Is ethanol really worth $3.81 for the octane but costs only $1.39 on the market? How could that be?
Math majors around the country are frequently perplexed by this one. If you start with 84-octane RBOB gasoline and add a 10 percent blend 100-octane ethanol, how the heck do you get 87-octane gasoline at the pump?
(Don’t you get, in that typical scenario, a 85.6 octane regular unleaded fuel — below the recommended values from many car manufacturers for preventing engine knock?)
The secret is this. It’s not really the measured value of “octane improvers” that matters, when it comes to blending components into a finished fuel. It’s the “blending values of octane improvers”. Lots of refinery components like FCC gasoline, reformate, alkylate — or, additives like ethanol — can improve octane. “But, measured octane is different than performance octane,” explains Steve VanderGriend of the Urban Air Initiative.
Here’s a standard textbook table of those values. In fact, it comes from the textbook “Petroleum Refining”, written by Dr. Tareq A. Albahri at the Center for Petroleum Refining Studies at Kuwait University.
Turns out, the blending value of ethanol is 119-octane, according to Albahri. That explains how you add so much octane to RBOB gasoline with ethanol.
Which raises the question: how much is that ethanol worth? Forget for a second its value in complying with the Renewable Fuel Standard. What’s the value as an octane enhancer? If mandates were to go away, are there other considerations that make ethanol an attractive molecule for refiners?
The background on octane for newer readers
Octane is the measure of an fuels’ ability to resist premature detonation (called pinging or knocking) which reduces efficiency, releases more unburnt hydrocarbons and air pollution, and can lead to severe engine damage.
Straight run gasoline does not have a high-enough octane rating to be sold as regular unleaded gasoline. So, refiners make blends, and blending components add value not only based on energy content but octane rating (plus Reid Vapor Pressure and other performance considerations).
In the US, typical octane ratings are reported two ways — the RON (research octane number, think “mild operating conditions”) and MON (motor octane number, think “severe operating conditions or high speed”), and what appears on a pump is the average. So, if a given fuel has a RON of 80 and a MON of 94, that’s an “87-octane fuel”.
That’s the theory. But each blending component at a refinery has a different set of RONs and MONs, and octane ratings change based on the interaction of the molecules. So, it does not exactly work that a blend of 85-octane and an 89-octane blendstock will give you 87-octane gasoline.
And, you can improve the octane of FCC gasoline, for example, based on the catalysts used in Fluidized Catalytic Cracking operations. And, octane can vary from refinery to refinery based on the properties of the feedstock crude oils. Not to mention, the impact of regulations in some markets which require more expensive “summer blends” — expensive because they have less low-cost butane (but which can generate higher levels of smog).
The best method for determining price
Feedstock costs vary and blends vary, refinery to refinery. In the end, the best way to look at the value of octane in the marketplace is to look at market prices.
For example, the difference between regular, mid-grade and premium gasoline. Since gasoline prices vary from grade to grade, city to city, and in conventional vs “reformulated” markets. Also, regular unleaded is 85 octane in Colorado and some other high altitude areas, and premium can range up to 93 octane in some areas
To simplify, we’ve used 87, 89 and 91 for regular, mid-grade and premium fuel.
Ethanol’s octane value
In the US, a step-up of one grade of gasoline (regular to mid-grade, or mid-grade to premium), costs $0.238 this week at retail, according to the US Energy Information Administration. That’s for two points in octane rating.
From that, we can imply a retail value of 11.9 cents per octane point, in today’s market. Ethanol has a 32 point octane blending value advantage over 87-octane gasoline, which gives us a retail value of $3.81 for a gallon of ethanol’s octane, irrespective of mandates.
Right now, ethanol futures are priced at the Chicago Board of Trade at $1.393 for the February 2016 contract. Which indicates that ethanol is, overall, a pretty good deal right now as an octane booster.
Here’s our chart on that.
Now, the caveats
What about wholesale? Generally, the differential between retail and wholesale prices reflect taxes and the retailer margin, which are generally based on the gallons not the price. So, the differential would be relatively minimal, in terms of octane value.
But the biggest factor is the price of competing refinery products that also supply octane. For example, toluene. Problem is that you have limitations on how much toluene goes safely into gasoline, because of potential carcinogenic effects.
But, if you look at the table of blending octane values we cited above, you’ll see that there are just under 10 different refinery product options, such as 100 RON reformate, that could conceptually raise octane. At today’s low oil prices, even intensive refining practices to produce somewhat exotic high-octane blendstocks are going to cost well under $1.39 per gallon, the latest ethanol cost. (That equates volumetrically to $58 per barrel, for those of you tracking oil prices).
Some additional value
Compared to other octane options, however, ethanol has regulatory compliance value.
When a refiner blends in a gallon of ethanol, as opposed to some other octane enhancer, the blender generates a RIN credit, which can be presented to the EPA as evidence of blending low-carbon renewable fuels as required under RFS, or can be detached and sold into the RIN market.
For example, the February 2016 D6 ethanol RIN contract is priced at $0.65 on the Chicago Board of Trade. That’s additional value that reformate, for example, does not have — owing to the social benefits of low-carbon domestic fuels (energy security, reduced greenhouse gas emissions, and economic development).
Chasing engine efficiency
One way to increase the efficiency of the internal combustion engine — and push for higher fuel economy — is by increasing the compression ratio. Problem is, higher compression increases the risks of premature fuel detonation, or knocking. So, high octane has a premium value in any consideration of super-efficient, next-generation engines, One of the reasons that many auto manufacturers are looking into E30 blends as they contemplate the next generation of fuel economy targets.
More background for new readers, on RINs
Since investors invest and measure returns in dollars, not external social benefits, the Renewable Fuel Standard is a mechanism that internalizes the social value in dollar form, thereby incentivizing the production of renewable fuels to achieve the social benefits. This is done through mandated levels of renewable fuels and the production and submission of RINs as evidence of compliance.
Accordingly, every gallon of renewable fuel produced has a Renewable Information Number associated with it — essentially, these are barcodes. These are passed along free to buyers, and when a qualifying renewable fuel is blended, that becomes a RIN which can be submitted to the EPA. One gallon, one RIN; one billion gallons, one billion RINs. Obligated parties can buy or sell RINs from other parties.
Whoa, Nelly, don’t go crazy. There are other considerations in fuel blends. Reid Vapor Pressure and cold-start performance, for example, and the tolerance of the vehicle components for higher alcohol blends. And octane is a consideration for gasoline engines. Diesel is a different technology.
The Bottom Line
Worth $3.81? There’s math to support those octane values, but refiners have alternatives — so, ethanol can capture only some of that value.
An important takeaway here is not only the value of octane, but octane as a demand driver. Any price you set on it, ethanol has real and enduring value as an octane enhancer because octane has real market value. Think “demand driver” and you’re on the right path, even in markets that lack mandates. And, especially in markets that will look to high-compression engines
This YouTube video is a great primer on this topic.