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          EPAct Section 1541(c)
          Boutique Fuels Report to
          Congress
EPA420-R-06-901
December 2006

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                                          EPA420-R-06-901
                                            December 2006
       EPAct Section 1541(c)
Boutique Fuels Report to Congress
      Office of Policy and International Affairs
           U.S. Department of Energy

                   and

      Office of Transportation and Air Quality
      U.S. Environmental Protection Agency

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                     EPACT SECTION  1541 (C)

                          BOUTIQUE FUELS

                     REPORT TO CONGRESS

   SUBMITTED TO THE COMMITTEE ON ENERGY AND COMMERCE OF THE
  UNITED STATES HOUSE OF REPRESENTATIVES AND THE COMMITTEES ON
  ENERGY AND NATURAL RESOURCES  AND ON ENVIRONMENT AND PUBLIC
                     WORKS  OF THE UNITED STATES SENATE


                           EXECUTIVE SUMMARY

   In  compliance with  Section  1541(c)  of the Energy Policy Act of 2005  (EPAct),  the
Environmental Protection Agency (EPA) and the Department of Energy (DOE) are submitting to
Congress this report regarding the impact of state fuel programs (approved under the Clean Air Act
Amendments (CAAA) Section  211(c)(4)(c))  on  air  quality,  the  number  of fuel blends,  fuel
availability, and on fuel costs. This report fulfills  one part of a broader EPAct requirement for EPA
and DOE to analyze the affects of boutique fuels, in addition to other unique fuels, on the nation's
fuel system.  Because  of the potential importance of these distinct fuel requirements on the nation's
fuel supplies, in the spring of 2006  President Bush established the Boutique Fuels Task Force to
gather  information from  numerous  stakeholders including state officials, refiners, public health
officials and automakers.  The Task Force issued a report in June 2006. This Report builds upon the
Task Force  findings.  It provides  an overview of the status of  state boutique fuel programs,
describes important regulatory and legislative changes that have or will soon change the landscape of
the broader transportation fuels market, summarizes other critical market factors that have had a
significant  influence  on  the  U.S.  transportation  fuels  sector,  revisits   the  Task   Force
recommendations from affected parties, and provides a plan that EPA and DOE will follow for a
more comprehensive  assessment  of the impacts of boutique fuels and other  varying transportation
fuels programs, as outlined in EPAct Section 1509 (the Fuel Harmonization Study).

    Significant changes have occurred in the last five years  that have affected  the refining industry's
ability  to  make and  distribute boutique  and other distinct  fuels.  While  some legislative  and
regulatory changes were specifically directed at boutique fuels, others had important indirect effects
on the  boutique fuels. Legislative and regulatory changes have also occurred  that have an effect on
fuel supply and emissions beyond the boutique fuels authorized by CAAA Section 211 programs,
such as the emergence of state renewable fuel requirements. These changes have occurred during a
period  in which increases in demand have outpaced increases in  U.S. refining,  distribution  and
storage capacity. These changes make it very difficult to rely on past experience with boutique fuels
to predict what the impacts on fuel supply and price might be in the future from the continued use
of boutique and other distinct fuels.

   Within  the  context of this changed environment,  the Boutique Fuels  Task  Force revisited
stakeholder concerns. The key findings of the Task Force were:

   •   The U.S. gasoline production and distribution system is  able to provide  adequate
       quantities of boutique fuels, as long as there are no disruptions  in the supply chain.

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       If a disruption  occurs  (for example,  due to unexpected refinery or distribution
       problems), it becomes more difficult to move gasoline supplies around the country
       because of the limitations imposed by the boutique fuel requirements.  Existing
       authorities have  been used to  temporarily waive boutique fuel requirements during
       times of supply disruption.

    •   The Energy Policy Act of 2005 includes provisions that will limit the future growth
       of new boutique fuels allowable under CAAA Section 211(c) and provides additional
       authority  to  EPA to waive boutique fuel  requirements  when necessary to help
       alleviate unexpected supply disruptions.

    •   State boutique fuel  programs have provided significant, cost-effective air quality
       improvements. Any additional policies affecting boutique  fuels should be done in a
       manner that at least maintains  these air quality benefits and avoids  restricting  state's
       authorities.

    •   Future analyses of potential changes to the number and types of fuels should  utilize
       the  most up-to-date data and  analytical  tools.  The joint EPA  — DOE Fuel
       Harmonization Study required under Section 1509 of EPAct should ensure that all
       aspects, including the impacts of  fuel requirement  modifications on  air quality,
       vehicle components and performance, fuel fungibility, fuel supply and fuel cost, are
       appropriately addressed.

    •   As part of the analyses of future fuel options, careful consideration should be given
       to the possibility of new legislative authority that would allow for the adoption of
       regional clean fuel programs.  A mechanism to require the same  boutique fuel in
       geographic areas that cross state boundaries merits further study.

    •   Renewable fuels  are an important part of the nation's plan to reduce our dependence
       on foreign oil. States are undertaking a number of actions to promote the use of
       such renewable fuels and the federal government is implementing programs, notably
       the Renewable Fuels Program established by EPAct, to do the same.  Additional
       study would be beneficial to ensure these programs are working together and will not
       create undue impacts on air quality, fuel fungibility, fuel supply and/or fuel cost.

    DOE and  EPA  have  concluded that further  evaluation  is required to  determine  whether
additional legislative changes affecting boutique fuels beyond those already provided in EPAct are
desirable.  Accordingly,  DOE and EPA propose  to coordinate the EPAct Section 1541 boutique
fuels report with the EPAct Section  1509 Fuel Harmonization Study.  The Fuel Harmonization
Study will require significant analysis and substantial resources  in order to update existing models
and fill in  major data gaps.  This includes, for example:  a multi-year program to generate and
analyze the  impacts of numerous fuel properties on emissions from engines and vehicles; and the
collection and analysis of data from the pipeline and terminal industries regarding how different fuel
types impact fuel distribution. Additional stakeholder involvement, particularly from the states, will
also be critical.  In the course of the  Fuel  Harmonization Study, EPA and DOE will continue to
actively engage and seek input from state participants, industry stakeholders  and others.

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                        TABLE OF CONTENTS
EXECUTIVE SUMMARY	1

TABLE OF CONTENTS	3

I.   INTRODUCTION	4

  BACKGROUND	5
  REPORT ORGANIZATION	9

II.   PAST EPA BOUTIQUE FUEL STUDIES (OCTOBER 2001)	10

III.  RELEVANT FUEL CHANGES THAT HAVE OCCURRED SINCE 2001	13

  REGULATORY CHANGES	13
  LEGISLATIVE CHANGES	14
  STATE FACTORS	15
  MARKET CHANGES	16
    CHANGES IN DOMESTIC PRODUCTION AND DISTRIBUTION CAPACITY IN RELATION TO
    DEMAND	16
    CHANGES In Import Supplj	17
  CHAPTER SUMMARY	18

IV.  BOUTIQUE FUELS TASK FORCE REPORT (JUNE 2006)	19

V.   WORK PLANNED FOR EPACT SECTION 1509 STUDY	21

  REQUIREMENTS OF THE ACT	21
    Emissions and Air Quality Analysis	25
   fJELS SUPPLY and PrICE ANALYSIS	26

VI.  LIST OF ACRONYMS	29

APPENDIX A	30
FIGURE 1. U.S. GASOLINE REQUIREMENTS	7
FIGURE 2. STATE BOUTIQUE FUEL PROGRAMS AS OF MAY 2006	8
FIGURE 3. SUMMER U.S. GASOLINE REQUIREMENTS IN 2001	12
FIGURE 4. CONCEPTUAL ANALYTICAL APPROACH TO THE FUELS
    HARMONIZATION STUDY	23
FIGURE 5. CONCEPTUAL ANALYTICAL APPROACH TO THE EMISSIONS AND AIR
    QUALITY ANALYSIS	23
FIGURE 6. CONCEPTUAL ANALYTICAL APPROACH TO THE SUPPLY/PRICE
    ANALYSIS	24

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                                I.   INTRODUCTION
    Over the past few decades, the number of distinct petroleum fuels produced and distributed has
increased, largely due to the environmental benefits such fuels provide. This growth in both the
number and location of different fuel  specifications has caused changes  to fuel production and
distribution.  To improve the understanding of the effects of these changes and provide guidance
for future policy and legislation, Congress directed the Environmental Protection Agency (EPA) and
the Department of Energy (DOE) to analyze the supply and environmental implications of a subset
of these distinct fuels, referred to as boutique fuels.  Boutique fuels are motor fuels that are a part of
any clean fuel program designed and  enforced under state authority to reduce motor vehicle
emissions and improve air quality; approved by the EPA under the authority of Section 211 (c)(4)(c)
of  Clean  Air  Act Amendments (CAAA) of  1990; and  included  in an  EPA-approved  State
Implementation Plan (SIP).

