* 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. Environmental Protection Agency has proposed a surprisingly deep cut in the amount of ethanol that must be blended into U.S. gasoline next year, according to an agency document seen by Reuters.
In a historic retreat from an ambitious 2007 law and a victory for refiners, the agency proposes a "significant" reduction in the overall renewable fuel requirements to 15.21 billion gallons, far less than the 18.15 billion gallon 2014 target established by law, the documents show.
That would reduce the volume of corn-based ethanol to about 800 million gallons less than this year's 13.8 billion gallons, a much larger cut than many industry observers had been expecting. The law had required 14.4 billion gallons for 2014.
The figures match those reported earlier on Thursday by news agencies including Reuters, but the document also includes previously unreported details on the EPA's proposal. The agency laid out three different approaches, one calling for a larger volume of corn-based ethanol and one calling for less, but it advocated the 13 billion gallons in the middle.
The apparent proposal stirred shock and some disbelief across biofuel and energy industries, as most officials and traders had not expected any further word on next year's rules until the White House had approved them. Shares of independent refiners surged, while the price of ethanol credits dived.
After months of increasingly bitter exchanges over the future of the Renewable Fuel Standard (RFS), the changes appeared to be a major concession to refiners, which say they cannot sell gasoline with a higher blend of ethanol.
If approved as is, the proposed rule "would represent a notable shift in the Obama administration's biofuel policy," said Jason Bordoff, professor and director of the Center on Global Energy Policy at Columbia University and a senior White House energy adviser until late last year.
A spokeswoman for the EPA was not immediately able to comment on the documents, and said that due to the government shutdown she may not be able to provide a rapid reply. Reuters has not been able to independently confirm the authenticity of the documents, or whether they were subsequently updated.
The EPA's proposal is laid out in the first 14 pages of an Aug. 26 draft notice of proposed rulemaking and a Sept. 6 presentation, dates that coincide with the timing of its submission to the White House Office of Management and Budget (OMB), which must approve the rule. It is not clear whether the documents are identical to those submitted to the OMB.
To get the volumes that low, the agency intends to tap into a waiver authority under the 2007 law that allows it to scale down required volumes under certain situations, such as a lack of available supply of the fuels or economic hardship. It intends to use the "inadequate supply" justification.
"We interpret the term 'inadequate domestic supply' as it is used under the general waiver authority to include consideration of factors that affect consumption of renewable fuel," the proposal states. In other words, demand is limited by the 10 percent ethanol blend that refiners and retailers say is the maximum that they are willing to sell.
"We would intend this framework apply not just to 2014 but to later years as well," the EPA said.
Corn-ethanol producers argue that refiners and retailers should be able to sell gasoline that is 15 percent biofuel, the maximum allowed by the EPA for most newer cars.
The OMB is not expected to make a decision until after the government shutdown ends.
Speculation and media reports about the potential reduction in the blending levels ripped through financial markets on Thursday, spurring a major rally in the shares of independent refiners, which have been paying hundreds of millions of dollars to 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 percent on the prospect of reduced demand for corn-based ethanol.
Renewable identification number (RIN) credits for the 2013 compliance year dived to 34.5 cents each, the lowest since early this year, a trader said, down from 43 cents.
The proposal, if ultimately approved, would be a significant victory for U.S. oil companies, which have been lobbying regulators and Congress to cut biofuel blending mandates, which had been eating into their market share.
It would also be a major blow to the U.S. corn ethanol industry, which has been urging regulators to keep the ambitious blending targets required under the law.
Already, some ethanol groups are threatening to sue the EPA, which administers the fuel blending program, if it lowers its volume target.
"We will pursue every option," Bob Dinneen, president of the Renewable Fuels Association, which represents the ethanol industry in Washington, D.C., said prior to the disclosure of the document.
The EPA considered three options for relaxing the biofuel mandate next year and will accept comments on all three, but it is proposing only the third option, the documents show.
Under the first option, it would have set the corn-based ethanol volume at 12.36 billion gallons; under the second, the figure would have been 13.18 billion.
In both cases, the "advanced biofuel" segment - which includes biodiesel made from recycled cooking oil - would have been adjusted to top up the total volume to 15.21 billion.
The agency decided on the third option, which took into consideration both available production volumes and also the 10 percent ethanol "blendwall," because it "ensures that both non-advanced and advanced (biofuels) play a role in addressing the blendwall while simultaneously accounting for limited availability", according to the document.