Authors: Elizabeth Hilbourn and John Auers
Refiners these days can really relate to the lyrics of Tom Petty’s classic, “Your Wreck Me” when they see the tab for their Renewable Identification Number (RIN) obligations. The industry, as a whole, spends billions of dollars each year on RINs in order to meet annual mandates set in November for each prior year. The 2018 mandates, which were just finalized last week (on November 30), seemingly provided an additional jolt to their bottom lines as they came in at higher levels than the preliminary values which were proposed in July. RIN expenditures show up on a merchant refinery’s annual report for no other reason than to meet the wishes of the government and those RIN expenditures are increasing at an alarming rate each year. In fact, RIN expenditures increased by over 50% from 2015 to 2016. A 20% increase in RIN expenditures is anticipated from 2017 to 2018. If the merchant refineries did not need to meet the RFS mandates, they would be able to spend it elsewhere such as capital projects to reduce emissions, more money to the shareholder and most prominently in lower cost motor fuel. To this last point, it is important to note that the RIN costs incurred by refiners are substantially imbedded in the market prices of gasoline and diesel, since every gallon of these fuels consumed in the U.S. ultimately carries a RIN obligation. As a result, most of the RIN costs are passed through to consumers, allowing refiners to recover them through higher sales prices, with consumers essentially paying most of the tab. In today’s blog we will discuss RIN costs at the refinery level while we leave the discussion of how those costs are passed through to the market in next week’s blog.
“You Wreck Me Baby, You Break Me in Two”
Back in 2016, RIN costs, and in particular the Merchant Refineries RIN cost burden, captured people’s attention. Since the D6 RIN fulfills approximately 80% of an obligation, the D6 RIN cost is often the pinch point when the RFS burden is felt. The second half of 2015 had lower D6 RIN costs. 2016 had a 7.0% higher obligation than 2015. When 2016 progressed and the price of D6 RINs fairly steadily climbed throughout the year, the RIN expenditures were painfully felt. 2017 began with yet a higher obligation of by 6.5%; however, there was a reprieve with low D6 RIN prices in the first half of the year. Now that the D6 RIN prices have been high, we are feeling the weight of the burden bearing down again. The annual RIN obligation cost depends on when RINs were purchased. Merchant refineries are more at risk with price fluctuations since they are not continuously purchasing renewable fuel to blend but rather having to buy the RINS straight out to fulfill an annual obligation. Still, despite their exposure to short term RIN price fluctuations, most of this cost is likely passed to consumers in the long run (more on this next week).
“Rescue Me, Should I Go Wrong”
The refining industry has lobbied both the Legislative and Executive branches of the Federal Government to alleviate their RIN burdens. The recent formal denial by the Environmental Protection Agency (EPA) to change the point of obligation for compliance was certainly a setback in these efforts. This happened on November 22, when the EPA denied requests from industry petitioners to initiate a rulemaking to move the point of obligation for compliance under the Renewable Fuels Standards program downstream to where physical blending takes place. Based on a wide range of stakeholder input and information provided as a part of the public comment period, the agency has determined that changing the regulatory point of obligation for compliance with the RFS program is not appropriate. Late July 2017, the U.S. Court of Appeals DC Circuit felt that EPA’s interpretation of “inadequate domestic supply” was not correct but pushed back addressing the point of obligation to the EPA. As early as August 2017, the Trump Administration leaked that they planned to reject the proposal. Refiners haven’t given up, however, and just last week it was reported that President Trump has agreed to meet with the refining industry and their legislative backers (prominently led by Texas Senator Ted Cruz) to discuss the overall biofuels program, possibly to set the stage for possible legislation to overhaul the RFS program.
RIN cost estimates are shown in the table below. These costs are based on average RIN prices throughout the year applied to final annual renewable fuel standards as shown in the following two tables. 2017 RIN costs are based on the average through November 2017 and 2018 RIN costs are estimated as the average November 2017 RIN price. The 2018 renewable fuel standard was finalized on November 30, 2017.
The last several years of RIN prices are shown in the figure below. 2015 and 2017 had periods of low ethanol RIN prices. Since 80% of the cost of the RIN obligation is toward ethanol RINs, this has kept the cost of the total RIN obligation lower than what it could have. At the same time, 2016 was the first year of a severe RIN obligation. The estimated $18.6 billion RIN cost for 2018 assumes the final RIN obligation is what was proposed and the RIN prices for 2018 are at the level they were in November 2017. This puts the RINs cost at more than 20% higher than for 2017.
Some believe that the ethanol RIN market cratered after President Trump’s election and appointment of investor and CVR Refining owner Carl Icahn. Carl Icahn fought for the end of RFS and even took a position with his own company in maintaining a deficit position for 2016, as allowed in the regulations for a maximum of one-year continuous period. By the second quarter of 2017, it was clear that the anti-Icahn pressure was having its effect and nothing substantial was changing with the RFS program. Mid-August, Icahn stepped down from his unpaid role. Icahn claimed that he did not want partisan bickering to cloud President Trump’s Administration. Icahn was also a proponent of moving the point of obligation which was just officially ended in late November as we noted earlier.
“Well if I Don’t Win, I’m a Gonna Break Even”
Merchant refineries have approximately 16% of the total RIN obligation yet they blend very little renewable fuels. Merchant refineries have to purchase RINs directly from the market to cover their obligation. They also experience RIN price risk if not hedging their bet and regularly purchasing RINs. Some merchant refineries, notably Andeavor and Marathon Petroleum, are making sizeable investments to reduce their RIN purchase obligations or passing the costs down the supply chain.
Merchant refinery RIN costs and a breakdown by company is shown in the figures below. In 2016, merchant refiners paid almost twice what they paid in 2015 for RIN expenses as shown in the figure below. 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. Though in 2016, compliance was due for years 2013 through 2015, we expect that most merchant refineries kept abreast of RIN purchases.
It will be interesting to see how the market reflects the obligation burden; and, in particular, the price of the 2018 RINs once the New Year rolls around. January RIN prices have changed dramatically the last four years as shown in the first figure in this article. January 2013 D6 RINs jumped from 5 cents to 30 cents in one month’s time. 2014 showed a change from 30 cents to 50 cents from the first week in January until the end of the first week in February. The month prior to January 2015 and January 2016 had the D6 RIN price increase. January 2017 had a D6 RIN price drop from 85 cents to 44 cents.
While the RIN costs showing up on refiner’s earnings statements appear extremely onerous, the realities of the market are that a large proportion of these costs are ultimately recovered through higher market prices for gasoline and diesel. A great deal of work has been performed by various analysts to demonstrate the extent to which RIN costs are passed onto consumers. We will delve deeper into this issue in next week’s blog with our own analysis of the matter.
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 (the 2018 Edition is scheduled to be released in early February 2018) 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.