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MEMORANDUM Subject: Illustrative Costs Impact of the Final RFS2 Standards, 2014

- 2016
From: Michael Shel l and Michael Shelby , U.S. EPA, Office of Transportation and Air

Quality
To: EPA Air Docket EPA

- HQ

- OAR

- 2015

- 0111

In this m emo we provide further description of our assessment of the illustrative costs of the final advanced biofuel and total renewable fuel standards for 2015 and 2016

. We start with an overview of considerations of a baseline from which to assess the impacts, followed b y descriptions of the specific costs assessed. We provide cost estimates for three illustrative scenarios

– one, if the entire change in the final advanced standards is met with soy bean oil biodiesel ; two, if the entire change in the final advan ced standards is met with Brazilian sugarcane ethanol; and three, if the entire change in the volume of the non

- advanced renewable fuel required b y the final standards is met with corn ethanol. While a variety of biofuels could help fulfill the advanced standard beyond soy bean oil BBD and sugarcane ethanol from Brazil, these two biofuels have been most widely used in the past. We believe these scenarios provide a range of possible costs of meeting the final standards. For this anal ys is, we estimate the per gallon costs of producing biodiesel, sugarcane ethanol and corn ethanol relative to the petroleum fuel they replace at the wholesale level, then multiply these per gallon costs by the applicable volumes established in this rule for the advanced and tot al renewable fuel categories. Because we are focusing on the wholesale level in each of the three scenarios, these comparisons do not consider taxes, retail margins, and any other costs or transfers that occur at or after the point of blending (i.e., trans fers are pay ments within society

and not additional costs). Also, w e did not attempt to estimate the infrastructure costs (e.g., E85 pump installations) that wou ld be required to meet these RFS standards. In addition, because more ethanol gallons must be consumed to go the same distance as gasoline and more biomass

- based diesel must be consumed to go the same distance as petroleum diesel due to each of the biofuels’ lesser energy content, we consider the costs of ethanol and biomass

based diesel on an ene rgy equivalent basis to their petroleum replacements (i.e., per energy equivalent gallon (EEG )).

**1. Baseline Consideration** 

A number of different scenarios could be considered the “baseline” for the assessment of the costs of this rule. For the purp oses of showing illustrative overall costs of this rulemaking, we are proposing to use the preceding year’s standard as the baseline (e.g., the baseline for the 2016 advanced standard is the applicable 2015 advanced standard), an approach consistent with p ast practices. Arguments could be made for using a variety of alternative baselines such as the statutory renewable fuel volumes (e.g., the required volumes in the Energy Independence andPage 2 of 9

Security Act (EISA) of 2007 for 2013, 2014, and 2015) or the volumes of renewable fuels that would be produced in the complete absence of the RFS program (e.g., “no RFS”). However, we believe the difference between each ye ar’s standards provides information that is illustrative of the magnitude of the potential overall costs of the standards being finalized today without adding the complexity

of trying to project a hy

pothetical future baseline that would only call into question the use fulness of the cost comparison. Use of alternati ve baselines other than the 2013, 2014 and 2015 applicable standards is problematic from a practical standpoint. For example, using the 2013, 2014, and 2015 statutory volumes would require estimating a h ypothetical set of cellulosic fuel costs as part of the baseline. Since liquid cellulosic fuels are not currently being produced in significant quantities, estimating their average costs of production would be highl y speculative on EPA’s part. Furthermore, trying to estimate the hy pothetical mix of fuels that could meet the annual EI SA volumes would introduce a level of complexity that would not necessaril y provide a more robust estimate of costs. There are similar complexities with trying to project what volumes of renewable fuels would be consumed in the U.S. in the absence of any RFS program, a h ypothetical “no RFS” baseline. One option would be to try to estimate the amount and types of biofuels that would have penetrated the market without the RFS program from its inception in the relevant years of consideration 2013, 2014 and 2015. Estimating the quantities of renewable fuels that would have been used b y market participants absent an y RFS requirements from the inception of the program would be an uncertain exercise

