By: Tom Hogan and John Auers
For all of the folks waiting with bated breath for the renewable fuel standards that were supposed to be set one to two years ago, they have arrived! While they are not earth- shattering, they have been seen by both the petroleum industry and the renewable fuel producers as significantly less than optimum. This sounds like a bit of deja-vu all over again. What does this final rule mean for refiners? Read on to find out.
The final rule was announced by the EPA on the afternoon of November 30, 2015, the last possible day allowed by the consent decree requiring the EPA to set the standards. The final rule generally followed the pattern set in the proposed rule with total renewable fuel increasing 0.35, 0.63 and 0.71 billion gallons in 2014, 2015 and 2016, respectively. These are relatively small changes from the June 10, 2015 proposed levels which portend a potentially large problem. Some important points are listed below:
- The 2014 and 2015 obligations appear to be set higher than the actual/projected RINs available. The only way to meet these shortfalls is to reduce the RIN inventory;
- The 2016 obligation appears to be set at a level where gasoline would need to contain on the order of 10.8 volume percent ethanol. The only way to achieve those levels would be to increase E15 or E85 sales;
- The 2016 problem could also be solved by higher biodiesel/renewable diesel usage; however, it seems unlikely that higher volumes of diesel alternatives could be manufactured on such short notice;
- The prior year, RIN carryover from 2013 appears to be about 3.3 billion RIN-gallons; and
- Assuming the 2014, 2015 and 2016 shortfalls are all met by drawing down RIN inventory, the balance is shown in the table below:
Image may be NSFW.
Clik here to view.
The 2016 inventory draw is similar to what was expected in 2014 and which resulted in the two-year delay in setting an RVO. It also resulted in very high RIN prices which were only alleviated when the EPA suggested that they were going to recognize the ethanol blendwall and reduce the obligation.
Since 2016 is upon us, it is unlikely that the E15 and E85 markets, or the amount of other biofuel volumes blended, can be increased enough to eliminate the inventory drawdown. It is likely that RIN prices will increase significantly in 2016, which could again precipitate action by the EPA to modify the program.
Refiners must choose between purchasing RINs today to assure a maximum RIN carryover from year-to-year in anticipation that these RINs will be cheaper than buying future RINs, or delaying purchase of more expensive RINs on the hope the EPA will again intervene if the RIN prices become more expensive than the EPA desires. The refiner’s risk is either high-cost RINs that lose their value if EPA modifies the program, or even higher-cost RINs if the refiner does not prepurchase RINs and the program stays as currently promulgated.
The Obligation
Image may be NSFW.
Clik here to view.
The final renewable volumes are generally significantly less than the volumes in the legislation as shown below:
Image may be NSFW.
Clik here to view.
The actual cellulosic requirement is the primary change from the Clean Air Act obligation. Cellulosic biofuel cannot currently be produced in large volumes economically. The reduction in the cellulosic biofuel obligation rippled through the other categories because the obligations are “stacked.” That is, the cellulosic biofuel and the biomass-based diesel are included in the advanced biofuel and the advanced is included in the renewable fuel. The shortfall of cellulosic biofuel has been recognized in the program from the outset and the obligations have been set accordingly. What is different in the final rule is that in the early years of the program, when the cellulosic availability did not meet the Clean Air Act volume, the EPA did not reduce the advanced or renewable volumes to reflect the lower cellulosic obligation. The petroleum industry challenged this interpretation in court and the EPA’s interpretation prevailed. The 2016 obligation is the first prospective obligation that has been set less than the Clean Air Act obligations.
Although the EPA sets a target volume, the regulatory requirement is translated into a percentage and the percentage requirements become the actual standards for the regulated parties. Therefore, if the actual volumes of gasoline and diesel produced or imported are greater or less than the gasoline and diesel assumed by the EPA in setting the percentages, the volume of renewable fuel added to the transportation pool will be more or less than the volumes shown above.