    In particular, Section 1541(c) of the  Energy Policy Act of 2005 (EPAct or Act) directs EPA and
DOE to jointly undertake a study regarding the impact of state fuel programs (approved under the
CAAA Section 211(c)(4)(c)) on air quality, the number of fuel blends, fuel availability, and on fuel
costs.  Congress directed EPA and DOE to determine how to develop a Federal fuels system that
addresses  air quality requirements, maximizes motor fuel fungibility and supply, reduces motor fuel
price  volatility, including that which has resulted  from the increase in  boutique fuels, and  to
recommend to Congress  such regulatory and  legislative changes necessary to implement such a
system.  Furthermore, Section 1541(c)  directs EPA and DOE to consider the impacts on overall
energy supply, distribution and use due to any recommended legislative changes.  It also directs EPA
and DOE to coordinate the report required by this section with other studies required by the Act.
In developing the  report, EPA and DOE are to use sound science and objective science practices,
consider the best available science, use data collected by accepted means, and consider and include a
description of the weight of the scientific evidence.

    As this  report will highlight, the impact that the  various  state fuel  programs  have on  the
transportation fuels market is complex.  EPA and DOE have completed several boutique fuels
reports in the past five years that address many of the issues identified in Section 1541(c) of the Act.
The most recent report, published in June of this year, provides important information and insights
on the relevant issues under Section 1541(c), however, it also illustrates that boutique fuel issues are
only a part  of the broader issue of distinct fuel types,  including additional renewable, diesel, and
heating oil fuels.  In order to develop appropriate legislative recommendations, the impacts on  air
quality,  fuel  fungibility, availability and supply,  cost, price, and other factors  have to be  fully
evaluated, taking into consideration supply and environmental  issues beyond  the boutique fuel
subset.  Given the  conclusions of the past boutique fuel studies, a broader evaluation, as described in
Section 1509 of the Act (the Fuel Harmonization  Study), is required  to develop recommendations
for a  Federal fuels system or legislative  changes.  This Report will address  the requirements of the
narrower  in scope Section 1541(c) by providing an overview of the status of state boutique fuel
programs.  Specifically, this report describes important regulatory and legislative changes that have
or will soon change the landscape of the broader transportation fuels market and  summarizes other
critical market factors that have had a significant influence on the United States (U.S.) transportation

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fuels sector.  Furthermore, it provides a plan that EPA and DOE will follow to conduct a more
comprehensive assessment of the impacts of varying transportation fuels programs.
BACKGROUND

    Most of the increase in the variation of petroleum fuel types has been with gasoline, the major
light-duty (i.e., passenger cars and trucks) transportation fuel used in the United States. Prior to the
CAAA of 1990, types of gasoline differed primarily by octane grade. Gasoline grades were generally
the same nationwide and through the seasons with only gasoline volatility differing by region and by
season.

    During the late 1980s and the 1990s, Congress, EPA, states and other stakeholders realized the
strong impact certain motor vehicle fuel properties have on air pollution.  Furthermore, controlling
various  fuel properties was  considered a very cost-effective way to reduce vehicle emissions that
contribute to air pollution, while providing widespread and immediate benefits. In response to the
serious air quality problems, which were occurring across the U.S., Congress, EPA, and many states
took a number of actions,  which have both  resulted in  large emission reductions  as well as  an
increase in the number of distinct motor fuels.

    The gradual increase in the number of unique fuel types first began in the late 1980s, with the
emergence of both new federal and state standards.  Beyond the phasing down of lead in gasoline,
which began in the mid 1970s, quality controls on gasoline at the federal level remained constant
until new volatility controls were first implemented beginning in  1989.  In addition, some states
began to  require  oxygenated gasoline in the winter months to reduce  carbon monoxide (CO)
pollution.

    Congress included new federal and state programs in the CAAA of 1990 specifically designed to
address  our nation's serious air quality issues and the contribution from the mobile  source sector.
EPA was tasked with developing and implementing new gasoline  and diesel  programs that would
provide significant air quality benefits and support progress in attaining the National Ambient Air
Quality  Standards (NAAQS).  Over a 5-year  period from 1990 to  1995, in accordance with the
directives in the CAAA, EPA set standards for diesel fuel  and gasoline including a requirement for
states to introduce wintertime oxygenated fuel  in 1992 in certain areas exceeding the CO standards.
In 1993, the nationwide low sulfur (500 parts per million) highway diesel fuel program began, which
was designed to reduce the emissions from the on-highway sector of the heavy-duty diesel truck and
bus fleet.  In 1995, phase 1 of the federal reformulated gasoline (RFG) program went into effect,
which was designed to reduce ozone-forming  emissions and control harmful air toxics in the nine
worst ozone non-attainment areas.

    States, with support of stakeholders including the oil industry, began to investigate and consider
controls on fuels as a way to support attainment  of the NAAQS.  States began to evaluate both the
existing menu of fuels, including federal RFG, and other potential fuel options. While the CAAA
allowed states having ozone non-attainment areas that were not required to use RFG to opt-in to
the program, many states selected their own cleaner-burning fuels tailored to meet their emission
reduction targets, with most selecting low Reid vapor pressure (RVP) gasoline  standards, stopping
short of requiring cleaner burning Federal RFG. These are the so-called boutique fuels.

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    Figure  1, below, illustrates the different types of gasoline present in  the  marketplace today,
including both boutique fuels as well as other available gasoline fuel types.  For example, several
RFG types are shown.  California's RFG is required to meet a more stringent standard than federal
RFG and is therefore  a unique blend.  Ethanol blends are  distinct and have properties that vary
compared to non-oxygenated or MTBE-blended RFG  and therefore require different distribution
methods.

    Figure 2, below, illustrates the seven distinct fuels included in State Implementation Plans and
defined as boutique fuels which are used in 15 different areas.

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                                                     AMN
Legend:
I   I Conventional
H Northern RFG
I   I Southern RFG
I   | CA Cleaner Burning Gasoline
I   I Fed/CARFG
^ Northern RFG w/Ethanol
fifis Southern RFG w/Ethanol
    RVP of 7.0psi w/Sulfur Content  I   I AZ Cleaner Burning Gasoline
    RVPof7.0psi
    RVPof7.2psi
    RVPof7.8psi
	Oxy Fuel/Ethanol Mandate
• Oxy Fuel/7.0 RVP
I   I Oxy Fuel/7.8 RVP
|   | NV Cleaner Burning Gasoline Winter Gasoline
I   I Texas Low Emission Diesel Fuel & State RVP
         Controls of 7.8psi
I   I Texas Low Emission Diesel and Federal RFG
         or RVP Control
                                  Figure 1.  U.S. Gasoline Requirements

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Legend:
    RVP of 7.0psi w/Sulfur Content
    RVPofT.Opsi
    RVPof7.2psi
    RVPof7.8psi
I   I Cleaner Burning Gasoline
|   | Winter Gasoline
I   | Texas Low Emission Diesel Fuel & State RVP
         Controls ofT/jfogi
I   I Texas Low Emission Diesel and Federal RFG or
         RVP Control
                 Figure 2. State Boutique Fuel Programs as of May 2006

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    Some  fuels are easier to produce and  distribute than  others.  Consequently, boutique  fuel
requirements can affect the decisions  of individual  companies to produce, distribute, and market
them and affect the sources of fuel for particular areas.  In some situations one fuel producer may
choose to optimize their operations around the production of one fuel type (e.g., low-RVP gasoline),
while others optimize their operations to produce another fuel type (e.g., conventional gasoline). In
other situations, the addition of new fuel grades may require the delivery and storage system to make
adjustments to accommodate more fuels.  Most petroleum-based transportation fuels travel from
refineries through pipelines to local distribution terminals, where tanker trucks move the products to
nearby retail outlets.   Pipelines ship different products sequentially in batches.   For example, a
pipeline might ship gasoline, diesel fuel, kerosene, jet fuel, kerosene and heating oil.  Each grade of
each type of fuel must be shipped in separate batches.  As more fuel types evolve, smaller batches
result, which may require changes  to pipeline operations.  Each fuel type must also be stored in
separate  tanks.  Terminal  operators must either build more tanks or hold less volume  of each
product to accommodate the increasing number of fuel types.