. For example, a bsent the RFS, billions of gallons of ethan ol would still be produced for consumption in the U.S. fuel market due to ethanol’s value as a low cost octane enhancer. Another factor that would impact consumption absent the RFS is individual state renewable fuel mandates, each of which would have to be assessed to determine this baseline. Thus, we believe that estimating the quantities of renewable fuels that would be used in the absence of the RFS program, as well as their associated costs, would be highl y speculative. The choice of a baseline wil l have a directional implication for the costs assessed. For example, reducing the standards from a high renewable fuel volume baseline (e.g., the EI SA 2013, 2014, or 2015 volumes) would show cost savings (assuming a gallon of renewable fuel is more costl y than its petroleum

- based fuel equivalent). Conversel y, increasing the volumes from a low renewable fuel volume baseline (e.g., the “no RFS” volumes) would show cost increases as a result of the 2014, 2015, and 2016 standards (assuming a gallon of renewable fuel is more costly than its petroleum

- based fuel equivalent). For the purpose of providing illustrative costs, we have opted for a more straightforward and real world baseline assumption of the applicable standard for the previous year as a baseline to assess the costs. In evaluating the costs for 2014, we would use the actual applicable standards for 2013 as the baseline. In evaluating the costs for 2015 and 2016, we would use the applicable standards for 2014 and 2015, respectivel y, as the baseline

. 1

1 Given the near - term time frame of the impacts we have not deflated the illustrative costs to a base year. Illustrative costs are in nominal 2015 dollars.Page 3 of 9

The 2014 standards were not finalized in 2014 so it is difficult to estimate what their costs may have been. Market participants may have anticipated that a final 2014 standard would require higher levels of biofuels than the market would provide in the absence of the standard, which would contribute to the positive RI N prices witnessed in 2014. In contrast, the 2014 standards being finalized in this rulemaking represent reductions in both the advanced and conventional volumes compared to the 2013 standards, suggesting cost savings for this final 2014 rule. Finall y, the 2014 standards being finalized in this rulemaking are based on actual production levels in 2014, suggesting that the 2014 standards we are proposing have no costs. Given the disputable foundation of this historical dy namic , we have not attempted to estimate the costs of the 2014 standards. Therefore, we onl y evaluate costs for the 2015 and 2016 advanced standards and total (i.e., non - advanced) standards.

**2. Cost of Displacing Petroleum** 
**- Based Diesel with Soybean** 
**- Based Biodiesel** 
Consistent with our previous work in this area, EPA’s estimate is a “bottom

- up” engineering cost anal ys is that quantifies the costs of producing a gallon of soy bean

- based biodiesel and then compares that cost to the energy

- equivalent gallon of petroleum

- based diesel. 2 Similar to the analy sis EPA undertook for the 2013 annual standard, we have made the simplifyi ng assumption that the marginal biodiesel feedstock used to meet the higher total advanced biofuel standard will come from soy bean oil. EPA recognizes that a variety of different feedstocks in addition to soy bean oil could be used to make additional biodi esel. These include other oils (e.g., canola oil) as well as waste oils, fats, and greases. However, projecting the proportions of different feedstocks that may be used to make extra biodiesel as a result of the standard and the different feedstocks’ cos ts would be speculative. Based on historical data, 52 percent of the feedstock used for U.S. biodiesel production in 201 5 (through August) was from soy bean oil, the largest source of feedstock used to make biodiesel. 3 Other feedstocks such as oils derive d from wastes are generally less costly

so they will be preferentially

used regardless of the volume set. However, there are not enough oils derived from wastes to fully suppl y the advanced standards we are proposing. Thus, we believe it is appropriate to make the simplifying assumption that the marginal feedstock used to produce biodiesel to meet the total advanced biofuel standard will be from soy bean oil. We base our estimates of soy bean oil feedstock costs in 2015 and 2016 on the latest United Stat es Department of Agriculture/World Agricultural Supply and Demand Estimate

2 Notice Department of Energy, Alternative Fuels Data Center. Fuel Properties Comparison. http://www.afdc.energy.gov/fuels/fuel_comparison_chart.pdf 3 In terms of feedstock poundage. By w ay of com parison, the next largest source of feedstock for 2015 biodiesel production wa s yellow grease ( 13 % ), followed by c orn oil ( 11% ) and canola oil ( 9% ). For calendar year 2014 these proportions were soybean oil ( 51% ) , yellow grease ( 11% ) , canola oil ( 11% ) , and corn oil ( 10% )

