Analysis: Brewing U.S. ethanol legal battle hinges on meaning of 'supply'

By Cezary Podkul

CHICAGO (Reuters) - The fate of a landmark U.S. requirement to blend increasing amounts of biofuels into the nation's gasoline pool rests on the meaning of three words tucked into a mammoth law: unless there is "inadequate domestic supply."

But "supply" of what? The law does not say.

As a years-long battle over the future of the U.S. fuel supply begins to shift to the courts, the two fierce foes - the biofuel industry and oil refiners - are debating a definition that lawyers say leaves much room for interpretation.

To ethanol backers, the phrase seems clear: it's the volume of renewable fuel that can be produced or imported; and at the moment ethanol is abundant, with falling corn prices and a record harvest spurring production.

To the oil industry, it's something else entirely: the volume of biofuel-blended gasoline or diesel that can be physically sold in the United States. They say the country lacks the consumer demand and physical infrastructure to sell gasoline blended with more than 10 percent ethanol - a "blend wall" that, in essence, restricts supply.

According to a draft U.S. Environmental Protection Agency proposal reported by Reuters and other news outlets last week, the EPA appears sympathetic to the oil groups' argument.

In the proposal for the 2014 blending requirements - which are not yet finalized - the agency proposed to cut them a break by invoking for the first time a clause in the law that allows it to waive the blending targets if it finds there to be "inadequate domestic supply."

The constraints on fuel consumption caused by the blend wall, the EPA argued, are grounds for such a finding.

"The language of the statute is ambiguous enough to at least be open to some more expansive interpretation like this," said Alan Sachs, a consultant to Washington, D.C.-based law firm Beveridge & Diamond, which works on environmental issues.

Sachs said he would expect a legal challenge to any interpretation of the three-word phrase. The blending rules have already been heavily litigated by the ethanol and oil lobbies, with two more lawsuits filed just last week over the EPA's 2013 biofuel blending requirements.

ESCAPE HATCHES

The "inadequate supply" clause is one of two escape hatches Congress built into a 2007 law mandating increasing blending volumes of the biofuels. Anticipating the possibility that the EPA might need to waive the requirements at some point in the future, lawmakers gave them two possible reasons to do so.

The first of the so-called general waivers is relatively clear: it allows for a volume decrease if "implementation ... would severely harm the economy or environment of a State, a region, or the United States."

The second one, invoked by the EPA in its proposal, allows for a reduction in mandated volumes only if there is "inadequate domestic supply."

To the Renewable Fuels Association, which represents ethanol producers, there is no question.

"Inadequate domestic supply of - and this is important - of renewable fuel," said Bob Dinneen, the organization's president. "And we're swimming in renewable fuel. Inadequate domestic supply is not an issue."

The oil industry takes a different view. Refiners need to prove they are using a certain percentage of ethanol to meet the EPA's quotas, and use RINs or Renewable Identification Numbers, as proof of compliance. But they fear that it will be impossible to blend enough ethanol into gasoline to meet next year's quota, causing a shortage of RINs.

"We can only supply as much gasoline and diesel into the United States for consumption in the United States as we have RINs to meet the obligation that supplying that fuel incurs," John Reese, downstream policy and advocacy manager for Shell Oil Products, told a packed industry conference in Chicago on Thursday.

Critics had a ready retort: If there's inadequate domestic supply of fuels, it's only because oil companies decide to short the market by not providing enough gasoline or diesel.

"Making an economic decision to short the market because you don't want to blend renewable fuels is not a supply constraint," Monte Shaw, executive director of the Iowa Renewable Fuels Association, said at the sidelines of the industry conference, hosted by data provider OPIS.

Some say that challenging the EPA's interpretation of "supply" might prove difficult due to a nearly 30-year-old principle called the "Chevron Deference."

The idea comes from a 1984 decision in which the U.S. Supreme Court held that courts should defer to agency interpretations of statutes they administer, unless they are unreasonable.

ECONOMIC HARM TOO

In August, the oil industry's top two lobby groups, the American Petroleum Institute and American Fuel and Petrochemical Manufacturers, requested that the EPA reduce ethanol blending requirements due to the "inadequate domestic supply" of fuels that would result.

But for good measure, the two groups also threw in an argument for the other possible waiver condition - economic harm. A chart modestly labeled "the death spiral" in an attached consultants' report warns the rising mandates will reduce gasoline production, causing prices to rise and harm the economy - worsening each year as volumes creep higher.

But the economic harm argument has been a very high bar to meet.

Twice before, in 2008 and in 2012, the EPA received petitions for waivers under the economic harm scenario. It denied both - the first filed by Texas Governor Rick Perry and the second by a broad coalition of food groups such as pork producers - on the ground that they didn't demonstrate the mandates were causing severe economic harm. It also said in its 2012 waiver decision that the economic harm provision gave it only a "narrow" authority to waive the mandates.

Perry spokeswoman Lucy Nashed said last week that the EPA's proposal was "a victory of common sense over heavy-handed bureaucracy."

At the National Pork Producers Council, Chief Environmental Counsel Michael Formica is still wondering how last year's drought did not merit a waiver of the blending requirements. The drought decimated corn crops in much of the nation, leading to a surge in prices for the main ingredient for fuel ethanol in the United States, and for animal feed for chickens, beef and pigs.

"At the end of the day, we were in an emergency situation. We wanted to make sure that animals could get fed," Formica said. "It's hard to say that in the worst drought in 70 years we make no adjustment."

When the 2007 blending bill was being drafted, Formica said he recalled ethanol groups assuring him that the waiver would take care of food producers in extreme cases. "With the drought, we were telling them ‘this is exactly why we asked for a waiver-kind-of provision originally,'" he said.

But once Formica submitted the waiver request on behalf of 22 food groups, the ethanol industry moved to block it.

(Reporting by Cezary Podkul in Chicago; Editing by Jonathan Leff and Phil Berlowitz)