    As Figure 1 illustrates, fuel types are distributed in geographic regions of various sizes. In some
cases, such as portions of the  Midwest and the East  Coast, product must travel several weeks from
refineries on the Gulf Coast.  If a region runs short of its special fuel or there is a supply disruption
(e.g. pipeline rupture), it cannot borrow from its surrounding areas without a special waiver.  Thus,
the speed with which new supplies can be brought into such an area can be affected by its  use  of a
special fuel.

REPORT ORGANIZATION

    This  report begins in Section  II with a summary of the boutique  fuel-related  studies  done in
2001.  Much has changed since then.  Section III provides an overview of the relevant legislative,
regulatory, and petroleum  market changes that have occurred since the 2001 studies, setting the
stage for a  discussion of boutique fuel issues today. Section IV focuses on the current boutique fuel
perspectives, including a summary of a recent Presidential task force report on boutique fuels.  This
chapter illustrates the complex nature of the issues, and provides the rationale for the work planned
in the integrated fuel harmonization study required under Section 1509 of EPAct 2005.  Section V
summarizes a  coordinated  plan to determine how to develop a federal fuels system, provided the
necessary resources are available, and  to prepare the  Fuel  Harmonization Study as required by
Section 1509 of EPAct.

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   II.   PAST EPA BOUTIQUE FUEL  STUDIES (OCTOBER 2001)

    The Environmental Protection Agency wrote two studies in 2001 that contain direct and indirect
analyses  of boutique fuels.1  The first study was  performed in response to a directive  of the
President's 2001  National  Energy Policy Report.  The second study EPA performed focused on
improving the transition from the winter grade to summer grade standard for RFG volatility. These
studies are no longer fully representative of today's market situation given the implementation of
new federal and  state legislation and regulations over the past five years.  However, many of the
major issues highlighted in  those reports are still applicable today.

    In response to the President's directive, EPA issued a "Study of Unique Gasoline Fuel Blends
("Boutique  Fuels"),  Effects  on  Fuel  Supply and Distribution and Potential Improvements" on
October 23, 2001.2   This  study examined the motivation and  causes for state boutique fuels,
assessed the impact  of these fuels on the fuel  production and distribution systems,  and analyzed
potential ways to mitigate the impact of disruptions  (due  to, for example, natural disasters or other
unforeseen  circumstances)  by allowing for a more  fungible system.  In preparing this study, the
Agency sought input from the  U.S.  Departments  of Energy  and Agriculture, and more than 40
stakeholders.3 Figure 3, below, illustrates the U.S. gasoline requirements that were in place in the
summer of 2001.

    The report concluded  that despite the  number  of state and local  fuel programs, the gasoline
production  and  distribution system would be  able to continue providing adequate  quantities  of
boutique fuels, as long as  there were no  disruptions in the  supply  chain.  If a disruption were to
occur,  it  would  become  difficult to move gasoline supplies around the  country because  of
constraints caused by the boutique fuel requirements.  In addition, at the time, fuel providers were
concerned that recently enacted state laws to ban the use of MTBE would increase the number of
boutique fuels and present new challenges to the country's fuel production and distribution system.

    The underlying  assumptions for the analysis done in the 2001 study (costs,  legislation and
regulations,  emergence of renewable fuels, and so forth) have changed considerably, requiring a new
assessment of the fuels  situation. As  discussed in Section IV of this report, EPA and  DOE believe
it is appropriate that a new, comprehensive analysis be performed to fully assess today's situation, as
part of the Fuel Harmonization Study.
1    While this section focuses on the 2001 EPA study, the Energy Information Administration provided a Service
Report on the topic: Gasoline Type Proliferation and Price Volatility, September 2002,
http://www.eia.doe.gov/oiaf/servicerpt/fuel/gasoline.html


2    Study of Gasoline Fuel Blends ("Boutique Fuels"). Effects on Supply and Distribution and Potential Improvements, October 2001.

3    Stakeholder comments on the 2001 study are available for review in the EPA docket (EPA-HQ-OAR-2002-0003).
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    In the second boutique fuels related report released by the Agency in 2001,  EPA investigated
seasonal transition concerns that arise when summer grade gasoline replaces winter grade gasoline.4
In the 2001 fuel transition study,  EPA  identified a set of administrative and regulatory options as
near term actions that could better facilitate seasonal gasoline transition and reduce the incentives
for low inventories.  Some of the options discussed in the 2001 study have since been implemented
to address these transitional issues.   While these actions have not resulted in a reduction of the
number of  boutique  fuels, they  have  served to  allow for  greater  flexibility in the  supply and
distribution  of these fuels,  ultimately relieving some of the transitional issues that affected these
localized market areas.
4  It is important to note that industry would make this seasonal transition at some level to support vehicle performance
and operational issues, regardless  of whether  any environmental regulations are in  place.   However, the RVP
specifications established by industry for vehicle performance reasons are not as stringent as  those established by
regulation for environmental protection purposes.

5   Study  of  boutique  fuels  and  Issues Elating  to  Transition  from  Winter  to  Summer  Gasoline,  October  2001,
http://www.epa.gov/otaq/regs/fuels/r01051.pdf.
                                            11

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Legend:
   Northern RFC
   Southern RFC
   CACBG
   Fed/CARFG
    _ 7.0RVP, 150ppmS
    B 7.0 RVP
    I—1 7.2 RVP
    |   | 7.8 RVP
Figure 3. Summer U.S. Gasoline Requirements in 2001
I  J Oxy Fuel/Ethanol Mandate
H Northern RFC w/Edianol
,   ] Convenlioiial
                           12

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   III.   RELEVANT FUEL CHANGES THAT HAVE OCCURRED
                                      SINCE 2001

    Since the release of the first EPA boutique fuel study in 2001, several significant regulatory,
legislative, and market changes have occurred that have influenced the U.S. fuels market situation.
These factors have resulted in a significantly different fuels market today than at the time the first
2001 study was released.  These changes are important to take into consideration because they can
influence decisions of states interested in boutique fuels as  well as the relative costs and benefits of
those boutique fuels.  This  section  summarizes the most significant  regulatory  and  legislative
changes that have occurred since 2001 and provides a brief overview of how these changes have
impacted both the boutique fuels situation and more broadly, the U.S. fuels market.  The legislative
and regulatory factors coupled with the  various market factors, further demonstrate the need and
rationale for conducting  a more  comprehensive  evaluation prior to proposing  any legislative or
regulatory recommendations.

REGULATORY CHANGES

    Tier 2 Vehicle  and Gasoline Sulfur Standards and  Toxics Reduction: The Tier 2 vehicle
and low sulfur gasoline program (65  FR 6698, February 10, 2000), went into effect in 2004.  This
program includes more stringent emission standards for light-duty vehicles enabled by low sulfur
gasoline. This comprehensive program reduces smog-forming emissions from motor vehicles by up
to 95 percent.  The Tier 2 program began to phase-in in 2004 and ultimately requires all gasoline to
average 30 parts per million (ppm) sulfur  (fully phased in  by January 1,  2011), whereas previously
only RFG required additional sulfur control in order to meet the emission performance standards
for RFG.

    EPA recently proposed making additional changes to national gasoline requirements in order to
reduce mobile source air toxics.  The proposed Mobile Source Air Toxics (MSAT2) Rulemaking (71
FR 15804, March 29, 2006) proposes standards to significantly lower benzene  emissions.  With
respect  to gasoline properties, the EPA proposal would lower the benzene content in gasoline. If
implemented as proposed in 2011, this MSAT2 benzene content standard will replace the separate
air toxics performance standards currently in place for RFG and conventional gasoline, resulting in
the same gasoline air toxics standards nationwide, with the exception of California.

