Statement of

Dr. Mark J. Mazur

Director

Office of Policy

U.S. Department of Energy

Before

Committee on Agriculture, Nutrition

and Forestry

United States Senate

April 11, 2000

Mr. Chairman, members of the Committee, I am pleased to be here to discuss the role that oxygenates like methyl tertiary butyl ether (MTBE) and ethanol play in the production and supply of gasoline, and how possible reductions in the use of MTBE and other changes in the Federal Reformulated Gasoline (RFG) program may affect the use of ethanol.

The Department's Analytical Focus

Over the last decade the Department of Energy has assisted the Environmental Protection Agency (EPA) in developing and implementing the RFG program and subsequent clean fuel rulemakings including ongoing efforts to develop a low sulfur diesel fuel requirement. The Department has done detailed analyses of the costs and refinery operational impacts of the various product quality regulations as well as broader fuel supply and pricing issues. More specific to this hearing, we have spent considerable time over the last year working with EPA and the Blue Ribbon Panel on Oxygenates examining the possible consequences of constraining the use of MTBE and modifying the statutory oxygenate requirements for the RFG program. Other analysis efforts related to the impact of changing oxygenate use have been carried out as part of the National Petroleum Council's ongoing Petroleum Refining study and by the Office of Fuels Development within the Department's Energy Efficiency and Renewable Energy Office.

In addition to these specific, focused analyses, the Department has the lead within the Administration for gathering and disseminating energy markets data, as well as producing analysis and forecasts of energy markets through our Energy Information Administration. As you are well aware, Secretary Richardson has taken the lead in responding to the widespread concerns about high prices for crude oil, gasoline and distillate fuels seen in the past three months. In this regard, the Secretary has directed the Energy Information Administration and the Office of Policy to pay careful attention to the gasoline market, due to concerns that we could experience very tight gasoline supplies this year.

In addition to the work we do within the Department and the comments and analyses we have provided to EPA, we have asked the National Petroleum Council (NPC), a Federal advisory committee to the Secretary of Energy, to examine various issues related to environmental regulations and petroleum product markets. The NPC is now finishing its study on U.S. Petroleum Refining, which addresses the cumulative impacts of several product quality regulations, including changing the role of oxygenates in reformulated gasoline, on refinery viability and product deliverability.

Oxygenates and Reformulated Gasoline

This brings me to the subject of this hearing which is the role of oxygenates in reformulated gasoline production and the potential impact that limitations on MTBE may have on ethanol use and gasoline markets. The Federal Reformulated Gasoline program has been an air quality success with very few negative impacts on gasoline markets and consumers. There have been adequate supplies of RFG and its price has generally been only slightly higher than conventional gasoline. There are three main reasons for this. First, just a relatively small fraction of gasoline production is represented by RFG (about 25% of the total outside California) and there are a large number of refineries (about half of east coast, gulf coast and mid-west refineries) and importers participating in the production of RFG. Second, the fungible nature of the gasoline allows the gasolines produced at the different refineries and going to different states to be mixed and exchanged. Third, refiners have significant flexibility to formulate the gasoline in different ways to match their refining capacity. While the statutory mandate to use a specified amount of oxygenate in RFG has been controversial, refiners have adapted to this and integrated MTBE and ethanol use into the economic production of their total gasoline pool.

Our analysis, and that of others, indicates that the current level of oxygenate use in the total gasoline pool is not far from the level of use that refiners would choose, at today's gasoline and oxygenate prices, even if there were no specific oxygenate mandate. This is largely because oxygenates like MTBE and ethanol are valuable blendstocks for producing clean, high performing gasolines. Under these circumstances, simply removing the oxygenate mandate would have little immediate effect on overall oxygenate use in gasoline other than allow some additional flexibility to decide where, within a refiner's total gasoline pool, these oxygenates are used. This is not to say the volume of MTBE or ethanol in any given gallon of RFG might not drop if the oxygen standard were removed. Rather, the total amount of MTBE and ethanol used in the Nation's gasoline supply would stay about the same in the short run if the oxygenate mandate were removed, based on the economics of the products involved.

