Approximately 40% of all corn grown in the United States goes to ethanol production. Photo: Wikimedia Commons.

To blend or not to blend? That is the question refiners will need to answer in 2014 as they cope with falling gasoline demand and strict ethanol blending mandates set by the EPA. The Renewable Fuel Standard has been in place since mid-2005, although for the most part, consumers haven't noticed one way or the other. That could change in a big way if refiners' predictions prove correct.

I recently spoke with Charles Drevna, president of the American Fuel and Petrochemical Manufacturers, to discover how ethanol blending will affect refiners, consumers, and the economy in 2014 and beyond if ethanol mandates aren't adjusted downward. Here's what I learned.

Tug-of-war
Before speaking with Drevna, I figured that a lot of the arguments stemming from the refining industry were just attempts to protect its own agenda. That obviously plays a part for all sides involved in the issue, but it now appears to me that refiners are largely caught in the middle. Refiners serve a relatively simple purpose: They create finished petroleum products from crude oil and distribute it to the market, be it independent gas station owners or third-party distributors. That simplicity is getting much more complicated with soaring ethanol blend rates.

Source: Energy Information Administration.

The nation is precariously close to the Blend Wall, or the line the auto industry has drawn in the sand for ethanol blending ratios. It is currently defined as 90% gasoline and 10% ethanol, or E10. It is also at the heart of the battle between the EPA and the ethanol industry and the refining, automobile, and food industries. The EPA thinks E15 can solve the problem, and it could, but only if the nation's auto industry and infrastructure agree.

Refiners are hit particularly hard because they're required to purchase renewable identification numbers, or RINs. The University of Missouri succinctly summarized the issue in a December 2012 study titled "A Question Worth Billions: Why Isn't the Conventional RIN Price Higher?" (Link opens a PDF.)

(RINs) are certificates fuel blenders use to prove mandate compliance. Fuel blenders can buy or sell RINs. The conventional RIN price indicates how difficult it is for fuel blenders to meet the overall mandate. ... Pushing more ethanol through the system would be increasingly difficult for fuel blenders, meaning conventional RIN prices could rise.

In a case of academic foreshadowing, the report was published right before RIN prices jumped from a few pennies per gallon to nearly $1.50 per gallon this summer. Those costs are inevitably passed on to you, the consumer, but things could get much worse. The amount of ethanol required to be blended into gasoline is directly determined by how much fuel a refiner or blender sells to the market. If the supply of RINs continues to tighten up, top refiners such as Valero and Phillips 66 could simply produce less gasoline to reduce their obligations and costs -- a realistic business decision. That, of course, would tighten the nation's gasoline supply and send gasoline prices much higher.

How are refiners caught in the middle? They can't sell ethanol blends to independent gas station owners if they (and their customers) don't want the product, which limits hopes that E15 and E85 can solve the problem. Exporting isn't always an option, either, as many nations refuse to purchase E10 gasoline outright or impose tariffs on imports to spur domestic biofuel programs. Furthermore, refiners would be in a tough spot for selling blends greater than E10 if it causes millions of Americans to void the warranties on their cars -- the biggest question mark heading into 2014.

Well, this is awkward ...
The auto industry has yet to take a unified stance on E15, but all companies do agree that more extensive testing needs to be performed on engines. Toyota (TM -1.08%) isn't taking any chances. It began putting stickers on the gas caps of its various car models in 2012 that simply state "Up to E10 gasoline only." That was seemingly a shot at E15. Ford (F -0.41%), General Motors, and Chrysler have yet to place visual warnings on their cars, although each has chosen words carefully when it comes to E15. Cynthia Williams, Ford's environmental policy manager, was quoted as saying "Ford does not support the use of E15 in legacy vehicles," instead advising drivers to consult their owner's manual.

A warning to drivers about using E15. Source: Boise Guardian.

Does that mean the Blend Wall is a firm ceiling? While it's entirely possible that more testing could prove E15 is safe in vehicles produced after 2001 (as the EPA has certified), smaller engines such as off-road vehicles, lawnmowers, motorcycles, and boats are not. It looks as if the fuel market may get much more complicated for consumers.

This could get ugly
The EPA did extend an olive branch of sorts this summer, axing cellulosic ethanol requirements for 2014 because of supply constraints. The problem is summed up by KiOR (NASDAQ: KIOR) , which owns 11 million of the nation's 19 million gallons of cellulosic ethanol capacity that will generate RINs in 2013. It has run into problems hitting internal production targets since its first commercial facility came online. Management admitted that operations could be jeopardized if the company can't find adequate funding in the next several quarters while the kinks are worked out of its catalytic process.

Other leaders, such as POET and DSM, are looking to make a big splash in cellulosic ethanol in 2014, but the industry has had an embarrassing start out of the gate. Besides, while cellulosic ethanol would provide some relief to the RIN market (corn ethanol and cellulosic ethanol carry their own RINs, but both can be blended to meet obligations), it wouldn't alleviate fears of exceeding the Blend Wall.

Are consumers doomed? It seems that it's a real possibility beginning next year, but this is a complicated issue. Be sure to check back in the coming weeks as I dive into the topic in more detail.