    To the extent the MSAT2 program is finalized as proposed, then the  combination of the Tier 2
and MSAT2 programs will have addressed two of the fuel parameters (sulfur and benzene) states
might otherwise have been interested in controlling in their own fuel programs.

    Clean Diesel Programs: EPA's  clean diesel programs require diesel fuel to meet  a per-gallon
cap of 15  ppm sulfur (ULSD) beginning in 2006 for highway diesel fuel (66 FR  5002, January 18,
2001), in 2010 for nonroad diesel fuel (69 FR38958, June  29, 2004) and 2012 for locomotive and
marine diesel fuel. The new emissions standards established in these programs, coupled with new
cleaner diesel fuel, provide for significant reductions across  both the on-highway and nonroad diesel
sectors. The phased introduction of these new diesel engines and fuels is intended to provide for a
smooth market transition. Specific flexibilities were included in the regulations to support and ease
any production and distribution issues that might arise. During the phase-in period for ULSD, some
                                        13

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parts of the distribution system are choosing to accommodate two grades of on-road diesel fuel;
other parts of the distribution system are choosing to simply switch to ULSD.  Ultimately, when
these programs are fully phased in, the entire transportation  sector nationwide  will be using one
diesel fuel. As with the Tier 2 and MSAT2 programs for gasoline, the  federal action on diesel fuel
sulfur addresses a fuel parameter that states might otherwise have considered for control.

    8-hour Ozone NAAQS:  In 2004, EPA established a new 8-hour ozone NAAQS.  These new
standards  require states with areas that are not in attainment with the standard to submit a State
Implementation Plan to bring the ozone non-attainment areas into attainment.  In  some instances,
the geographic size of the new non-attainment areas may encompass only a few counties. As in the
past, some states may consider boutique fuels as a cost-effective solution to reduce air pollution and
help them to quickly come into attainment with the new ozone standard.  The number of unique
fuels being used cannot increase due to the limitations on boutique fuels prescribed by EPAct 2005
and described below under Legislative Changes.  However, the existing fuel programs may increase
in size or expand to new areas.  The impact  that the 8-hour ozone standard may have on states'
interests in boutique fuels and how this may affect the fuels market should be further explored and
understood prior to making any recommendations.
LEGISLATIVE CHANGES

    EPAct Boutique Fuels List: The Energy Policy Act of 2005 included several provisions, which
specifically address boutique fuels. EPAct established a fixed limit on the number of boutique fuels
that EPA can approve.  Specifically, Section 1541(b) required EPA to publish a boutique fuels list
based on  fuels approved into SIPs as of September 1, 2004.  On June 6, 2006, EPA published a
draft listing of boutique fuels for public comment (71 FR 32532).  In EPA's proposed approach,
seven different fuel types used in 15 areas in 12 states were identified that have been implemented in
an EPA-approved boutique  fuel program to support cost-effective attainment of the  air quality
standards.  Charts indicating the fuels  contained under both  interpretations of the statute are
included in the Appendices.

    By publishing this list, the number and type of fuels, and to some extent geographical application
(by Petroleum Administration for Defense Districts (PADDs)) of these fuels in the U.S. market is
explicitly  limited.  EPA is permitted  to approve  state  requests  for fuel standards  (waive the
preemption set for in CAAA Section 211(c)(4)(c))  only for fuels  already on this list or by replacing
fuels on the list.  Therefore, states seeking approval of new fuel programs generally would be limited
to fuel  types already in existence within the PADD in which the state is  located.  The PADD
restrictions are a powerful constraint on the expansion of state  fuel programs.  It is important to
note that these  restrictions  apply in addition to  the requirements set forth in  CAAA Section
211(c)(4)(c), under which states must request approval for a program that is  otherwise preempted
under the CAAA.

     Removal Of The RFG Oxygen Content Standard: The CAAA required that RFG contain a
minimum content of oxygen.  Refiners initially met this requirement primarily through the addition
of MTBE, a clean-burning fuel component.  Until recently, MTBE was also used to  increase octane,
and to reduce air toxic emissions. MTBE made up a significant amount of volume  of the RFG
gasoline pool. In the late 1990s, concerns over the use of MTBE began to increase because of its
                                        14

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potential for contaminating  drinking water.  Beginning in 2003, state MTBE bans resulted in a
substantial reduction in the use of MTBE and a subsequent increase in ethanol use to replace this
product.

    In 2005, the enactment of EPAct subsequently removed the oxygen requirement for RFG. To
implement this change, EPA  completed a rulemaking that took effect on May 5, 2006.6  This change
allows refiners and importers to produce or import RFG with or without oxygenate as long as the
gasoline meets  all other RFG requirements.  While removal of  the oxygen standard provides
additional flexibility, enabling refiners and importers to produce and distribute RFG in the most
cost-effective manner, the industry's near-universal response has been to remove MTBE from the
market and replace its presence in RFG with  ethanol. The result has been a movement toward one
type of RFG (ethanol blended) nationwide.  However, the future economics  of producing gasoline,
including the blending of ethanol, may be influenced by factors such as compliance with the federal
renewable fuels standard (RFS) program, the  application of additional state renewable fuel program
requirements and incentives, and other such factors. The removal of the oxygen requirement in
Federal  RFG enables refiners to produce either an oxygenated or un oxygenated RFG, however, as
in the past with MTBE-blended RFG, these two fuels are generally not fungible when ethanol is the
oxygenate of choice.  The potential  impact  these factors  have on the market should  be further
explored and understood prior to making any recommendations.

    Renewable Fuels Program: EPAct also set forth a new national renewable fuels program that
established renewable fuel volume requirements beginning in 2006. On September 6,  2006, EPA
proposed a regulation to implement the comprehensive program for 2007 and later.  This important
new program is designed to help the U.S. reduce our  reliance on foreign sources of energy. Ethanol
is expected  to be the primary renewable fuel used  to meet the requirement  for the near future.
However, because ethanol must be transported and distributed separately due to its affinity to water
and  the  presence  of water  in the petroleum distribution system, the need to  handle  ethanol
separately will need to be taken into consideration.  For example, the distribution system may need
to handle reformulated blendstock  for oxygenate  blending (RBOB)  for  ethanol, conventional
blendstock  for  oxygenate  blending  (CBOB), ethanol,  and potentially  non-oxygenated  RFG
(discussed above).  As with the other  Federal and state legislation and regulations mentioned in this
section,  closer evaluation of the current and future market dynamics, as well as how the RFS affects
air quality, will be necessary to support any recommendations.

STATE FACTORS

    State Renewable Fuel Programs: Since 2000, several states have implemented renewable fuels
programs, and with the increases in petroleum prices in the past few years, more states are pursuing
renewable fuel requirements  (Appendix A). While these state renewable programs are not boutique
6   Because California is treated differently under the Clean Air Act, EPA removed the oxygen content requirement for
California RFG through a separate action in April.
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fuels, they may play an increasingly important role in the nation's fuel system in the future.7  As with
the federal renewable fuels program, ethanol is likely to be the main renewable fuel used, at least for
a number of years, as other renewable fuels are less widely available and less economically aligned
with  that  of petroleum  based fuels.   While  the federal  renewable fuels  standard includes  a
requirement to establish a credit trading program to  allow  suppliers to use renewable fuels in the
most economic and efficient manner nationwide, state renewable fuel mandates could have an effect
of limiting some of this flexibility. Additional analysis is necessary to determine to what extent these
programs will affect the overall fuels markets.

MARKET CHANGES

    In addition to new legislation and regulations, petroleum market changes have occurred that
could affect the supply system's ability to manage  multiple, distinct fuel types, including boutique
fuels, in the future.  These issues are discussed in more detail below.

CHANGES   IN  DOMESTIC  PRODUCTION  AND  DISTRIBUTION   CAPACITY  IN
RELATION TO DEMAND

    In recent years, petroleum  demand growth has outpaced the growth in  both refinery and
distribution capacity, reducing excess production  and distribution capacity, which in turn,  has
reduced  supply flexibility  to handle unexpected supply disruptions.  Producing and distributing
boutique fuels and other fuel types  is easier in an environment that has excess capacity than in one
where both production and distribution  capacity are  tight.  At the same time, today's tight supply
environment is also resulting in  plans  for new investments  to expand capacity.   Increased
investments in capacity may work to relieve some of the supply and distribution pressures associated
with handling multiple fuel types in the future.