. Monthly Biodiesel Production Report . October 30, 2015. U.S. Energy Information Administration http://www.eia.gov/biofuels/biodiesel/production/Page 4 of 9

(USDA

- WASDE) forecasts. 4 Soy bean oil feedstock costs represent the majority of the overall costs of biodiesel, usually somewhere between 70 and 90 percent of overall costs. In add ition to soy bean oil feedstock cost, we assume variable production costs to estimate the total per gallon cost. We use two sources to represent a range of potential variable costs. For the higher cost estimate, we used per gallon cost estimates from the Universit y of Missouri, Food and Agricultural Policy

Research Institute (F APRI

- Missouri) March 2015 U.S. Baseline Briefing Book. They

estimate variable biomass

- based biodiesel production costs of $0.4 7 /gallon, net of the coproduct (i.e., glycerin) value for both 2015 and 2016. 5 FAPRI

- Missouri also include an average net operating return to produce biodiesel of $0.10 per gallon in 2015 and $0.39 per gallon in 2016. 6 For our lower cost estimate, we used a forecast of 2014 average biodiesel variable cost p rojections of $0.50/gallon from the National Biodiesel Board. 7 We then compare these ranges to estimates of the average price of wholesale petroleum

- based diesel in 2015 and 2016. We assume that the wholesale price of petroleum

- based diesel represents it s costs. EPA obtained the projected average wholesale petroleum

- based diesel 2015, and 2016 cost estimates from the U.S. Department of Energy , Energy Information Administration ’s (EIA) Short Term Energy Outlook (STEO) Report. 8 The STEO price is $ 1.71 in 2015 and $ 1.82 in 2016. The final 2014 standard is being set at the actual level of advanced biofuels produced in 2014, 2.6 7 billion gallons. The total advanced biofuel volumes are being finalized for 2015 at 2. 88 billion gallons and 3. 6 0 billion gallons in 2016. Consistent with the approach we used for the 2013 BBD standard, EPA estimates that increasing volumes of soybean oil for biodiesel will create upward pressure on the price of soy bean oil. Based on work from Iowa State Univer sity , we assume each additional 200 million gallons of so yb ean oil used to produce extra biodiesel results in an increase in soy bean oil costs of 3.2 cents per pound. 9 However, given the current low

- price or glutted condition of commodity

markets in general, including soy bean oil markets , it is also possible that changes in biomass

- based diesel volumes would have minimal impacts on prices in the near

- term, before supply adjusts. Therefore, in our low price estimate, we assume there is no upward price press ure on soy bean oil prices from greater biomass

- based diesel volumes. Applying th e cost impact assumptions to the projected range of USDA

- WASDE soy bean oil prices results in soy bean oil price estimates at 3 2 to 34 cents per pound for 2015, and 28 to 4 0 cents per pound for 2016.

4 2014/2015: 3 1

. 6 cents/lb , 2015/201 6 : 2 7 .5

- 3 0

. 5 cents/lb USDA, World Agricultural Supply and Demand Estimates ( October 2015). We use WASDE’s 2014/2015 estimates as a base for 2015, and the 2015/2016 estimates as a base for 2016. http://www.usda.gov/oce/commodity/wasde/latest.pdf 5 University of Missouri, Food and Agricultural Policy Research Institute. U.S. Baseline Briefing Book (March 2015)

. http://www.fapri.missouri.edu/wp

- content/uploads/2015/03/FAPRI

- MU

- Report

- 01

- 15.pdf 6 We are comparing the cost of producing a gallon of soybean oil biodiesel to a projected petroleum diesel cost (i.e., price) at the wholesale level which wo uld include upstream operating returns. Therefore, we think it is appropriate to include operating returns into our soybean cost estimates. 7 Presentation to EPA: Analysis of Cost of Carbon Reduction January 27, 2014. Although processing costs for soy bean biodiesel may be lower than industry average costs (which include a heterogeneous mix of feedstocks that may have higher processing costs), we do not have sufficient data to incorporate potentially lower soybean oil processing costs at this time. 8 Energy Information Administration (EIA), Short Term Energy O utlook (STEO)

