Tightening environmental mandates are leading to a greater push for higher blends of ethanol in European gasoline, which could have a profound impact on how European gasoline is priced and hedged.
The higher ethanol blend into gasoline was first introduced into Europe in 2009 but since then it has gathered significant momentum with around half of the total EU member states adopting it. The majority of countries in northwest Europe have adopted the higher ethanol blendstock and several eastern European countries. Crucially, the higher ethanol blend means a reduction in the volume of petroleum-based gasoline in the final blend.
The U.S is already based on a blendstock with 10% ethanol, therefore, the changes in the European gasoline market will bring Europe in line with the U.S. and will increase the benchmarking role that NYMEX RBOB gasoline futures play in the international traded market.
The higher ethanol blends in gasoline help to boost overall greenhouse gas savings in finished grades of the road fuel, especially when products like renewable ethanol are used.
NYMEX RBOB Gasoline: the global benchmark
In the U.S. gasoline market, there are two main formulations for gasoline, the first is reformulated gasoline and the second is conventional gasoline, as required by a complex network of federal and state regulations.
The U.S. Environmental Protection Agency (EPA) administers the Clean Air Act (CAA) requirements and various state agencies regulate their own specific air rules. Under the CAA, the urban areas with the highest levels of smog pollution are required to use clean-burning Reformulated Gasoline blended with 10% ethanol.
Reformulated gasoline is currently used in 16 states and the District of Columbia. Urban areas include the entire Northeastern United States, California, Chicago, Atlanta, and Houston. These areas account for approximately 25% of gasoline sold in the U.S. The Renewable Fuel Standard program, which was mandated by the CAA, has contributed to the long-term reduction of smog levels in the U.S.
The RBOB gasoline futures contract is a reformulated blendstock for oxygenated blending and is intended for mixing with products like ethanol to produce finished gasoline.
The depth of liquidity in the NYMEX RBOB futures and options markets shows that the centrality of RBOB futures to the global gasoline trade. Whilst the physical trade is centred around the port and storage infrastructure in New York Harbor, the sea of the futures and options as a pricing benchmark is far reaching.
Export-orientated refiners in Europe refer to the NYMEX futures contract in their export sales to the U.S. market. The growth of international participation in the contract has been very beneficial to the global trade in gasoline components such as RBOB and its European equivalent, Eurobob.
Trading volumes in NYMEX RBOB Gasoline futures and options surpassed 155,000 lots per day in the 12-month period to May 2023 and around 16% of this volume was traded in European hours as shown in Chart 2.
Spread trades between RBOB gasoline and the different regional gasoline markets are a common way to manage complex trading strategies in the global gasoline markets. The convergence between the European and U.S. gasoline markets should help to simplify trading and risk management between both markets.
During the period from January 2020 to May 2023, there was a strong correlation between the European Eurobob non-oxy gasoline and the U.S RBOB gasoline, which reached approximately 99%.
Given the high levels of correlation between both markets, commercial end-users and trading firms can hedge any underlying price exposure in one market with the other, benefiting from the deep liquidity afforded to them by NYMEX RBOB Gasoline futures.
This may also partly explain why some European clients have turned to RBOB futures to manage risk for the European gasoline trade for E10.
Some of the more European focused trading firms may look to trade the Eurobob non-oxy or E10 gasoline-based contracts and these are listed as futures contracts by CME Group. The contracts sit alongside the highly liquid RBOB futures and options contracts.
European gasoline blendstock exports to the U.S. rise
The European blendstock market for exports has remained active with a growing number of refiners exporting cargoes to the U.S. market.
The latest data from the U.S. Energy Information Administration (EIA) shows that nearly eight million barrels was exported across the Atlantic in January 2023, which accounted for 50% of the total volumes arriving in the U.S. This level was over three million barrels higher than at the same point 12 months earlier.
European exports of Eurobob non-oxy gasoline or E10 are operationally easier to handle than the prior blends of European gasoline, such as E5, as the chemical makeup of the blend allows for the ethanol to be blended into the gasoline at the point of sale in destinations like the U.S. Cargoes can be blended to suit the requirements for a particular state.
European ethanol benefits from higher blends
The doubling of the ethanol content in gasoline has been a welcome boost for the Rotterdam-based paper markets, on which the main ethanol feedstocks are traded.
Futures trading volumes in European ethanol, as listed by CME Group, look set to rise throughout 2023 as traders further adopt strategies to deal with higher blends being used in gasoline across the continent. Other markets such as sustainable aviation fuel (ethanol to jet fuel) and some of the bio plastics are also seen as a positive boost on demand for ethanol.
There is open interest in the futures in 2024 and interest levels are expected to expand into 2025 as the E10 markets continue to expand. Trading volumes in 2022 reached 6,510 lots per month and have remained at around these levels in the first quarter of 2023, as shown in Chart 5.
Renewable ethanol, made from corn, wheat, sugars, and other cereal crops, is expected to play a key role in the realization of the European Union’s (EU) energy and climate ambitions.
Regulating greenhouse gas emissions in road transport
The EU has embarked on a pathway to reduce overall greenhouse gas emissions by 55% by 2030 and sees the “Fit for 55 Package” as a central piece of legislation. The European “Fit for 55 Package” (Fit for 55), which forms part of the “EU Green Deal” stipulates a reduction in greenhouse gas emissions of 55% by 2030.
Road transport emissions account for 25% of total European emissions, according to the European Environmental Agency (EEA). Member states are therefore selecting the appropriate energy policies to achieve the tightening regulatory limits. The International Energy Agency estimates that global carbon emissions from road transport fuels was over 7.5 gigatons at the end of 2021.
Countries are looking at ways to make the ethanol supply more sustainable and one way of doing this is through products like renewable ethanol, which is manufactured by fermenting sugars into alcohol or in some cases with waste feedstocks such as biomass. Under the Renewable Energy Directive, the EU introduced Indirect Land Use Change (ILUC) where biofuels that are produced from feedstocks avoid the displacement of food and feed crops through improved agricultural practices or through the cultivation of areas not previously used for crop production.
E10 supplies across Europe rise
The supply of E10 gasoline is becoming more readily available across much of northwest Europe and is available for sale in 13 EU member states. Chart 6 shows the percentage of gasoline supply that is sold as E10 across Europe.
Typically, such investors attempt to predict in advance, the additions and deletions to the Russell 2000 index and manage these positions in the run-up to the constitution becoming formalized.
Especially in the small- and mid-cap equity share arena, it is often tactically preferable to trade addition candidates versus the benchmark and deletion candidates versus the benchmark, rather than to trade the prospective additions versus prospective deletions via outright trades in the underlying stocks. From the standpoint of reliable liquidity, ease of execution, capital efficiency, and transparency of pricing, this can be well implemented with CME E-mini Russell 2000 Index futures.
These futures contracts can be executed intraday to manage notional risk around cash basket adds or deletes and can also be used to target the cash close via a BTIC transaction.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.