    During the first half of the 1990s, refinery capacity in the U.S. changed very little.  In the early
1990s, a recession held down demand growth, but capacity utilization still increased from 87 percent
in 1990 to  92.6 percent in 1994.  By the second half of the 1990s, the U.S. was running its refineries
near capacity during the  peak summer  months.  Demand  continued to  grow,  but U.S.  refining
capacity was  growing as well.  U.S.  capacity growth seemed to keep up with demand increases, and
utilization  remained around 93 percent.   Since  2000, the refinery capacity/demand balance again
shifted. Demand growth continued, with demand for products from refineries increasing over one
million bpd from 2000 to  2005, but capacity increases slowed to grow only 0.6  million barrels per
day (bpd), with increasing imports making up most of the balance.

    Another  significant change has been that financial incentives for investments have improved
since 2000, and the industry is announcing plans for substantial capacity increases over the next five
years.  Capacity  expansion plans and estimates  for  capacity creep indicate U.S. refineries  could
7   Boutique fuels are motor fuels that are a part of any clean fuel program designed and enforced under state authority
to reduce motor vehicle emissions and improve air quality; approved by the EPA under the authority of Section 211
(c)(4)(c) of CAAA of 1990; and included in an EPA-approved SIP.
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expand 1.7 million  bpd  from  2005  to  2010, which  is  grater than  the  Energy  Information
Administrations^ projected demand increase for refinery products.

    The growth in demand has also  affected the distribution infrastructure.  Several significant
pipeline changes have occurred.  The  Centennial Pipeline opened  in 2002, which helped to ease a
critical transportation bottleneck in moving  product from the Gulf Coast to the Midwest.  This
pipeline had been a  natural gas pipeline.  Converting from a natural gas pipeline to a petroleum
product pipeline  reduced  many of the issues  that arise when trying to  construct a grass-roots
pipeline.  At about the same time, the Explorer pipeline, which also moves product from the Gulf
Coast to the Midwest, expanded. Another major addition was the  Longhorn pipeline, which began
operations  in 2005.  Initially a crude  oil pipeline,  it was extended and converted to handle light
petroleum products.  The Longhorn pipeline moves products from refineries  on the Gulf Coast to
West Texas.  From there,  shippers may use  other pipelines to move product to New Mexico and
Arizona.   Thus, this  pipeline served  to connect many  Gulf Coast refineries  to rapidly growing
markets in Arizona and Nevada. While we have not seen widespread public announcements in the
past year as with  the refining industry, recently, Colonial Pipeline  announced a planned expansion
from the Gulf Coast to the Southeast.

CHANGES IN IMPORT SUPPLY

    Motor  gasoline  imports are a critical component of U.S East Cost supply, accounting for
approximately 25 percent  of the East Coast market.  Since 2000, U.S. gasoline  imports have
increased 71 percent  or about 500,000 bpd, to average almost 1.1 million bpd in 2005.  In 2005, 41
percent of those volumes came from Western Europe, 26 percent came from Canada and the Virgin
Islands, and 12 percent from Eastern Europe.  These regions were  also the areas  supplying the
largest growth volumes. Western Europe accounted for 62 percent of the growth, Eastern Europe
22 percent, and Canada and the Virgin  Islands 13 percent.

    As U.S. fuel  quality specifications have become  more stringent,  some  sources  of imported
product have chosen not to invest to comply.  Gasoline volumes from Brazil, for example, have
declined significantly in recent years, though this situation could reverse in the future.  At the same
time, other sources  of imported product that  could  meet U.S. specifications  have shifted  more
products to the U.S.  In total, there has been a net increase in gasoline imports.  Western Europe is
an area that has been able to supply a growing volume  of high quality fuels, since the European
Union fuel specifications are similar to U.S. specifications, and since European demand for gasoline
is declining, freeing up more volume for export. The U.S. now depends on fewer import suppliers,
which may reduce flexibility to respond to unexpected changes in supply or demand.

    Multiple fuel types also  can have an impact on how importers respond to changes in the market.
Importers must determine which fuel  types are needed before they can begin assembling cargoes.
Traders have adapted to these issues in various  ways.  Some are storing blending components that
can be used to produce RBOB or conventional gasoline as needed, to be able  to respond to market
changes more quickly.  While this can help traders meet specific fuel needs through more flexibly, it
can require the use of more tanks  for the different blending components than if storing simply
RBOB and finished conventional gasoline, and total inventory volumes stored may be less.
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CHAPTER SUMMARY

    In summary,  since 2001, significant legislative, regulatory, and market changes have  occurred
that affect boutique fuel incentives and  industry's ability to handle these products.  While some
legislative and regulatory changes were specifically directed at boutique fuel issues, many affected
boutique fuel  incentives indirectly.  Furthermore, some of the changes  that have  occurred may
increase the incentive for  states to use boutique fuels, while others may decrease  the incentive.
Legislative and regulatory changes have also taken place that could have an effect on fuel supply and
emissions beyond state boutique fuels, such as the emergence of state renewable fuel requirements
and the beginning  of the  ULSD  program.  Meanwhile, the petroleum market  has  experienced
shrinking excess capacity in the areas of refining, distribution and storage, and diminished sources of
product imports.   At the same  time,  changing financial incentives are  encouraging capacity
expansion. Additional analysis is needed to assess these many different and competing impacts on
the fuels markets.
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   IV.   BOUTIQUE FUELS TASK FORCE REPORT  (JUNE 2006)

    On April 25, 2006, President Bush directed the EPA Administrator to convene a Task Force of
States to review the variety of regulatory requirements related to fuels. The Task Force on Boutique
Fuels (Task  Force), which included states,  EPA,  DOE,  and the  United  States Department  of
Agriculture (USDA), concluded with EPA issuing its most recent report on June 23, 2006.

    The Task Force was charged with identifying opportunities to increase cooperation among the
federal government and states on gasoline supply decisions and to reduce the number of boutique
fuels.   In addition,  critical stakeholders, including those  in the  refining, marketing  and fuel
distribution sectors, were provided with an opportunity to  present their views and opinions to the
Task Force for  evaluation and consideration.

    The Task Force was specifically charged  with reviewing the current boutique fuels situation in
the U.S., any actions taken  since EPA last investigated and  reported on the boutique  fuels situation,
and the relevant provisions in EPAct. The process provided for stakeholder input prior to reporting
on any options, recommendations or further informational needs necessary to effectively address the
impact boutique fuels have on the U.S. fuels market.

    Boutique fuels, as defined in the Task Force report (as in the 2001 study) are:

    •  Fuels that are a part of any  clean fuel program designed and enforced under state
       authority to reduce  motor vehicle emissions and improve air quality; and,

    •  Approved by the EPA under the authority of Section 211 (c)(4)(c) of the CAAA of
       1990; and,

    •  Included in an EPA-approved SIP.

       The  Task Force gathered relevant information related to boutique fuels from participants
and stakeholders. Based on the information  collected from the participants and stakeholders, EPA
prepared a Report8 to the President on potential actions and next steps to  simplify the U.S. fuel
system, increase fuel supply, improve fuel fungibility, and encourage cooperation among the states
on  fuel supply decisions.  Specifically,  the Report to the President noted the following conclusions
and recommendations:

    •  The  U.S. gasoline production  and distribution system is  able to  provide adequate
       quantities of boutique fuels, as long as there are no disruptions in the supply chain.
       If a  disruption occurs  (for example, due to a  natural disaster), it  becomes more
       difficult to move gasoline  supplies around  the  country because of the limitations
8    Report to the President— Boutique Fuels Task Force, June 2006,
http://www.epa.gov/otaQ/boutiQue/resources/bftf62306fmakeport.pdf.
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       imposed by the boutique fuel requirements.  EPA has used existing authorities to
       waive boutique fuel requirements temporarily during such times of supply disruption.

    •   State boutique fuel programs  have provided  significant,  cost-effective air quality
       improvements. Any actions to modify the slate of existing boutique fuels or limit a
       state's ability to adopt fuel specifications should be done  in a manner that at least
       maintains the air quality benefits and avoids unnecessarily restricting state authority.

