Feared supply shortfalls have failed to materialize ahead of the Jan. 1, 1995, deadline for introducing reformulated gasoline (RFG) required in certain areas of the U.S. under federal clean air law.
Quite the opposite is the case. Not only are there apparently ample supplies of the new fuel, but the last minute pullout from the federal program by some counties in Pennsylvania and New York have roiled oil markets.
The abrupt drop in expected demand that is resulting from the withdrawals contributed to declines in crude oil and refined products futures prices the previous 2 weeks (OGJ, Dec. 12 and Dec. 19, Newsletter).
Although the Environmental Protection Agency has come under heavy criticism for allowing the pullouts, the Energy Information Administration said early withdrawal has lessened the possibility of RFG shortages.
It said Pennsylvania's request to remove 28 counties from the RFG program amounts to about 170,000 b/d, or 7% of U.S. RFG demand. EPA is allowing Pennsylvania to withdraw those counties.
EIA said, "If the petition were approved immediately, the reduction in RFG demand in December would imply that production capacity is available to build another 5 million bbl of RFG stocks during the month."
IMPLEMENTATION
Industry analysts expect no big problems in implementing RFG mandates by Jan. 1.
RFG supplies on U.S. markets are expected to be adequate to meet 2.52.6 million b/d of demand. In addition, EIA believes there is enough U.S. RFG capacity to build primary inventories equal to more than 20 days' supply.
Further, many consultants agree, U.S. refiners, products terminal operators, and wholesale and retail distributors in recent years have successfully handled too many other new fuel requirements for RFG rules-however costly-to trigger much alarm.
But U.S. gasoline markets even in the best of limes can be jolted by sudden imbalances. A severed refined products pipeline can disrupt supplies as easily as an unexpected regulatory decision can blunt demand, as occurred in early December when Pennsylvania Gov. Robert Casey agreed to allow 28 counties in the state to opt out of the federal RFG program.
Still, disruptions of RFG supplies could do more harm sooner on U.S. East Coast gasoline markets in Petroleum Administration for Defense District (PADD) 1, where demand ordinary was expected to exceed production by 700,000-800,000 b/d. The greatest regional surplus of RFG appears to be forming in PADD III on the U. S. Gulf Coast, where combined RFG capacity is expected to exceed demand by more than 750,000 b/d. Imported RFG in 1995 is expected to maintain balance on East Coast markets, accounting for as little as one fourth of the region's imported gasoline supplies.
In the weeks following Jan. 1, regional RFG demand likely will ebb and flow as customers in retail markets weigh the perceived benefits of RFG Phase I implementation against the program's apparent costs.
However markets eventually shake out, responding to future uncertainties such as whether a share will be reserved in the RFG pool for renewable oxygenates. The uncertainties will be especially difficult in an era when U.S. gasoline markets are being redefined.
A NONEVENT
With RFG and oxygenate inventories ample and supplies building in the right places, Bill Ludlow, DeWitt & Co. Inc., Houston, described arrival of the RFG era in the U. S. as a nonevent.
Ludlow pointed out that U.S. refiners and marketers successfully phased out leaded gasoline and more recently introduced oxygenated gasoline and low sulfur diesel fuel to U.S. motorists.
"Right now, I feel that we're going to introduce RFG with very little difficulty," he said.
U.S. refiners need supplies of imported methyl tertiary butyl ether (MTBE) as well as domestic ethanol and ethyl tertiary butyl ether (ETBE) to be assured of enough oxygenates to manufacture RFG. But Ludlow said refiners in early December were so unconcerned about oxygenate supplies that MTBE spot prices on the U.S. Gulf Coast remained steady at about $1.075-1.085/gal, even though three major MTBE plants were down.
"So, right now, we feel that although there are going to be some fits and starts, it appears that implementing the RFG program will be a nonevent," he said.
John R. Dosher, managing partner of Pace Consultants Inc., Houston, said the decision in Pennsylvania not to require retail outlets in 28 counties to sell only RFG could decrease RFG demand in the state by 100,000150,000 b/d.
"We were expecting RFG supplies in the U.S. Northeast to be somewhat tight-by about 100,000 b/d. But at least that much demand now appears to be coming out of the picture," Dosher said.
In spite of the last minute decision, he said, some degree of turmoil, confusion, and other short term problems are unavoidable when markets begin matching RFG supplies with demand.
LOGISTICS
The extent to which areas across the U.S. are allowed to opt in or out of the federal RFG program will bear heavily on the logistics of moving supplies where they are needed.
