* EPA proposal would cut corn-based ethanol mandate for 2014
* Reduction to 13 bln gallons is preferred of three options-document
* EPA pins rationale for waiver on "inadequate supply"
* Refiner shares rally, corn dips, RINs dive on proposal
By Cezary Podkul
NEW YORK, Oct 10 (Reuters) - The U.S. EnvironmentalProtection Agency has proposed a surprisingly deep cut in theamount of ethanol that must be blended into U.S. gasoline nextyear, according to an agency document seen by Reuters.
In a historic retreat from an ambitious 2007 law and avictory for refiners, the agency proposes a "significant"reduction in the overall renewable fuel requirements to 15.21billion gallons, far less than the 18.15 billion gallon 2014target established by law, the documents show.
That would reduce the volume of corn-based ethanol to about800 million gallons less than this year's 13.8 billion gallons,a much larger cut than many industry observers had beenexpecting. The law had required 14.4 billion gallons for 2014.
The figures match those reported earlier on Thursday by newsagencies including Reuters, but the document also includespreviously unreported details on the EPA's proposal. The agencylaid out three different approaches, one calling for a largervolume of corn-based ethanol and one calling for less, but itadvocated the 13 billion gallons in the middle.
The apparent proposal stirred shock and some disbeliefacross biofuel and energy industries, as most officials andtraders had not expected any further word on next year's rulesuntil the White House had approved them. Shares of independentrefiners surged, while the price of ethanol credits dived.
After months of increasingly bitter exchanges over thefuture of the Renewable Fuel Standard (RFS), the changes appeared to be a major concession to refiners, which say theycannot sell gasoline with a higher blend of ethanol.
If approved as is, the proposed rule "would represent anotable shift in the Obama administration's biofuel policy,"said Jason Bordoff, professor and director of the Center onGlobal Energy Policy at Columbia University and a senior WhiteHouse energy adviser until late last year.
A spokeswoman for the EPA was not immediately able tocomment on the documents, and said that due to the governmentshutdown she may not be able to provide a rapid reply. Reutershas not been able to independently confirm the authenticity ofthe documents, or whether they were subsequently updated.
The EPA's proposal is laid out in the first 14 pages of anAug. 26 draft notice of proposed rulemaking and a Sept. 6presentation, dates that coincide with the timing of itssubmission to the White House Office of Management and Budget(OMB), which must approve the rule. It is not clear whether thedocuments are identical to those submitted to the OMB.
To get the volumes that low, the agency intends to tap intoa waiver authority under the 2007 law that allows it to scaledown required volumes under certain situations, such as a lackof available supply of the fuels or economic hardship. Itintends to use the "inadequate supply" justification.
"We interpret the term 'inadequate domestic supply' as it isused under the general waiver authority to include considerationof factors that affect consumption of renewable fuel," theproposal states. In other words, demand is limited by the 10percent ethanol blend that refiners and retailers say is themaximum that they are willing to sell.
"We would intend this framework apply not just to 2014 butto later years as well," the EPA said.
Corn-ethanol producers argue that refiners and retailersshould be able to sell gasoline that is 15 percent biofuel, themaximum allowed by the EPA for most newer cars.
The OMB is not expected to make a decision until after thegovernment shutdown ends.
Speculation and media reports about the potential reductionin the blending levels ripped through financial markets onThursday, spurring a major rally in the shares of independentrefiners, which have been paying hundreds of millions of dollarsto buy ethanol credits to cover their blending obligations.
Shares of refiner PBF Energy surged by 12 percent,and those of Valero Energy gained nearly 5 percent,while corn futures in Chicago tumbled more than 1 percenton the prospect of reduced demand for corn-based ethanol.
Renewable identification number (RIN) credits for the 2013compliance year dived to 34.5 cents each, the lowest since earlythis year, a trader said, down from 43 cents.
The proposal, if ultimately approved, would be a significantvictory for U.S. oil companies, which have been lobbyingregulators and Congress to cut biofuel blending mandates, whichhad been eating into their market share.
It would also be a major blow to the U.S. corn ethanolindustry, which has been urging regulators to keep the ambitiousblending targets required under the law.
Already, some ethanol groups are threatening to sue the EPA,which administers the fuel blending program, if it lowers itsvolume target.
"We will pursue every option," Bob Dinneen, president of theRenewable Fuels Association, which represents the ethanolindustry in Washington, D.C., said prior to the disclosure ofthe document.
The EPA considered three options for relaxing the biofuelmandate next year and will accept comments on all three, but itis proposing only the third option, the documents show.
Under the first option, it would have set the corn-basedethanol volume at 12.36 billion gallons; under the second, thefigure would have been 13.18 billion.
In both cases, the "advanced biofuel" segment - whichincludes biodiesel made from recycled cooking oil - would havebeen adjusted to top up the total volume to 15.21 billion.
The agency decided on the third option, which took intoconsideration both available production volumes and also the 10percent ethanol "blendwall," because it "ensures that bothnon-advanced and advanced (biofuels) play a role in addressingthe blendwall while simultaneously accounting for limitedavailability", according to the document.
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