    •   Any future analysis of potential changes to the number  and types  of fuels must
       utilize the most up-to-date data  and  analytical tools.   In  particular,  the 2008
       EPA/DOE Fuel  Harmonization  Study should ensure that  the  impacts  of fuel
       requirement modifications on air quality, vehicle components and performance, fuel
       fungibility, fuel supply and fuel cost, are appropriately addressed.

    •   As part of the analyses of future fuel options, careful consideration should be given
       to the possibility of new legislative authority that would allow for the adoption of
       regional clean fuel programs. Cleaner burning fuels used in geographic areas broader
       than states merit further study as an additional option for addressing fuel supply and
       fungibility concerns.

    •   Renewable fuels are an important part of the Administration's plan to reduce U.S.
       dependence on foreign  oil.  States are undertaking a number of actions to promote
       the  use  of such  renewable fuels and  the federal  government is  implementing
       programs, notably the Renewable Fuels  Program established by EPAct,  to do the
       same.  Additional study is necessary to ensure these programs  are working together
       and will not create undue adverse  impacts on air quality, fuel fungibility, fuel supply
       and/or fuel cost.

    The Task Force Report is the first step of a comprehensive effort to reassess issues related to the
nation's fuel supply.  It is a key part of the broader process in which EPA and DOE, in response to
EPAct requirements, will be analyzing the affects  of boutique fuels,  in addition to other unique
fuels, on the nation's fuel system.

    The observations and recommendations  resulting from the Task Force Report have provided
useful input into developing the plan described in Section V of this report, regarding the future Fuel
Harmonization Study.  The report also serves as  a foundation for developing this report. Additional
stakeholder involvement, particularly from the states, on this plan will also be  critical.  In the course
of the Fuel  Harmonization Study, EPA and DOE  will continue to actively engage and seek input
from interested state participants from the Task Force as well as other interested stakeholders.
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     V. WORK PLANNED  FOR EPACT SECTION  1509 STUDY

REQUIREMENTS OF THE ACT

    In addition to the Boutique Fuels study required under section 1541  of EPAct, section 1509 of
EPAct further requires EPA and DOE to submit a joint report to Congress on the results of a Fuel
System  Requirements Harmonization  Study  by June  1, 2008.   When  completed,  the  Fuel
Harmonization report may contain  recommendations for legislative and  administrative actions that
reflect the following principles: improve air quality, reduce fuel costs to  consumers and producers,
and increase fuel supply liquidity.  The recommendations shall take into account the need to provide
advance notice of required modifications to refinery and fuel distribution  systems in order to ensure
an adequate supply of motor vehicle fuel in all states.  In developing the report, EPA and DOE shall
consult with  the Governors of the States, automobile manufacturers,  state and local air pollution
control regulators, public health  experts, motor vehicle fuel  producers  and  distributors, and the
public.

    The  Fuel Harmonization Study  is  required  to  cover standards  relating to RFG, volatility
(measured in RVP), oxygenated fuel, diesel fuel, and  any other requirements that vary from state to
state, region to region, or locality to locality.  The study must assess the  effect the variety of these
fuel standards have on the following:

           •    Supply, quality, and price of motor vehicle fuels available to the consumer;

           •    Achievement  of national, regional, and local  air quality standards and goals and
               related environmental and public health protection standards and goals (including
               the protection of children, pregnant women, minority or  low-income communities,
               and other sensitive populations);

           •    Domestic  refiners, the fuel distribution system;  and industry investment in new
               capacity;

           •    Emissions from vehicles, refiners, and fuel handling facilities;

           •    The feasibility of developing national  or regional motor vehicle fuel slates for the 48
               contiguous states  that, while  protecting and improving air quality at the national,
               regional,  and  local  levels,  could enhance   flexibility  in  the  fuel  distribution
               infrastructure  and  improve fuel fungibility; reduce price volatility and costs  to
               consumers and producers;  provide increased  liquidity to the gasoline market; and
               enhance fuel quality, consistency, and  supply;

           •    The feasibility of providing incentives, and the need for the development of national
               standards necessary, to promote cleaner burning motor vehicle fuel; and
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       •   The extent to which improvements in air quality and any increases or decreases in
           the price of motor fuel can be projected to result from the following programs, rules,
           and requirements:

                       o   EPA's  Tier  2/Gasoline  Sulfur  requirements  for  conventional
                           gasoline and vehicle emission systems,

                       o   EPA's on-road and off-road diesel rules,

                       o   The RFG program,

                       o   The  renewable  fuels program established under section 1501  of
                           EPAct,

                       o   State programs regarding gasoline volatility, and

                       o   Any  other requirements imposed by the federal government, states
                           or localities affecting the composition of motor fuel.

OVERVIEW OF PLANNED APPROACH TO THE 1509 STUDY

    The Fuel Harmonization Study is  much broader in scope than the  1541 study, including
analysis of more  distinct fuel programs and requirements. It also requires a comprehensive
evaluation of fuel supply, cost, and emission impacts associated with these distinct fuel programs
and, in particular, how these impacts might change under possible legislative or administrative
changes.

    Figure  4 illustrates the  conceptual analytical approach, which will be  used for  the Fuel
Harmonization Study and some of the  key interrelationships in the fuel system.  As illustrated,
two major  areas for analysis are interrelated: (1)  Emissions and Air Quality and (2) Supply and
Price.  Potential scenarios to be evaluated generally would be  directed towards affecting either
fuel characteristics  or  supply, with  accompanying impacts on both emissions and price.  For
example, a scenario could be evaluated that  requires a single very clean fuel, which might have
the largest improvement on air quality and the lowest price volatility, but might have the highest
increase in  costs for the consumer.  Scenarios will be developed to explore the implications of a
range of potential options and other factors.  However, as Figure 5 (Emissions and Air Quality
Analysis) and Figure  6  (Supply  and Price  Analysis)  begin  to illustrate, these  scenarios are
complex.
                                     22

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                    Scenario Definitions
                            /\
  Fuel Characteristics
              i
    Impacts on:
    Emissions
    Air Quality
    Health/Welfare
            Supply
            i
        Impact on Price:
        Level & Volatility
           Figure 4. Conceptual Analytical Approach to the Fuel Harmonization Study
State Initiatives
Fuel Specifications
Number of Fuel Types
Size & Location of
Geographic Fuel Islands
 Fuel Characteristics
       Impacts on:
       Emissions
       Air Quality
       Health/Welfare
       Figure 5. Conceptual Analytical Approach to the Emissions and Air Quality Analysis
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    Figure 5, while still a simplified diagram, expands further the Emissions and Air Quality
Impacts Analysis, which will estimate the air quality impacts and the impacts on health and
welfare. Some of the information generated for each individual scenario analysis will also be
needed as an input for the Supply and Price Analysis. As described in more detail below, in
order to generate the emission outcomes, significant testing and analysis must be done to
develop the relevant vehicle and engine emission information.  Work must also be done to
develop various fuel types and volume for future situations in enough detail to capture the
potential fuel specifications and geographic use of those fuels.  The Emissions and Air Quality
work will also require estimates regarding what will occur in the area of state fuel initiatives,
whether they are boutique driven, renewable or other.
        Fuel specifications
        Number of fuel types
        Size & location of
        geographic islands
Other factors such as
demand, crude price,
State initiatives.
Supply
                                                      Impact on Price:
                                                      Level & Volatility
              Figure 6.  Conceptual Analytical Approach to the Supply'/Price Analysis

    Figure 6 expands the Supply and Price Analysis in a similar fashion, illustrating the input
information required in  order to ultimately evaluate the supply and price implications.   The
focus of this area (in red) is to generate refinery and distribution capacity and cost impacts for
various  scenarios, and determine the corresponding changes in  factors that would ultimately
impact availability or reliability of supply.  The diagram shows that, dependent upon the scenario
being analyzed, state initiatives may be an input into the analysis along with other  supply
assumptions such as  demand growth, and  crude and product prices.    It also  shows  the
information needed for and generated from the Emission  and Air Quality Analysis supporting
the Supply and Price Analysis.