RFG administrative requirements force manufacturers and shippers to segregate batches prior to delivery to retailers. DeWitt's Dexter Miller said that mandate has prompted products terminals to change operating procedures and reassign storage capacity rather than build new tanks.
"Many terminal operators are rededicating tankage because in the past they stored three grades of gasoline: regular, midgrade, and premium," Miller said. "Almost all refiners we talked to about RFG tell us that terminals are dropping the midgrade as a separately stored product and blending regular and premium to make the midgrade."
The disclosure in Pennsylvania weeks before the Jan. 1 deadline that counties representing 40-60% of the state's gasoline demand plan to use conventional supplies offers a preview of the logistical readjustments possible each time EPA excuses another area from the RFG program.
Dosher said terminal operators in the area by then had converted storage to serve RFG markets, and marketers had begun building RFG inventories.
"Now, here it is on the eve of the switchover, and those markets say they're going the other way," he said.
Marketers with RFG stored at area terminals now have unneeded supplies and will have to find substitute markets for the supply or sell it at a loss into conventional markets. Surplus RFG in the area could weaken the fuel's regional wholesale prices.
In addition, suppliers now must restore logistics needed to move more conventional supplies into the area through a system reconfigured for RFG.
"The same pipeline systems serve RFG and conventional markets," Dosher said. "Moving conventional gasoline up there in a distribution system that has adjusted to handle RFG creates logistical problems for conventional markets in the Northeast similar to those facing RFG markets a few weeks ago. There will be a lot of scrambling over the next few weeks to get everything lined up the way it ought to be."
RFG SUPPLIES
The American Petroleum Institute said refinery production of RFG, destined for about one third of the U.S. gasoline market year round, was running at slightly more than 2 million b/d by the end of November, and inventories had jumped to 37 million bbl.
Deliveries of RFG to service stations and other secondary inventories were about 270,000 b/d in November.
API said in November that imports of RFG were 43,000 b/d out of the total 246,000 b/d of finished gasoline brought into the country.
Offshore suppliers able to provide RFG to the U.S. market are in the Virgin Islands, Venezuela, Canada, Europe, and other places.
API said U.S. refiners have been busy making the new product. Refinery utilization averaged 93.2% in November, up more than 1 percentage point from a year ago. Utilization recently peaked at 95%.
"Gasoline output by refiners and blenders, which for most of this year had been lagging behind year ago levels as product imports surged, jumped to a recent year high in November," API reported.
"Versus a year ago, production of finished gasoline was up 2%. Production of RFG reached more than 1.3 million b/d for the month as a whole and was running at roughly 2 million b/d at month's end."
Inventories of finished stocks rose 8 million bbl in November from October's ending level to 1.072 billion bbl.
One of the main contributors to that rise was gasoline, whose inventories rose 14 million bbl to 214 million bbl.
Although 8 million bbl below year ago levels, this was their highest level since last May.
RFG stocks were building rapidly by the end of November, when they stood at 37 million bbl or about 21% of finished gasoline stocks of 173 million bbl. Not included were components that eventually may be blended into RFG.
API noted, "The move to RFG represents another stage in the tightening specifications on motor fuels. Lead phasedown began in the early 1970s, the summer gasoline volatility program in 1989, the winter oxygenate program in 1992, and low sulfur diesel in 1993.
"In 1998 and again in 2000, the RFG specifications are due to change further. Changes in fuels and vehicles over the years have reduced tailpipe pollution to one third of what it was 40 years ago."
EIA CONFIDENT
EIA made a preliminary assessment of the RFG supply/demand situation in October, which it updated Dec. 15 with information based on data through November.
Although RFG is not required until Jan. 1, terminals were required to supply only certified RFG to retail stations in RFG areas as of Dec. 1.
Thus, the RFG program was fully implemented through the wholesale level by Dec. 1.
EIA said, "Supplies are adequate to meet the estimated demand level of 2.608 million b/d, but we face a tight supply/demand balance, typical of new product transitions, which leaves the system with relatively little ability to absorb an unexpected supply or delivery system disruption.
"A refinery outage in the Northeast or in southern California, for example, could lead to shortages in those regions.
"In addition, the likelihood of local shortages-for example, a single county-are possible due to diminished system flexibility and the fact that in complex circumstances, everything may not work right the first time."
EIA said RFG stocks entering December were low but near estimated demand levels.
Stocks were 38.9 million bbl Dec. 2 or about 15 days of supply-in reality perhaps 17-19 days of supply due to gaps in the reporting system-a level that still is relatively low.
