Naimi rejects ethanol's impact, but gasoline begs to differ

True. Petroleum prices are high. And there are strong arguments that energy consumers are in fact no more secure than they have been, despite the ethanol boom worldwide, but particularly in the US.

But it's getting increasingly difficult to argue that ethanol is having no impact on the price of gasoline, watching the almost daily tumble that it is taking relative to the price of crude and, even more so, distillate fuels: diesel, jet fuel, heating oil.

US ethanol demand in the last four months of 2007, according to the Renewable Fuels Association, went from 422,000 b/d to 518,000 b/d, a jump of almost 100,000 b/d. Meanwhile, US total motor gasoline demand during those four months was basically flat at about 9.24 million b/d,and according to the Department of Energy, dropped to 8.8 million b/d in January.

Ethanol prices relative to gasoline in the Gulf Coast strengthened as well. In the beginning of October, a gallon of spot conventional gasoline in the Gulf Coast was 29 cts more than a gallon of ethanol. That spread got as high as 50 cts. The market then reversed, and at one point, ethanol rose to a position that at one time was assumed to be permanent: a level more than gasoline. And now, gasoline is about 9 cts more than ethanol on the Gulf Coast, according to Platts data. That sort of movement would be consistent with a concurrent rise in ethanol demand and a decline in gasoline consumption.

But those aren't the most interesting numbers. Taking a basic crack, we subtracted the price of Light Louisiana Sweet crude from the market price of US Gulf Coast conventional gasoline, and the price of LLS from the US Gulf Coast ultra low sulfur diesel assessment.

The LLS-gasoline spread, on a per barrel basis, opened October at a little more than $3/barrel. It's been above $6 a few times, and in recent weeks even rose above $7. But in the past few days, according to Platts data, it's slipped to less than $3.

The diesel spread? Driven by rising demand and supply constraints caused in part by tighter sulfur specifications in many nations, ULSD was $13 more than LLS on October 1. That spread is now closer to $30.

It's hard to conclude that an additional 100,000 b/d of a gasoline substitute has been dumped into the market and has had no role in the diverging paths of these two transportation fuels. Yes, there are many other factors. But clearly, ethanol is working to keep the price of gasoline down relative both to its feedstock and to diesel.

In his address, Naimi said that ethanol production was set to reach an equivalent of 5 million b/d by 2010 or about 6% of total global petroleum consumption. He described it as "a small percentage," but argued that its high price of production made it "the de facto artificial floor for global petroleum prices, and by extension the worldwide energy market as a whole."

You can accept every negative argument about whether the boatload of subsidies and other considerations for ethanol make any economic sense. But it would be hard to accept that putting 5 million b/d of ethanol into the market over just the next two years is going to put a floor on anything. Yes, if ethanol was subject to normal economics, that might be the case, because we wouldn't be looking at another multi-million barrel jump in supply; it is a fuel that can’t make it on its own. But it is not subject to those economics. It is the favored child of political candidates across the spectrum, and that isn't going away.

World crude output the next two years won’t come close to rising 5-million b/d. How can a 5-million b/d jump in liquids supply, as narrow as its use may be, put a floor on prices? Instead, if that sort of increase is realized, its impact will be to keep hammering the price of gasoline relative to crude and other products. But at a certain point, it will so distort those spreads that a new paradigm will face refiners: making diesel is like spinning straw into gold, and making gasoline is a wallet-flattening proposition. Unfortunately for refiners, you can’t just make all diesel. If nothing else, you need to make gasoline to get hydrogen as a byproduct, which is needed in the units that remove the sulfur from diesel.