasoline blendstock is ethanol. The "standard" requires its use, and is indistinguishable in intent or effect from a "mandate." Also, there is no such thing as a "flexible mandate" which was EPA's initial euphemism for this program. Like "living death" or "wakeful sleep" the words "flexible mandate" are a contradiction in terms and hence oxymoronic. Policymakers who advocate basing a significant portion of America's gasoline supply on mandatory use of an already heavily subsidized product provided by an extremely concentrated industry should say so.

2. The only likely beneficiary of the national ethanol mandate is corn-based ethanol. Proponents of the national ethanol mandate are claiming that it will provide significant benefits for ethanol from biomass other than corn. The proponents allege that imminent "technological breakthroughs" will enable non- corn-derived biomass ethanol to reap significant benefits from the mandate. It would be imprudent to rely on a significant portion of gasoline supply upon such a speculative source. But the much greater likelihood is that corn ethanol will be positioned to take all of the market for ethanol in the foreseeable future, and that cellulosic biomass will fill only the tiniest increment of any ethanol actually supplied. Once corn ethanol has occupied the additional market created by the national mandate it is hard to imagine that its producers will step aside and surrender any significant portion of that market to competing suppliers of ethanol from cellulose. The Administration's emphasis upon the positive impact of the national mandate on corn prices in its recent paper gives away the real intent behind this national mandate.

3. The existing ethanol subsidy is unlikely to be repealed. Opponents of the subsidy have been trying for two decades to eliminate it. The result is usually extension of the subsidy far into the future, and often an increase in the subsidy itself. This means that revenues intended for the Highway Trust Fund will continue to be diverted. The only alternative is to take these funds from general revenues, which has other serious drawbacks. Analyses suggesting that reduction or elimination of the subsidy is a real possibility are misleading unless they indicate that the likelihood of this happening is very remote.

Conclusions

Federal policymakers should reject the call for a national ethanol mandate. Congress and the Administration should learn from, rather than repeat, the mistakes of the past. The ethanol lobby has been trying to mandate ethanol throughout the national gasoline supply for more than ten years. The oxygen mandate that has led to current water quality concerns was supported by large agribusiness in order to guarantee an ethanol market for them. Enacting another mandate to replace the problematic current one could have much greater negative consequences, including higher gasoline costs, tighter and less reliable fuel supplies, the potential for increased smog-creating emissions and a potential to create a consumer backlash. Refineries and ethanol producers can work together better to provide America's future transportation fuels in the absence of a national ethanol mandate. That will really clear the air.

Congress and EPA should follow the recommendations of the EPA's Blue Ribbon Panel. They should help refiners serve the real energy and environmental needs of the nation by repealing the federal oxygen mandate, and by reducing MTBE levels while maintaining air quality benefits. And they should provide enough time for the transition to allow refiners to continue providing adequate supplies of gasoline and other petroleum products to consumers without undue cost increases.

I look forward to responding to your questions.