As refiners face additional requirements to meet tighter environmental standards for gasoline, like the recently promulgated standards for Tier 2 low sulfur gasoline, they will find oxygenates such as MTBE and ethanol even more valuable to make up for lost volume, octane, and other property changes. The availability of oxygenates also provides valuable immediate gasoline blending flexibility to refiners trying to meet tight product specifications: the oxygenates are aromatic-free, high octane, virtually sulfur-free blendstocks that can be put in almost any shipment of gasoline to offset performance shortfalls in other parts of the refinery. This is particularly true for MTBE which can be blended at the refinery and shipped in pipelines and which has little negative impact on vapor pressure. The effect of being able to readily blend even small amounts of MTBE into gasoline is to help assure product deliverability, reliable supplies and affordable gasoline prices to consumers.

Oxygenates can also provide important energy security benefits by increasing the gasoline supply and bringing non-petroleum and renewable feedstocks into the overall mix of refinery inputs. To the extent that these oxygenates come from non-petroleum and domestic sources, and the large majority of oxygenates we now use does come from domestic sources, they have the added benefit of displacing imported oil or imported products.

Addressing Problems Associated with MTBE

We share the concerns expressed by many over the impact of MTBE on water quality. The Administration is responding to these concerns with a number of actions including recommendations to Congress in the form of "Legislative Principles For Reducing or Eliminating MTBE". The key elements of these recommendations are:

- a gradual phase down or elimination of MTBE use in gasoline;

- ensuring that RFG air quality gains are not diminished; and

-replacing the reformulated gasoline oxygenate requirement with a renewable fuel standard for all gasoline.

This last point is particularly important from the standpoint of assuring adequate gasoline production. Reducing or eliminating MTBE with or without an RFG oxygenate requirement will increase, not diminish, the continued need for high quality blendstocks such as ethanol, in the production of clean, good performing gasoline in the needed volumes at affordable prices.

Avoiding Potential Problems

As we work together to develop the details of a program to reduce MTBE use and to increase the use of renewables, it will be of the upmost importance that we move deliberately and carefully so that we do not create gasoline supply and price problems or any other unintended consequences. We are operating in a tight gasoline supply/demand situation this year. The significant new investments required to meet the low sulfur gasoline regulations and other possible regulations affecting gasoline and diesel fuel, including reduced use of MTBE, combined with continued rising gasoline and diesel fuel demand make it likely that the motor fuel supply/demand balance in the U.S. may remain tight for the foreseeable future.

Current gasoline demand is almost 8.5 million barrels per day, a record level. The Energy Information Administration is forecasting more than 1.5 million barrels per day growth in gasoline demand over the next ten years (about 1.7% per year increase in demand) and they expect that gasoline imports will have to rise roughly 3/4 million barrels a day by 2010 to help meet that demand growth.

It is in this context that we must find a way to reduce or eliminate over 280,000 barrels a day of MTBE use, which is equivalent to a loss of up to 400,000 barrels a day of gasoline production (due to the valuable characteristics of MTBE). This is a large volume-- about 4% of U.S. gasoline supply and equivalent to the output of four or five large refineries. To accommodate these changes will require substantial additional investment in refineries and ethanol production capacity and significant additional work by the engineering and construction industry. This issue is of concern and is being addressed in the National Petroleum Council study which will be complete in June of this year.

We want and need to work with Congress to develop legislation that is consistent with the Administration's Legislative Principles and recognizes the practical limitations to making a large number of changes in industries that will face significant uncertainty about new technologies and demand growth. A well-measured approach gives us the best chance of preserving a reliable gasoline supply thus avoiding price volatility, and maximizes the opportunity for biomass-based ethanol to participate in this market growth. Given enough time, the fuel supply industry can respond to the loss of MTBE. Clearly, increased use of ethanol, mandated or not, will play an important role. However, what is not so clear is the speed and degree to which refiners can or will make up the loss in volume and quality of gasoline given all the other demands on their resources, the uncertain market conditions, and the continuing growing demand for all petroleum products.