Image may be NSFW.
Clik here to view.
After three tables, that is a lot of numbers. What do they all mean?
How to Comply
The first question is how to comply. For 2014 and 2015, the answer is essentially set since all but one month of activity is complete. Compliance for 2014 and 2015 will be made through retiring RINs generated in the two years, plus RINs from 2013 that can be used for up to 20% of the 2014 obligation. RINs generated from the production or importation of renewable fuel in 2014 and 2015 are shown below.
Image may be NSFW.
Clik here to view.
The shortfalls in 2014 and 2015 are about 0.31 and 0.53 billion RIN-gallons, respectively. This shortfall could be made up by using prior year RINs. The program allows up to 20% of the current year obligation to be met with prior year RINs. Typically, there have been enough RINs unused in any given year to satisfy 20% of the next year’s obligation. RINs can only be carried over for one year and therefore if enough RINs are not generated in a specific year, prior year RINs can make up the deficit, but there will be less than 20% of the next year’s obligation carried over. Therefore, if the shortfalls in 2014 and 2015 are made up by prior year RINs, the carryover into 2016 will depend on the 2013 through 2015 RIN carryover. The RIN carryover is described below:
2013 carryover into 2014 = 2013 obligation X 20% or about 3.31 billion RINs (16.55 X 0.20)
The 2014 obligation that can be met by 2013 RINs is 3.31 billion gallons. Since the 2014 obligation is 16.28, the total 2014 available to carryover to 2015 is about 3 billion gallons (3.31-(16.28-15.97)).
The 2015 obligation that can be met by 2014 RINs is 3 billion gallons. Since the 2015 obligation is 16.93, the total 2015 available to carryover to 2016 is about 2.47 billion gallons (3-(16.93-16.40)) which is only about 13.6% of the 2016 obligation.
Once the RIN inventory is used up, the renewable fuel obligation will need to be met by current RIN generation.
What Happens to RIN Prices?
At the beginning of the renewable fuel program, RIN pricing began with an abundant surplus of RINs and very low RIN prices of a few cents per RIN-gallon. RIN prices spiked in early 2013 when people realized that if the program were not modified, it would be very difficult to obtain enough RINs to meet the demand. The RIN prices eased when the EPA indicated that at least for then, it recognized the gasoline blend wall and intended to reduce the obligations.
The final rule is likely to push RIN prices higher as the RIN inventory decreases. Neither the 2014, 2015 nor the 2016 obligations are likely to leave the petroleum industry with an insolvable obligation since the RIN inventory can cover any shortfall; however, without knowing what the obligation might be for 2017 and beyond, the industry is likely to assume the worst and RIN prices could again increase. Indeed, the ethanol RIN market price increased by a little less than 100% on the first two days after the final rule was announced.
Conclusions
The renewable fuel obligations set by the final rule are not likely to disrupt transportation fuels in the United States. It is likely that the price of RINs will increase, but they are not likely to skyrocket in the near future. It appears that some of the obligation will need to be met by reducing the prior year RIN inventory. If the prior year RIN inventory falls significantly, it is likely we will see RIN prices as high as, or higher than, those seen in early 2013, over $1.00 per RIN gallon.
Politics will continue to be a consideration in the renewable fuel program. The final rule for 2017 does not need to be set until November 2017, after the presidential elections. As a result, it is unlikely that the administration will allow the program to significantly impact the supply or pricing of transportation fuels before the election.
A section on regulatory initiatives will be included in our 2016 Crude and Refined Products Outlook, scheduled to be issued in early February. Also included in this report will be detailed forecasts of supply, demand and prices for refined products, both in the U.S. and throughout the world. The impacts alternate fuels have on the refined products markets will be incorporated into the forecasts. We also use this analysis, which we update on a regular basis in our other industry studies and work products. For more details about any of our publications, studies or other TM&C services, please visit our website, send us an email or give us a call.