By Elizabeth Hilbourn and John Auers
Monkey in the Middle is a throwing and catching game for a small group where players try to keep the ball away from one player (the “monkey”). Merchant refineries may feel a bit like the monkey in the middle as RFS programs get jockeyed around. The whole business model of Merchant Refineries got stirred up when they started incurring the added RIN expense with RFS1 and RFS2. It was not as big of a financial impact until the blend wall was reached in 2013 and the price of the ethanol RIN skyrocketed. Though an obligated party has to meet four categories of obligation, the ethanol obligation is by far the largest. Figure 3 depicting RIN price history shows that prior to 2013, ethanol RINs were in the single digits and then as the year progress increased to over one dollar per RIN. The last blog, The RFS Program- After a Monkey Wrench Has Been Thrown In, discussed the ruling on the 2014-2106 RFS obligations by the U.S. Court of Appeals for the District of Columbia (the Court). The Court determined that EPA did not properly interpret “inadequate domestic supply” for the total renewable requirements for 2016 and remanded the rule to EPA for further consideration.
RINs are frequently in the news as of late. The proposed 2018 RFS obligation was announced early July followed by the Court’s ruling in late July. Then rumors spread of EPA’s formal denial the requests by refiners to shift the biofuel compliance burden away from their companies and move it to the fuel blenders. All these announcements have an effect on refiners, but even more so to the bottom line the merchant refiners.
Cost to the Industry as Depicted with Merchant Refiners
In 2016, merchant refiners paid almost twice what they paid in 2015 for RIN expenses as shown in Figure 1. In 2012 and earlier, RIN expenses for merchant refiners were under 500 million dollars. When the blend wall was reached in 2013, RIN costs became expensive. In 2016, the merchant refiner RIN expense is estimated at $2.8 billion dollars based on information directly from annual reports.
Most of the RINs a merchant refiner purchases are the D6 RIN or commonly referred to as the ethanol RIN. If you assume that there are no D5 RINs and you need to purchase D4 RINs in place of D5 RINs, you would have needed 7.6 more D6 RINs than D4 RINs in 2012. That ratio reduces to 4.5 in 2017 since the D4 and D5 obligation increased more than the D6 obligation. The D6 RIN price averaged 82.3 cents per RIN in 2016, averaged on a daily average price.
If the 2016 renewable fuel obligation is increased as a result of the July 28, Court ruling, then the 2016 RIN expenses and all later years have the potential to skyrocket. The RIN price would increase because there would likely be a shortage of the D6 RIN. Image may be NSFW.
Clik here to view.
Figure 2 depicts various merchant refiners 2016 RIN expenses. Valero has the largest RIN expenses followed by PBF Energy and Marathon Petroleum.Image may be NSFW.
Clik here to view.
Image may be NSFW.
Clik here to view.
The table below compares merchant refineries 2016 RIN expenses to operating income and net income. The table depicts how significant RIN expenses are to the bottom line of these companies. Take Valero Energy, the largest merchant refinery. In 2016, Valero had 749 million dollars in RIN expenses, while their operating income and net income was 3.6 billion dollars and 2.4 billion dollars, respectively. RIN expenses comprised an amount equal to 30% of Valero’s net income in 2016.Image may be NSFW.
Clik here to view.
Point of Obligation
The divide on the point of obligation has existed for some time, but has gained a lot of fire in the last two years. It was a point investor Carl Icahn had in his August 9, 2016 letter to the EPA asking for reform of the RFS program. Which side of the divide you were on was dictated by if you were a refinery that blended renewable fuel in your products. AFPM sided with Icahn while the API sided with keeping the point of obligation where it was.
Various petitioners including AFPM, HollyFrontier, Valero and the Small Refinery Ad Hoc Coalition petitioned the EPA to change the point of obligation for RFS from the refiners and importers to the blenders. On November 10, 2016, EPA denied requests from petitioners to initiate a rulemaking to change the point of obligation for compliance under the Renewable Fuel Standards (RFS) program. The agency opened it up to public comment on the proposed denials to ensure they received input from the wide variety of stakeholders that could be affected. The public comment period was extended thirty days to February 22, 2017, at the request of the Small Retailers Coalition.
The appropriateness of the current point of obligation was the final issue raised by Court; however they issued no opinion and left it to the EPA to decide. The Court left it up to the EPA whether to address the point of obligation issue with the remand of the Final Rule or when the EPA considers comments on its proposed denial of a set of petitions, or in both proceedings. Nothing has formally been announced yet; however, there were August 3 news flashes stating that the EPA is preparing to deny requests by refiners to shift the point of obligation to the fuel blenders and other entities. At the same time, Trump Administration is set to reject Carl Icahn’s proposals to relieve oil refiners the burden to satisfy the biofuel mandates.
Small Refinery Exemption and Small Refinery Hardship Exemption
One defense a merchant refinery has is applying for a temporary exemption from its annual Renewable Volume Obligations (RVOs); however, it can do this only if it is a small refinery and it can demonstrate that compliance with the RVOs would cause the refinery to suffer disproportionate economic hardship. A small refinery is defined as running less than 75 thousand barrels per day on a calendar-year basis. There is a clause where the 75 thousand barrels per day is not limited to both 2006 and the year of the petitioned hardship, but is allowed to only apply to the year petitioned. This is how HollyFrontier’s Cheyenne refinery got the approval in 2016. Also, the small refinery hardship is not limited to a small refiner’s small refinery but can apply to any small refinery.Image may be NSFW.
Clik here to view.
TM&C constantly monitors changes and proposed changes in regulations which can impact all segments of the petroleum industry. Many of these are associated with transportation fuels, affecting not only demand, but also production costs, compliance challenges, and other aspects of petroleum refining. We include our independent analyses of these impacts in our semiannual Crude and Refined Products Outlook (which is being released today) and our various other studies. TM&C also assists clients involved in all aspects of transportation fuel production, blending activities, planning and compliance-monitoring. More information on these publications and our other work involving oil industry developments and dynamics can be obtained by contacting either one of us, visiting our website at turnermason.com or calling Shanda Thomas at 214-754-0898.