Also, it is not clear how fast and under what conditions ethanol production can or will expand. It will take more than a simple expansion of ethanol plant capacity for ethanol to become a major component of the fuels markets. In addition to building enough production capacity to meet expected demands on a reliable basis, better, lower cost transportation links , extensive terminal blending and quality control capability and capacity to hold significant inventory will be necessary. Providing some degree of certainty, sequencing these changes with the other changes, and moving deliberately enough so that producers and markets can adjust will be important to the success of this transition.

Biomass-based Ethanol Development

The major renewable fuel currently used in this country is ethanol from the starchy parts of corn, i.e., kernels. Corn ethanol production is approximately 1.5 billion gallons per year and represents a little less than 1 percent of the energy of our annual gasoline consumption.

Biomass ethanol refers to ethanol derived from cellulosic matter that is available on a renewable or recurring basis including agricultural and forest residues, the organic components in municipal solid waste, and future energy crops such as fast growing grasses and trees. The cost of producing cellulosic ethanol - currently about $1.10 to $1.25 per gallon for low-cost niche feedstocks - is in the competitive range with corn ethanol. DOE's Biofuels Program focuses on research and development aimed at lowering further the production costs of cellulosic ethanol so that a major domestic transportation biofuel industry can be established. The Department's Transportation Biofuels FY 2001 budget is $54 million, a substantial increase over the FY 2000 appropriation. The request includes stepped up R&D to develop cost-effective technology for breaking down cellulose into simple sugars, which could be used to manufacture ethanol and other higher value chemicals.

The nation is endowed with plentiful biomass resources. To illustrate, just corn stover, i.e., the biomass residues associated with the harvesting of corn, constitutes a sizeable supply of cellulosic feedstock for a domestic biofuel industry. Even after subtracting the amount of residues that should be left in the field for erosion control and soil nutrients, approximately 7 billion gallons of ethanol per year could be produced using the stover. Other residues, including municipal solid wastes, wheat straw, and waste wood from forest thinning operations, could also supply a growing biofuel industry. Furthermore, future plantations of biomass dedicated to fuel production would produce specialized grasses and trees as reliable feedstock supplies for the ethanol industry.

As an example of the progress being made, BCI Corporation's project in Louisiana is expected to result in a cellulosic ethanol plant operating by 2003 and producing 23 million gallons per year of ethanol. The state of Louisiana and domestic and foreign biotechnology and engineering firms are contributing to the financing package. A major engineering firm has reviewed the technology and issued a legally binding guarantee of the process economics, a prerequisite for closing the financing arrangement.

From this developing cellulosic ethanol technology base we could see significant growth in cellulosic ethanol production on the order of over 1 billion gallons a year by 2010, if there is a reliable market for the ethanol. It is fairly clear that overall ethanol use could increase several fold by 2010 depending on the circumstances. For example, replacing MTBE on an oxygen content basis with ethanol would require more than twice current ethanol production levels. Replacing MTBE on a gallon-for-gallon basis would result in ethanol demand four times current levels. Obviously, the specific nature of the restrictions on MTBE use, the possible elimination or modification of the oxygenate requirement for RFG, and the size and nature of the renewable requirement will be key determinants of ethanol use. Other factors that may affect ethanol use are ethanol prices (including the current excise tax exemption and tax credit), the total demand for gasoline, the impact of sulfur controls on gasoline octane and volume, and gasoline prices. Any estimates of future ethanol demand will have to be viewed in the context of what assumptions are made about these factors.

Summary

MTBE getting into water supplies from leaking underground storage tanks and gasoline spills represents a serious problem that we propose addressing through the recommendations contained in the Legislative Principles and other actions. We want to work with Congress to develop legislation that fully addresses this problem while protecting American motorists from unnecessary gasoline price increases or price volatility and providing the best opportunity for growth in biomass based ethanol production.

Thank you for the opportunity to present this testimony. I will be glad to answer any questions you may have.