Ethanol Industry Braces for Growing Pains

WASHINGTON -- After a spurt of good fortune, the fledgling U.S. ethanol industry is anticipating some growing pains that could bring it unwanted attention this summer.

Ethanol's public profile rose significantly for the better last July when Congress passed an energy bill that mandates the doubling of biofuels output by 2012. In January, President Bush gave the industry a further boost with a strong endorsement in his State of the Union speech. And with the imminent phaseout of a petrochemical added to gasoline to reduce tailpipe emissions, more U.S. motorists will depend on the corn-derived fuel than ever before.

But there's trouble looming: The ethanol industry might not be ready to satisfy the expected summertime jump in demand. And by crimping the overall supply of motor fuel, this could contribute to a spike in gasoline pump prices at the start of the country's peak driving season.

That, at least, is the view of the Energy Department, which issued a report last month detailing the challenges midwestern ethanol producers will have in getting their fuel to key markets along the East Coast because of railroad, trucking and other distribution bottlenecks. The report also highlighted concerns about the limited output capacity of an industry still in its infancy.

The Renewable Fuels Association, a trade group representing ethanol producers such as Archer Daniels Midland Co. and Pacific Ethanol Inc., says the industry's challenges and their influence on gasoline prices are being overblown. The association sent an angry letter to the Energy Department last week, questioning the overall thoroughness of its research and accusing it of creating "unnecessary fears in the marketplace."

Still, ethanol-related worries hang over the U.S. market, contributing to a 42-cent-per-gallon increase in unleaded gasoline futures since mid-February. There are other factors behind the recent wholesale gasoline price spike, including soaring oil prices, strong demand and persistent strains on the U.S. refining system.

The average retail price of gasoline in the United States is $2.51 a gallon _ the highest level since October _ and some analysts say $3 is a possibility by summer.

Wholesale prices for ethanol, meanwhile, have surged to roughly $2.75 a gallon, or about 50 cents per gallon higher than usual, according to the Oil Price Information Service of Wall, N.J. Because ethanol makes up one-tenth of every gallon of unleaded gasoline with which it is blended, this windfall for ethanol producers ends up costing motorists an extra 5 cents per gallon at the pump.

High prices will spur more ethanol production _ there are 33 new plants under construction _ but some minor near-term complications can be expected due to the rapid increase in demand, said Bob Dinneen, president of the Renewable Fuels Association and the author of the letter sent to the Energy Department.

Dinneen said the industry is taking steps to mitigate the problems, such as filling ethanol storage tanks on the East Coast before summer arrives and contracting barges that can ship ethanol down the Mississippi River and then up the Atlantic seaboard.

Energy analysts said it is unclear whether ethanol producers can manufacture and distribute enough supply once U.S. refiners phase out the use of a petrochemical called methyl tertiary butyl ether, or MTBE, which enables gasoline to burn more completely, and thus more cleanly, but carries some public health risks.

The refining industry says it warned Congress for years about the difficulty ethanol producers would have in offsetting the loss of MTBE, which accounts for about 10 percent of the volume of every gallon of gasoline with which it is blended.

"When it comes to ethanol, Congress is guilty of more irrational exuberance than on any other issue," said Bob Slaughter, president of the National Petrochemical and Refiners Association.

California, New York and Connecticut have banned MTBE in recent years, but consumers from Virginia to New Hampshire, as well as in Texas, still depend on it.

MTBE, a natural gas derivative, has been the oxygenate of choice since the mandate was established roughly 10 years ago as a byproduct of the Clean Air Act.

But MTBE also has been found to contaminate drinking water supplies and it may cause cancer, exposing the petroleum industry to lawsuits filed by water districts and municipalities on behalf of their citizens. After Congress refused to grant the industry protection from such lawsuits, refiners made clear their intention to stop using MTBE.

Valero Energy Corp., Exxon Mobil Corp. and Shell Oil Co., the U.S. subsidiary of Royal Dutch Shell Plc, all plan to cease using MTBE in gasoline by May 5, spokespersons for the companies said.

Valero, the country's largest independent refiner, estimates the country's total gasoline supply will shrink by 145,000 barrels per day, or about 1.5 percent, once MTBE is removed _ a transition expected to be complete by May 5. That is when an obscure provision of the energy bill goes into effect, eliminating the need for a so-called oxygenate in gasoline.

Now it is up to ethanol producers to bridge the gap. While U.S. ethanol producers have the capacity to produce roughly 4.3 billion gallons per day in 2006, the near-term crunch means more imports will be needed from Brazil, Dinneen said. The United States imported more than 150 million gallons of ethanol in 2005.

Dinneen said part of the problem for the U.S. ethanol industry right now is that it was caught off guard by the oil industry's faster-than-expected phaseout of MTBE. "Refiners made the decision to accelerate the removal of MTBE, not ethanol producers," Dinneen said.

Perhaps the biggest issue is distribution.

Gasoline with or without MTBE can be shipped in large quantities through an extensive network of pipelines. But ethanol, which tends to corrode pipelines, must be transported on trucks, trains and barges in relatively small batches to storage terminals where it is then blended with gasoline.

"I suspect there will be enough ethanol, but that logistics _ getting rail and truck transportation to furnish the ethanol to key markets _ will be the nightmare that drives prices," said Tom Kloza, an analyst at Oil Price Information Service.

The trucking industry is faced with a multiyear labor shortage and railroad capacity is tight because of strong demand to ship coal, grain and steel.

"Barges are in short supply too," said Joanne Shore, the Energy Department analyst who co-authored the report on the ethanol industry's challenges.