    The number of scenarios to be analyzed for the Fuel Harmonization Study must be limited
due  to  the  complexity of the analysis.   EPA  and DOE will attempt to identify the most
                                    24

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    important variables  for consideration, and  structure a set of scenarios to capture a range of
    policy options and potential impacts in order to provide meaningful policy recommendations.

       Before performing these analyses, we must better understand the current situation, which
    will require significant work to collect and update data in a number of areas, such as vehicle and
    engine emissions and performance data.  We also will need to evaluate past market behavior as
    fuel types increased, such as in  the area of supply  distribution, in order to help understand
    potential future market responses.

       In overview,  to analyze how  policy options may affect air quality and consumer prices, the
    Fuel Harmonization Study will explore:

    •   Changes in the nature, size, number, and location of distinct fuel-type areas

    •   The  potential changes  to refining and distribution  system  capacity resulting from  such
       modifications to the fuel system

    •   The potential local and nationwide impacts on the costs of producing and distributing fuel
       resulting from such modifications to the fuel system

    •   The impact such fuel system modifications may have on the reliability  of production and
       distribution capability during times of disruption

    •   The  local  and  nationwide  impacts  on emissions  and air quality  resulting from  such
       modifications to the fuel system

    •   The sensitivity of these impacts to various critical assumptions, including future expansion
       of the fuel production and distribution infrastructure, changes  in future  fuel demand, and
       changes in future crude oil costs.

    •   The tradeoffs among the impacts for  different scenarios

    The subsections  that follow describe in detail those  things that EPA and  DOE believe are the
most important to analyze as part of the Fuel Harmonization Study.  They also describe the nature
of the data and information that will need to be collected in order to carry out these analyses.

EMISSIONS AND AIR QUALITY ANALYSIS

    To ultimately assess the air quality and associated  fuel supply and price impacts of future
strategies, new vehicle  and engine emission factors that represent the current  fleet  must  first be
established. Today's  vehicle fleet is much different from  the fleet used to establish current estimated
relationships between fuel specifications/properties and emissions.

    Following the 1990  CAAA, fuel  effects were well characterized for passenger vehicles utilizing
model  year 1990 technology.  Under Section 211(k) of the CAAA, RFG was required to result in
reduced emissions relative to emissions from baseline or representative model year 1990 vehicles. In
support of the RFG  rulemaking, EPA developed the "Complex Model" to predict emissions based
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on fuel properties (such as sulfur, benzene, aromatics, olefins and RVP) that are readily measurable
and technologically feasible to control.  The data gathering effort necessary to develop this model
was enormous, involving both the auto and oil industries and costing approximately $35 million.
Since the development of the Complex Model, with the exception of studies on the  effects of
gasoline  and diesel fuel sulfur (in which EPA, DOE, and industry collectively spent roughly  $10
million),  only very limited data collection or analysis efforts have been undertaken to examine the
effects of fuel properties on vehicle emissions.

   Looking back to the  1990 model year, vehicle technology has changed dramatically.  Auto  and
engine manufacturers have used a combination of higher catalyst precious metal loading, improved
catalyst durability, close-coupled catalysts for faster catalyst light  off, and electronic controls to
greatly improve  air-to-fuel  ratio control (for achieving  hydrocarbon  (HC),  CO, and  oxides of
Nitrogen (NOx) exhaust emission reductions). Evaporative emissions have also been reduced since
1990  by the use of  electronic  controls versus earlier vacuum-controlled designs.  Additionally,
evaporative emissions have been reduced by better canister designs,  the use  of less permeable
materials in vapor control lines, and the  addition  of a system to collect refueling emissions. Another
significant  change between 1990 and today's  vehicles has been the implementation of an electronic
onboard diagnostic  control system to monitor the  performance  of critical emission control
components.   This  system detects failures in  individual  components  and, above prescribed
thresholds, indicates an increase in emissions and the need for service to repair components.

   As the Complex Model only covered light-duty gasoline, Tier 0 (model year 1990 technology)
vehicles under  summertime conditions, a significant amount of additional data will be needed on
light-duty as well as heavy-duty vehicles and nonroad  applications  for current engine technology
(both gasoline and diesel).  Furthermore, a significant amount of data will be needed under summer
and winter conditions to  form a sound data foundation on which analysis can be performed  and
conclusions drawn. A comprehensive test program, likely of similar magnitude to  that which went
into developing the Complex Model (e.g., $35 million), is necessary to fill these data gaps. Such a
comprehensive test program will require substantial resources as requested in the President's 2007
Budget.  The test program must assess the impacts  of fuel parameters directly affected by the
current distinct fuel types (e.g., RVP, sulfur, ethanol content, and biodiesel content), as well as  fuel
parameters which are impacted indirectly (e.g., benzene, aromatics, olefins, and distillation) in order
to allow for an assessment of the cause and effect relationships on emissions.

   Once these cause and effect relationships  are established, then models can be developed to allow
assessments to be performed of a range  of possible changes to the current slate of distinct fuel types
across the  country.  Using these emission impacts, air quality modeling can then be performed to
evaluate  their impact on  future  ozone  and PM (particulate matter) air quality.  Outputs from air
quality models  can also be used to consider  the impact of various fuel scenarios on human health
and welfare.

FUELS SUPPLY AND PRICE ANALYSIS

   The  fuel Supply and  Price Analysis requires work  in several areas: refining, distribution,  and
import supply.  As  shown in  Figure 6 in  red, for each  scenario, the work will  be focused on
projecting distribution system and refinery costs and capacity impacts, import supply availability and
basic  changes to  supply reliability, which will be the basis for estimating price and price volatility
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impacts.   Basic scenario  inputs for this  part  of the  analysis  will include  information from  the
Emission and Air Quality Analysis, such as the fuel specifications, number of fuel types, and  the
location and size of various fuel type geographic areas. The underlying petroleum market conditions
such as demand and crude price will also be needed.  It will be critical to separate the external
market factor impacts on cost, reliability, and price from the  impacts of the distinct fuel types being
evaluated.  For example, product prices  are a function of a number of factors, including worldwide
supply and demand  for crude oil and the local, national, and even worldwide supply and demand
balance for refined products.

    Cost, Capacity and Import Availability

    Similar to the Emission and Air Quality Analysis, the first step in the Supply/Price Analysis will
be to analyze current conditions  and the relationships among the various elements of the petroleum
supply system as they relates to boutique and other distinct fuels.

    The impacts of multiple fuel types on transportation, distribution, and storage must be studied
thoroughly.  This is true not only in the  case of individual distinct fuel specifications, but also in  the
case of how a unique fuel specification might affect the distribution of other products. Before any
recommendations  can  be  made  on changes  to the slate of fuels,  a much better understanding is
required  of how changes in the number  of fuels and in the number and size of fuel-type geographic
regions  may affect  the cost and ability to move and  store product,  and  thus  affect  overall
distribution costs and capacity.

    Quantifying delivery and storage system issues will require  working with pipeline and terminal
operators and marketers on a local and regional basis to assess their experience with how a changing
slate of fuels  has historically and in the future would likely affect their capacity, flexibility, and costs.
As changes to their marketing agreements and practices are also  a viable response to a change in fuel
slates, it will be important  to review past industry responses as a means of projecting into the future.
For example, the response of the distribution system may result  in "over-compliance" on the  part of
the fuel producers.  Over-compliance can occur when distribution and storage infrastructure  do not
accommodate a full  fuel spectrum. In  such a case, suppliers may provide  all  customers with  the
cleanest fuel required because of the lack of storage space for multiple fuels.

    To assess refinery production cost impacts, refining models and cost databases will be updated
to include the current number, type, and volume of motor vehicle fuels produced, the current and
planned production capacity and other assumptions concerning  feedstocks supply. This will require
incorporation of cost information associated with the newest technologies and equipment changes
to meet the latest processing requirements, as well as updated  information on refinery operational
changes, such as changes in purchasing materials from outside of the  refinery to  meet product
specifications, including renewable fuel  components.  Unlike many historical refinery production
analyses, the Fuel Harmonization  study  will  require looking at impacts  on  different types of
refineries rather than  an aggregate  production  analysis, in order  to consider both  the  policy
implications and marginal cost changes  that  affect price.  Again, data and models will need to be
adjusted to deal with different refinery types.