Historically, finished motor gasoline stocks average 24 days of supply at the end of November, EIA's supply/demand balance estimates suggest only a small stock increase during the month, which is typical of conventional gasoline in December.
In January, stocks will continue to be adequate but tight.
EIA said refiners plan an increase of about 100,000 b/d in RFG production, and total gasoline demand should be down about 66,000 b/d.
OXYGENATE SUPPLIES
With enough world MTBE capacity to serve international demand, DeWitt expects U.S. refiners to be able to acquire as much imported MTBE as they need to meet RFG demand.
U.S. gasoline markets are willing to pay a premium for MTBE for use as an oxygenate for RFG and oxygenated gasolines. MTBE's value outside the U.S. is less because the rest of the world uses it mainly to boost gasoline octane.
Effectively, arrival of the RFG era is expected to signal the end among U.S. refiners of using MTBE as an octane component.
DeWitt's Miller said U.S. refiners can take MTBE from the octane pool because they have a lot of other ways to boost octane. Similarly, a lot of foreign refiners can make more money substituting something else for octane, then shipping MTBE to U.S. markets, he said.
U.S. refiners are expected to continue receiving 15,000-20,000 b/d of imported MTBE from traditional sources such as Canada and Venezuela, as well as new supplies from Saudi Arabia, Dubai, Europe, and Malaysia. Blessed with ample supplies of butane and methanol, Saudi Arabia has boosted its MTBE capacity to about 70,000 b/d from about 13,000 b/d, the fastest rate of increase in the world.
DeWitt estimates U.S. MTBE consumption in 1995 will average about 250,000 b/d, with domestic supplies accounting for 63.1% of RFG oxygenate demand and imports 16.1%. Ethanol and derivatives are expected to capture a combined 20.8% of U.S. RFG oxygenate demand.
RENEWABLES MANDATE
Dosher said there is no environmental justification for requiring U.S. refiners to use ethanol as an RFG oxygenate. He doesn't expect EPA to be allowed to enforce its renewable oxygenate requirement.
"If it does happen," he said, "it will be extremely difficult to manage. It would add cents per gallon to the cost of RFG and make it more difficult to manufacture. Keeping records of all the component flows would make record keeping even more difficult. It would increase incentives to cheat. Negative effects go on and on."
Dosher said upholding court challenges to the requirement by API and National Petroleum Refiners Association "would be good for motorists and for the industry."
RFG ERA UP
Refining industry officials are studying price trends on current gasoline and oxygenate markets to draw conclusions about what to expect after Jan. 1. Many expect the spread between RFG and conventional gasoline wholesale prices to amount to 5-10/gal.
DeWitt's Ludlow noted that RFG futures prices on the New York Mercantile Exchange through 1995 have remained relatively flat at about 57/gal. With crude oil cash prices at about $18/bbl, unleaded regular gasoline on Gulf Coast spot markets in early December was selling for about 43.5/gal, a normal relationship between crude and gasoline prices.
Using those prices as a guide and adding about 2/bbl for transportation to outlets in the U.S. Northeast would leave a hefty 11/gal difference wholesale between conventional spot gasoline prices on the Gulf Coast and RFG futures prices. If that spread holds, retail RFG-conventional gasoline price differentials could be greater.
Dosher said gasoline futures prices cratered Dec. 2 because of Pennsylvania's announcement. RFG still was bringing a 6.75/gal premium over conventional supplies on Gulf Coast and New York Harbor spot markets.
"Both RFG and conventional gasoline prices went down, but the spread in favor of RFG more or less was maintained," Dosher said.
With no more surprises before arrival of the Jan. 1 RFG implementation date, Dosher expects RFG retail prices on the East Coast to amount to 6-10/gal more than conventional gasoline.
EIA said, "Prices for RFG are consistent with the costs underlying production, and the difference between RFG and conventional gasoline prices indicates confidence in supply."
ENFORCEMENT PITFALLS
Whatever price trends develop on U.S. gasoline markets, Dosher said, enforcing RFG rules and requirements will be a complex, difficult task.
"There is a risk for refiners in that enforcement will be so difficult they might not get good rulings," he said.
Some responsibility for enforcement rests with the companies manufacturing, handling, and shipping RFG, all of which will have to pay for independent sampling. Self-policing through independent auditors will send hundreds of reports flowing toward EPA.
When performing initial baseline assessments for refiners preparing to meet RFG antidumping rules, Dosher said Pace found the EPA thinly staffed and with few experienced people. If the RFG program is administered at the pace of enforcement procedures under the old crude oil entitlements program, some refiners could wait for months or years before settling allegations of violations.