. October 2015 http://www.eia.gov/forecasts/steo/pdf/steo_full.pdf 9 Babcock, Bruce, et. al. Biofuel Taxes, Subsidies, and Mandates: Impacts on US and Brazilian Markets (May 2 013) http://www.card.iastate.edu/publications/dbs/pdffiles/13sr108.pdfPage 5 of 9

Considering non

- feedstock variable production cost estimates from FAPRI

- Missouri and the National Biodiesel Board, and low and high WASDE soy bean oil estimates, the resulting biodiesel costs range from $ 3.16 to $ 3.42 per gallon i n 2015 and $ 2.82 to $ 4.28 per gallon in 2016 (on a diesel gallon equivalent basis). Comparing the petroleum

- based diesel price estimate and multiplying by the volume of fuel displaced on an energy equivalent basis, results in an overall annual cost of $ 2 03 to $ 240 million in 2015 and $ 480 to $ 1, 182 million in 2016. Table 1 below shows estimates of per gallon increases on an energy

equivalent basis as well as total annual costs for 2015 and 2016 of using greater amounts of biodiesel to meet the total advanced biofuel standard. These cost estimates assume that the increase in the total advanced biofuel standard is met with soy

bean

- based biodiesel, which is a simplifying assumption used for illustrative purposes. In all likelihood a variety of different sources of feedstocks and renewable fuels (e.g ., biodiesel from other feedstocks, sugarcane ethanol, sorghum ethanol, CNG/LNG from biogas) are expected to be produced to meet the 2015 and 2016 total advanced biofuel standard. It should be noted that soy

bean oil costs and petroleum

- based diesel costs c ould vary depending upon evolving suppl y and demand factors in their respective markets that are not reflected in current USDA/EIA price estimates. Table 1 Illustrative Per Energy

Equivalent Gallon Cost Difference and Total Cost Estimates of Meeting the Advanced Standard in 2015 and 2016 Using Biomass

- Based Diesel to Displace Diesel
2015 2016 Low High Low High Per Gallon Differences in Cost ($/gallon) 1. 4 5 1. 71 1. 00 2. 4 6 Total Annual Costs (millions of dollars) 203 240 480 1, 182

**3. Cost of**  **Displacing Petroleum**
**- Based Gasoline with Sugarcane Ethanol** 
While BBD can be used to meet the total advanced biofuel standard, other advanced renewable fuels can also be used to comply . One possible option is the use of sugarcane ethanol, the majority

of which is imported to the U.S., principally from Brazil. In this section, we provide illustrative estimates of what the potential costs might be for a scenario in which we assume that all additional volumes used to meet the 2015 and 2016 total advanced biofuel standards above the previous year’s total advanced biof uel standard are met with imported Brazilian sugarcane ethanol. W e compare the cost of sugarcane ethanol and gasoline at the wholesale stage, since that is when the two are blended together and represents the approximate costs to society absentPage 6 of 9

transfer p ay

ments. On this basis, EPA estimates the costs of producing and transporting a gallon of sugarcane ethanol to the blender in the U.S. We use the sugarcane ethanol free on board (FOB) price at Santos, the port of San Paulo, Brazil, from which sugarcan e ethanol is ty pically shipped to the U.S. Using dail y price data from the Oil Price Information Service (OPIS) from October 2014 to October 2015 , we estimate a range of prices for Brazilian ethanol exported to the U.S. Since OPI S does not project future sugarcane ethanol prices from Brazil, and a bottom

- up approach to estimate sugarcane ethanol prices from sugar futures prices is uncertain, we make the simplifying assumption that the observed high and low estimates from January 1, 2014 to the present are reasonable high and low price estimates for 2015 and 2016 as well. We assume that the reported price of sugarcane ethanol represents both the production and transportation costs of delivering sugarcane ethanol to the port at Santos. Using data collected b y Argus in a daily Argus Americas Biofuels report , we assume that it costs an additional $0.1 9 /gallon to transport the sugarcane ethanol from Santos to the U.S. where the ethanol can be blended with gasoline. 10 Ba **s** ed on the range of OPI S prices, the deliver ed price of sugarcane ethanol to the U.S. ranges from $1. 53 to $ 2.31 per gallon. For comparison purposes, we used the average wholesale price of gasoline for 2015 and 2016 from the STEO, which is $1. 7 0 per gallon and $ 1