    An increasingly important factor in assessing impacts on fuel supply in the U.S. is having a
proper understanding of the import and export market.  As U.S.  demand has continued to grow
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beyond domestic refining capacity, the ability of imports of finished gasoline  and diesel fuel  to
supply the U.S. market has become more critical.  The result is that changes in gasoline and diesel
fuel demand around the world have a  much more direct impact on  overall U.S. supply.   A
consequence is that changes in fuel  specifications in the U.S. and  abroad can cause significant
changes in the import and export market; creating new markets for some and closing down markets
for others.  Incorporating these  changes into our analysis will allow a better understanding of what
might happen to import availability in the future under different fuel scenarios and whether further
legislative changes would affect our sources of supply.

    Reliability of Supply

    Reliability of the U.S. supply system can be evaluated with probabilistic techniques which can
incorporate variables associated  with events or changes at the refinery, in the distribution system,
and even from the availability of imports.

    At the refinery, a better understanding is required of how producing one high quality fuel versus
an array of gasoline types affects production reliability.  For example, if one refinery process unit
goes down, what is the projected impact on production.

    Reliability of the distribution system involves a variety of dimensions that must be explored  to
assess how reliability changes among different fuel scenarios.  For example, pipelines move product
in batches.  The evolution of increasing the number of distinct fuels serving smaller demand areas
means many pipelines  now carry more products.  Smaller volumes of each product are potentially
stored in  the different demand regions.  Under these conditions, to maintain reasonable inventory
levels and prevent inventory outages, tank turnovers may occur more often, which means the time
intervals between product shipment arrivals may be smaller.  Scheduling  becomes  more complex,
and even  without major disruptions, there is the potential for increasing probability of outages.  In
the past,  this may not have  reached  critical constraints.   In some cases, suppliers working with
pipelines  and terminal operators found various means to solve critical pinch points in the system
with operating changes such as using product exchanges to allow one terminal to carry one product,
while another terminal carries the second product.  In-line blending was added to allow terminals  to
drop mid-grade gasoline and blend it  as needed from conventional and  premium gasoline at the
retail pump.  As we look ahead,  understanding the distribution capacity, efficiency, constraints, and
ultimately probability of outage  will help us  determine how  fuel harmonization issues may affect
distribution system reliability.
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LIST OF ACRONYMS
bpd
CAA
CAAA
CBOB
CO
DOE
EPA
EPAct
HC
MSAT
MTBE
NAAQS
NOx
PADD
PM
ppm
RBOB
RFC
RFS
RVP
SIP
ULSD
USDA
VOC
barrels per day
Clean Air Act
Clean Air Act Amendments
conventional blendstocks for oxygenate
blending
carbon monoxide
Department of Energy
Environmental Protection Agency
Energy Policy Act of 2005
hydrocarbons
mobile source air toxics
methyl tertiary-butyl ether
National Ambient Air Quality Standards
oxides of nitrogen
Petroleum Administration for Defense District
particulate matter
parts per million
reformulated blendstocks for oxygenate
blending
reformulated gasoline
renewable fuels standard
Reid Vapor Pressure
State Implementation Plan
ultra-low sulfur diesel
U.S. Department of Agriculture
volatile organic compounds
      29

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        APPENDIX A
Table 1. State Biofuel Standards Enacted

State
Hawaii



Iowa


Louisiana








Minnesota






Legislation Status
Legislation Enacted mid-
1990s; Administrative
Rule Signed 9/14/04

Enacted 5/31/06


Enacted 6/13/06








Enacted in 1997;
revision 5/12/05





Enabling Statute(s)
Title 15. Chapter 35.
Para. 15.35.3

Governor's Press Release
HF2754


HB685








SF4





Biofuels
Included
Ethanol



Ethanol;
Biodiesel


Ethanol;
Biodiesel;
Alternative
Renewable
Fuel




Ethanol;
Biodiesel





Content Requirement & Effective Date
85% of all gasoline must contain at least
10Vol% ethanol by 4/2/06. Exemption if
(a) competitively-price ethanol not
•i 11 /L\ _J 1 J 1 '
available or (b) undue hardship.
All motor fuel (gasoline + diesel) contain
10Vol% biofuel (ethanol + biodiesel) by
1/1/09, increasing acording to an annual
schedule to 25Vol% by 1/1/20.
2Vol% total gasoline contain ethanol after
rate of 50 MMGY ethanol production in
state; 2Vol% total diesel contain biodiesel
after rate of 10 MMGY biodiesel
production in state; 2Vol% total motor fuel
to be alternate renewable after rate of 20
MMGY production in state. All 3 take
effect 6 months after production targets
reached.
All gasoline contain ethanol at least
9.2Vol% and not more than 10Vol%. If all
gasoline by 12/31/10 is less than 20Vol%,
subject to Federal approval of E20, all
gasoline must contain ethanol between
18.4Vol% and 20Vol% by 8/30/13.
            30

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State
Missouri
Montana
Washington
Legislation Status
Enacted 7/10/06
Enacted
Enacted 3/30/06
Enabling Statute(s)
HB1270
Governor's Press Release
SB293
(Summary only)
SB6508
Biofuels
Included
Ethanol
Ethanol
Ethanol;
Biodiesel
Content Requirement & Effective Date
All gasoline contain 10Vol% ethanol by
1/1/08. Exemption (a) for premium grade
gasoline and (b) if ethanol more expensive
than oil-based gasoline.
All gasoline contain ethanol at 10Vol%
after state's ethanol production reaches
rate of 40 MMGY level.
All gasoline contain 2Vol% ethanol by
12/1/08 ramping up to 10Vol% by 2012.
All diesel contain 2Vol% by 12/1/08
ramping up to 5Vol% by 2012.
Table 2. Standards Pending Final Approval
State
California
Colorado
Idaho
Illinois
Legislation Status
Executive Order
(Target vs. Standard)
Passed Legislature;
vetoed by Governor
Passed by Senate;
pending in House
Passed by Senate;
pending in House
Enabling Statute(s)




Biofuels
Included
Ethanol;
Biodiesel
Ethanol
Ethanol
Ethanol;
Biodiesel
Content Requirement & Effective Date
Targets to produce and all gasoline contain
biofuels at minimum of 20Vol% by 2010,
40Vol% by 2020, and 75Vol% by 2050.
75Vol% of all gasoline contain ethanol at
10Vol% by 1/1/07.
All gasoline contain ethanol at 10Vol% by
60 days after state ethanol production
reaches rate of 30 MMGY.
All gasoline contain 10% ethanol by
volume by 1/1/08 increasing to 15% by
1/1/12
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State
Indiana
Kansas
New Mexico
Pennsylvania
Virginia
Wisconsin
Legislation Status
Enacted (Study
vs Standard)
Not passed
Not passed
Proposed by Governor;
to be taken up by
Legislature
Proposed by Governor;
rejected by Legislature
Passed by House;
amendment pending in
Senate
Enabling Statute(s)





AB15
Biofuels
Included
Renewable
Fuels
Ethanol;
Biodiesel
Ethanol;
Biodiesel
Ethanol;
Biodiesel
Ethanol
Ethanol
Content Requirement & Effective Date
Study committee created to find most
effective way to implement RFS under
EPACT 2005
All gasoline contain 10Vol% ethanol and
all diesel fuel contain 2Vol% biodiesel by
1/1/10.
All gasoline contain 10Vol% ethanol and
all diesel fuel contain 2Vol% biodiesel by
1/1/09.
All gasoline contains ethanol at a 'certain
percentage' and all diesel contain biodiesel
at a 'certain percentage' by unspecified
target date.
All gasoline contain ethanol at 10Vol% 12
months after state's ethanol production
reaches rate of 300 MMGY level for at
least 3 months.
All gasoline contain ethanol at 10Vol% by
10/1/07. Standard would be suspended if
E10 mandate "contributes to or will
contribute to a violation of federal ambient
air quality or visibility standards."
Last update: 7/13/06.
Source: Special Report: United States — State Renewable Content Standards, International Fuel
Quality Center, Hart, June 6,2006;               STATUS; 2006. State by State Ethanol Handbook
American Coalition for Ethanol, 1/06; Renewable Fuel News and World Refining &Nem Today, Hart.
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