"Simply dealing with an individual refiner's baseline is a massive job," Dosher said. "I think the EPA is going to get swamped trying to administer the law."
OPTING IN, OPTING OUT
The 1990 Clean Air Act amendments require RFG to be the only gasoline sold in the nine most severe ozone nonattainment metropolitan areas.
Later, 14 states and the District of Columbia decided voluntarily to place additional serious or moderate nonattainment areas into the program.
The opt-in areas include a population of nearly 30 million in addition to the 60 million people in the mandatory RFG areas.
Recently some areas that had opted in said they were opting out. They are the 28 counties scattered across Pennsylvania and Jefferson County, N.Y. The Pennsylvania counties are Carbon, Lehigh, Northampton, Blair, Erie, Cumberland, Dauphin, Lebanon, Perry, Cambria, Somerset, Lancaster, Columbia, Lackawanna, Luzerne, Monroe, Wyoming, Adams, York, Mercer, Allegheny, Seaver, Fayette, Washington, Westmoreland, Armstrong, Butler, and Berks.
API complained to EPA, noting that refiners earlier had shipped RFG to those regions in preparation for the Jan. I deadline. API argued refiners should be given a reasonable lead time to sell their RFG stocks and shift back to conventional gasoline.
API said several Maine counties were considering quitting, "and it is possible that other areas will follow suit if these opt-out requests are allowed."
EPA appeared to agree. It first said it would consider opt-out requests in an orderly process that gave refiners and marketers adequate notice (OGJ, Dec. 12, p. 29).
But it later told the governors of New York and Pennsylvania they could quit immediately.
EPA Administrator Carol Browner said EPA also discovered it had no regulatory process to allow opt-outs, so it would begin a rulemaking to formally remove the counties. In the meantime, she said, EPA simply would not enforce the Jan. 1 RFG deadline for those counties.
Pennsylvania Gov. Robert Casey said, "This action means that our motorists will be spared the higher prices associated with reformulated fuels."
He urged legislators from those counties to ensure their constituents know that gasoline distributors in the 28 affected counties are moving expeditiously to phase out any reformulated gasoline sales and hold down prices.
API REACTS
In a letter to Browner Dec. 14, API Pres. Charles DiBona said, "The last minute decisions by Pennsylvania and New York to reverse their earlier decisions to opt in to the RFG program have been disruptive to the industry and created confusion at a critical time in the introduction of RFG."
He said EPA apparently dismissed API's concerns in the rush to accede to the state reversals of their opt-in decisions.
DiBona wrote,"We remain particularly concerned over the use of enforcement discretion to address compliance until the rulemaking is completed. It may well encourage further differences in behavior among competing operations because the applicable requirements remain in effect.
"It would have been far better for EPA to have issued immediately an effective rule or to stay the rule, specifying a date certain by which the options would be no longer applicable. I urge EPA to reexamine its legal options and provide greater certainty to the industry."
DiBona urged EPA to work closer with industry to settle on reasonable opt-out criteria.
"EPA's approach to these two requests has set an unfortunate precedent which will discourage many in the business community from working with the agency or accepting its assurances.
"EPA's commitment to and reasonable management of the RFG program is crucial to successful introduction of clean fuels now and at future critical dates in 1998 and 2000 and will remain a major focus of the industry, given the enormous investment which is required to meet these deadlines."
UNNECESSARY SPENDING
Pennsylvania's action, Dosher said, might represent the first of many decisions against RFG mandates by other state, county, and local governments.
When federal officials announced plans for the RFG program, Dosher said many thought areas not required to use only RFG would choose to participate in programs covering adjacent areas. But as more people have studied RFG requirements and modeled Phase I effects, more questions have been raised about relative costs and effects.
"The benefits aren't that great in Phase I," Dosher said. "It doesn't do any good on NOx which a lot of scientists think is a primary component of ozone formation and a problem a lot of areas seem to be having trouble with."
Because more people in and out of the U.S. refining industry are beginning to consider RFG Phase I benefits marginal, and as costs to motorists of the program become better known, Dosher doesn't expect many more unmandated areas to opt into the program.
"Political pressure is going to increase for some marginal places to opt out," he said. "Even some environmentalists aren't too crazy about RFG anymore.
"Refiners and others have spent a lot of money to get ready for this thing, and we might end up with less demand than was thought."
Copyright 1994 Oil & Gas Journal. All Rights Reserved.
Issue date: 12/26/94