. 67 per gallon, respectively

. 11 Taking the difference between the sugarcane ethanol and the wholesale gasoline price estimates, and multiplying that by the volume of petroleum displaced on an energy equivalent basis, results in an overall estimated annual cost of $ 186 to $ 431 million for 2015 and $ 656 to $1, 493 million for 2016. Table 2 below shows estimates of per gallon increases on an energy equivalent basis as well as total annual costs for 2015 and 2016 of using greater amounts of sugarcane ethanol to meet the total advanced biofuel standard. These cost estimates assume that the increase in the advanced biofuel standard is met with sugarcane ethanol, which is a simplifying assumption used for illustrative purposes. In all likelihood a variet y of different sources of feedstocks and renewable fuels (e.g., biodiesel, sorghum ethanol, CNG/L NG from biogas) are expected to be produced to meet the increase in the 2014, 2015, and 2016 advanced biofuel standards. It should be noted that sugarcane ethanol costs and wholesale gasoline costs c ould vary

depending upon evolving suppl y and demand factors in their respective markets that are not reflected in current OPI S/EIA price estimates.

10 Argus Americas Biofuels , Argus. $0.19 per gallon estimate was taken from the October 14, 2015 daily report. This report is in the docket as “Argus, Argus Americas Biofuels, Issue 15

- 19 8._14 October 2015” 11 Energy Information Administration (EIA), Short Term Energy Outlook (STEO)

. October 2015 http://www.eia.gov/forecasts/steo/pdf/steo_full.pdfPage 7 of 9 Table 2 Illustrative Per Energy

Equivalent Gallon Cost Difference and Total Cost Estimates of Meeting the Advanced Standard in 2015 and 2016 Using Sugarcane Ethanol to Displace Gasoline

2015 2016 Low High Low High Per Gallon Difference in Cost ($/gallon) 0.89 2. 05 0. 91 2. 07 Total Annual Costs (millions of dollars) 186 431 656 1,493

**4. Cost of Displacing Petroleum** 
**- Based Gasoline with Corn Ethanol** 

Inthis section, we assess the difference in cost associated with a change in the implied volumes available for conventional (i.e., non

- advanced) biofuels for 2015 and 2016. We provide illustrative estimates of what the potential costs might be in a scen ario where corn ethanol is used to meet the entire conventional renewable fuel volumes. The implied 2014 volume allowance for conventional renewable fuel is 13. 61 billion gallons, 14.05 billion gallons in 2015, and 1 4

. 5 0 billion gallons in 2016. I f corn ethanol is used to meet the difference between the implied 2014 to 2015 and 2015 to 2016 conventional renewable fuel volumes, an increase in 44 0 million gallons of corn ethanol would be required in 2015 and 4 5 0 million gallons in 2016. In Table 3 , we show estimates of differences in costs on a per gallon energy

equivalent basis between corn ethanol and wholesale gasoline as well as total annual costs of the conventional biofuel standard for 2015 and 2016. To calculate the cost of corn ethanol, we use a bottom

- up engineering cost framework starting with USDA

- WASDE estimated corn prices for 2015 and 2016. 12 We then estimate the 2015 and 2016 marginal production costs of corn ethanol using data from the University of Missouri, FAPRIMarch 2015 U.S. Baseline Briefing Book. 13 There are many factors that influence the price of corn ethanol besides the RFS program. The price of corn is one of the primary drivers of the corn ethanol price, and corn is a commodity demanded for other end uses in addition to ethanol including food and livestock feed. Changes in demand for these other end uses will impact corn prices which will in turn affect corn ethanol prices. Also, corn ethanol is

12 2014/2015: 3. 70 $/bu shel , 2015/2015: 3. 5 0

- 4.1 0 $/bu shel USDA, World Agricultural Supply and Demand Estimates ( October 2015). We use WASDE’s 2014/2015 estimates as a base for 2015, and the 2015/2016 estimates as a base for 2016. http://www.usda.gov/oce/commodity/wasde/latest.pdf 13 University of Missouri, Food and Agricultural Policy Research Institute. U.S. Baseline Briefing Book

