1. George C. Marshall Institute’s Washington Roundtable: Cellulosic Ethanol Larry Kumins Executive Vice President Energy Policy Research Foundation Inc. National Press Club Washington, DC July 25, 2007

2. 2 EPRINC Energy Policy Research Foundation Inc. (EPRINC): successor organization to the Petroleum Industry Research Foundation Inc. (PIRINC)  PIRINC was founded in 1944 in NYC  Re-imagined in DC in 2007 as EPRINC  President: Lou Pugliaresi Executive Vice President: Larry Kumins  EPRINC brings policy analysis and industry economics to bear on current energy issues

3. 3 Agenda Part I: Ethanol – Background and Current Landscape Part II: Ethanol Consumption and Pricing Part III: Gasoline Pool and Vehicle Fleets Part IV: Investment Part V: Energy Security Issue Items Q & A

4. 4 Establishing the Landscape Rapid run up in Ethanol Consumption through 2006 was a One Time Event  Potential growth is currently 2/3 realized  Future growth will be predicated on ethanol’s ability to replace gasoline as a primary fuel  Gasoline replacement by ethanol is constrained by two factors:  The gasoline/ethanol distribution infrastructure does not provide universal supply  Physical limitations of vehicles’ ethanol usage

5. 5 Ethanol Background Used as a high octane motor fuel since internal combustion invented Energy Tax Act of ’78 started the federal tax exemption 4 cents/gal “gasohol” American Jobs Creation Act of 2004—51 cents per gal for ethanol blended EPAct 05 mandates—4.0 bil gals in 2006; 7.5 bil gal in 2012 Current Consumption exceeds 6 bil gal annually

6. 6 2006--Ethanol Becomes an Important Motor Fuel Component Ethanol consumption increases form 2.1 bil gal to 5.4 bil gal 2002-2006 MTBE was a blending component of choice, adding oxygen content and boosting octane MTBE Phase-out:  In process since 2000  Consumption peaked at about 300,000 b/d  Zeroed-out in 2006 Ethanol Phase-In:  ~400,000 b/d ethanol to replace MTBE  Essential and complimentary to making gasoline * Octane and O2 * Adds barrels to gasoline supply BUT, Ethanol is only a replacement for MTBE

7. 7 Ethanol and MTBE Consumption 2002-2006

8. 8 Ethanol Prices are Falling v. Gasoline Note the following:  Ethanol price spike as MTBE exits the gasoline pool  Convergence in gallon prices; ethanol becomes cheaper than gasoline  Ethanol prices decline as capacity and imports arrive in fuel markets

9. 9 U.S. Ethanol Plant Capacity Grows 119 operating plants; capacity is 6.2 bil gal/yr— 400,000 b/d 86 plants under construction; capacity 6.4 bil gal/yr—420,000 b/d US will have over 800,000 b/d of corn ethanol capacity—exceeds EPAct05 2012 mandate May exceed the amount of consumption physically possible Will a glut result? Will ethanol prices—and plant economics---collapse?

10. 10  Corn prices have doubled. They fell in early 2007, but future contracts for out months suggest return to $4+  Plants are buying more corn, driving corn prices up  Plants increase the supply of ethanol; prices drop Implication: - High corn demand and ethanol oversupply? - Commensurate price effects? Corn Prices are Rising Relative to Ethanol Prices; Ethanol Profitability Declining

11. 11 Farmers Respond to High Corn Prices - 2007 Record Corn Plantings - Highest Since 1944  Corn acreage increased 15% Using land from:  Cotton—acreage down 20%  Soybeans—acreage down 11% Price Implications  Near month corn prices fell ~$0.50 per bu on planting report release, but Price outlook for 2008 remains $4+  Cotton and soybean prices will rise because of smaller plantings Source: USDA, Prospective Plantings. Mar.2007

12. 12 Ethanol is NOT Oil Volume vs. Energy Content: Btu content is only 2/3rds gasoline Volumes do not hold comparable energy value; current $1.90/gal ethanol price is the energy equivalent of $2.84 gasoline Physical issues: Mix tends to separate; attract water. Can’t be shipped by pipeline Expensive transport: 75% by rail; 25% truck; oil moves by pipeline at 1/4 th cost Mixture has short shelf-life: blended locally Gallons vs. Barrels: Ethanol industry measures in gallons per year; petroleum in barrels per day. Optics of large numbers.

13. 13 Auto fleet designed to use 10% ethanol; it can’t use more Ethanol transport constraints prevent universal distribution  Not all gasoline blenders can get ethanol  Less than 100% mogas can be E-10 If higher blends are to be consumed, more E-85 (FFVs) needed in fleet E-85 vehicles have sold poorly:  Out of 237 million vehicles on the road, only 6 million are FFVs  Detroit makers pledged half 2012 output will be FFVs; foreign makers not showing interest  In 2017, 280 million vehicles on the road: How many will be FFVs? Vehicle Fleet Will Slow Ethanol Uptake Implication: if Detroit succeeds, only 25% of new vehicles sold will be FFVs

14. 14 Recap: Role of Ethanol in the Gasoline Pool % Ethanol Billions Gallons/ Year B/D (000) Fundamental FactorPrice Implication ~ %5~8500 Necessary- Complimentary—The current situation; replacing MTBE Higher than Gasoline 5% - 8%~12750 Enhancing Gasoline Performance and Increasing supply Volumes Converging on Gasoline Price 10%~151,000 Max % current vehicles can use Limited by Distribution Infrastructure Price Competition among Ethanol Producers Much greater than 10% 352,300 Exceeds likely Auto Fleet Capability Market Oversupplied— Serious Price Erosion

15. 15 Cellulosic Ethanol in the Gasoline Pool Must transition from lab to commercial activity Supplement corn-ethanol to minimize:  Crop cycle risk  Agricultural consumer vs. energy consumer conflict  Mitigate inflationary impact of ethanol on Agricultural commodities  Provided needed fuel components

16. 16 Continued…. Consumption will not exceed >10% of gasoline pool without substantial changes in the stock of capital  Pipeline transport & terminal facilities  Retail facilities  Universal distribution across the country  Automobiles capable of using 10% plus blends Investors have been quick to back ethanol production, but infrastructure has attracted little interest

17. 17 Investment: Ethanol Plant vs. Oil Refining Refining---2003-2006  Refining capacity grew by 0.6 mbd  Imports of refined oil product grew by 1.0 mbd  U.S. refining capacity continues to lag consumption growth  Results in very high refinery utilization w/o capability to deal with outages, scheduled maintenance, etc.  Current gasoline price situation--$2.15 in January; $3.25 in June--due to refinery outages  Challenged refinery capacity has become its own energy security issue Ethanol and oil compete for capital and for the same materials and services Ethanol may be crowding out investment in petroleum refining These factors taken together with the threat of additional ethanol mandates have had a chilling impact of refinery investment

18. 18 Energy Security Goals: Minimizing Risk Control Growth/Reduce Petroleum Imports Buffer Economy from Price Shocks Caused By Adverse World Market Events Encourage U.S. Refinery Capacity Catch-up With Consumption  Reduce risk from refinery mishaps BUT Depending on An Agricultural Commodity For Energy Supply Introduces New Risks Associated with Crop Cycle Implication: Important Role for Cellulosic Ethanol

19. 19 Thank you Q & A Lawrence Kumins Executive Vice President Energy Policy Research Foundation Inc. larryk@eprinc.org larryk@eprinc.org