. (March 2015) http://www.fapri.missouri.edu/wp

- content/uploads/2015/03/FAPRI

- MU

- Report

- 01

- 15.pdfPage 8 of 9

demanded internationally so changes in international demand will have impacts on do mestic prices independent of the RFS program. Using historical relationships developed b y Iowa State, we assume each increase of one billion gallons of corn ethanol results in an increase in corn costs of $0.21/bushel. 14 Using this relationship, we estimate that corn prices will increase b y roughl y $0.0 9 bushel in 2015 and $0. 18 per bushel in 2016 (approximately $0.0 3 and $0.0 6 per gallon of corn ethanol for 2015 and 2016, respectivel y). Based upon this methodology, EPA estimates that a gallon of corn ethanol will cost $1. 77 per gallon ($2. 6 6 per gallon on a gasoline gallon equivalent basis (GGE)) in 2015 and $1. 79 and $ 2

. 00 per gallon ($2. 68 and $ 3.00 per GGE) in 2016

. 15 To estimate the premium per gallon against wholesale gasoline, we estimated the price of a gallon of wholesale gasoline using the latest EIA STEO estimates. As mentioned previousl y, STEO estimates an average wholesale gasoline price of $1. 7 0 per gallon for 2015 and $ 1. 67 per gallon for 2016. We assume that the wholesale price of gasoline represents the costs of producing gasoline. Taking the difference between the corn ethanol and the wholesale gasoline price estimates, and multiplying that by the volume of petroleum displaced on an energy equivalent basis, results in an overall estimated annual cost of $ 424 million for 2015 and $ 453 to $ 597 million for 2016. Table 3 below shows estimates of per gallon increases on an energy equivalent basis as well as total annual costs for 2015 and 2016 of us ing greater amounts of corn ethanol to meet the entire conventional renewable fuel volumes

. Itis worth noting that corn ethanol costs and wholesale gasoline costs could vary depending on evolving suppl y and demand factors not reflected in current USDA/EIA price estimates. 16
Table 3 Illustrative Per Energy

Equivalent Gallon Cost Difference and Total Cost Estimates of Meeting th e Change in the Total Standard for 2015 and 2016 Using Corn Ethanol to Displace Gasoline
2015 2016

Low High Per Gallon Difference in Cost ($/gallon) 0.96 1.01 1

. 33 Total Annual Costs (millions of dollars) 424 453 597

14 Babcock, Bruce, et. al., Impact on Corn Prices from Reduce Biofuel Mandates , November, 2013 http://www.card.iastate.edu/publications/dbs/pdffiles/13w p543.pdf 15 WASDE only reports a single price for 2014/2015 versus a range, so we do not provide a high and low estimate for 2015. 16 For example, in the winter of 2013/2014 a combination of rail car shortages and harsh winter weather in the Midwest contributed to an increase in the “corn crush spread. ” The corn crush spread is a dollar value of the difference between the c om bined sales values of the products (ethanol and DDGs) and the cost of corn. This resulted in higher prices of ethanol than was forecasted.Page 9 of 9

The short time frame provided for the annual renewable fuel rule process does not allow sufficient time for EPA to conduct a comprehensive anal ys is of the benefits of the 2015 and 2016 standards and the statute does not require it. Moreover, as discussed in the proposed rule e stablishing the 1.28 billion gallon requirement for BBD in 2013, the costs and benefits of the RFS program as a whole are best assessed when the program is full y mature in 2022. 17 We continue to believe that this is the case, as the annual standard

- setting process encourages consideration of the program on a piecemeal (i.e., year to year) basis, which may not reflect the long

- term economic and environmental effects of the program. Therefore, for the purpose of this annual rulemaking, we have not quantified benefits for the 2015 and 2016 final standards. We do not have a quantified estimate of the GHG impacts for the single ye ar (e.g., 2015, 2016). When the RFS is fully

phased in , the program will result in considerable volumes of advanced and cellulosic biofuels that will reduce GHG emissions in comparison to the fossil fuels which they will replace. EPA estimated greenhouse gas, energy securit y and air quality

impacts and benefi ts in the 2010 RFS Final Rule.

17 77 FR 59477, September 27, 2012.