By Andy Hill, Ryan Couture and Beth Hilbourn
While much of the world remains keenly focused on the price of crude oil, the refining industry is closely watching the price of Renewable Identification Numbers (RINs) go up. The program has been anything but smoothly operated since initial mandates first approached the 10% blend wall for ethanol in gasoline in 2013. RIN prices spiked in mid-2013 when the industry expected to hit the blend wall, prompting the EPA to acknowledge it would slow down Renewable Volume Obligation (RVO) growth. Difficulty in setting the new lower targets resulted in RVOs being set for 2014 and 2015 in November 2015, or as the old saying goes, closing the door after the horse has left the barn. As a result of all that uncertainty and due to the targets set for 2016, RIN prices have continued to climb. Since this time last year, RIN costs have increased from about 40 cents per gallon to nearly $1 per gallon. This growth is significant, and continues to place further pressure on U.S. refiners and ultimately consumers, as the cost of compliance gradually gets passed down. What exactly is this cost of compliance, and how might it impact the industry? Read on to find out.
Before diving into what has become a multi-billion dollar expense to the industry, it may help to offer some basics of the program for those not familiar with the EPA’s Renewable Fuel Standard (RFS) program. The RFS program requires a specific amount of renewable fuel to be blended into the gasoline and diesel pool for domestic consumption. The RIN is used to indicate the renewable fuel was added to the fuel for the transportation pool. The RIN is initially attached to unblended renewable fuel and is separated from the renewable fuel under certain conditions. Once separated from the renewable fuel, the RIN can be used by any obligated party to satisfy their RVO. Refiners, petroleum fuel importers and gasoline-blenders can produce and blend this ethanol themselves, or they can purchase RINs. An individual company’s RVO target is based on how much gasoline and motor vehicle, non-road, locomotive and marine (MVNRLM) diesel it produced.
Renewable fuel targets are issued by the EPA as RVOs. There are multiple categories of renewable fuels that each have RVOs issued for each year. The 2016 final requirements are detailed below:
- D3 – Cellulosic Biofuel – 0.230 billion gal;
- D4 – Biomass-based Diesel – 1.90 billion gal;
- D5 – Advanced Biofuel – 3.61 billion gal; and
- D6 – Renewable Fuel – 18.11 billion gal.
Not all RINs are created equal. It is important to note that the obligations are nested. The D6 obligation includes the advanced biofuel category, and the advanced biofuel category includes the cellulosic and biomass based diesel categories. Therefore, D3, D4 and D5 RINs are used to satisfy a portion of the D6 obligation. Theoretically, it would be possible to meet all of the obligations without any D6 RINs. However, practically, there is not currently enough D3, D4 or D5 RINs to satisfy the entire renewable fuel obligation. In addition, current year obligations can be met with as much as 20% of prior year RINs.
Figure 1 below shows the four general types of RIN categories and what they are comprised of so far in 2016 (through August). For example, corn ethanol comprises 97.2% of renewable fuel D6 RINs.
It is difficult to piece together a complete picture of refinery costs from company reports, presentations and filings. Also, each refinery portfolio, and therefore its RIN sensitivity, is different. There are three general categories of obligated parties, 1) a merchant refiner that sells all products at the refinery gate with no renewable fuel blending, 2) a refiner that blends renewable fuel into most of its transportation fuel at a refinery truck rack or downstream terminal, and 3) a refiner that owns renewable fuel production equal to a large percentage of its RIN obligation. Refineries with no renewable fuel production capability and who blend little renewable fuel are the most vulnerable to RIN costs. Refiners that own renewable fuel production facilities are the least impacted by the cost of RINs. Refiners that purchase and blend renewable fuel would be impacted as much as the merchant refinery if the renewable fuel price reflected the entire value of a RIN. For instance, if the market price for ethanol without RINs was equal to the price for ethanol with RINs attached minus the RIN value, the RIN cost to the renewable fuel blending refiner would be the same as the merchant refiner.
An oversimplification, but a way to quickly put a number on RIN costs is obtained by taking the 2016 industry total RVO of 18.11 billion gallons and multiplying it by a RIN cost of $0.82/ gallon (close to the average of the RIN costs in Table 1 below), to obtain $15 billion. The majority of the $15 billion will be paid by crude oil refiners, but gasoline blender refiners and importers will also share some of the burden. What is different in 2016 and causing such concern is the increase in the obligation which results in an increase in RIN cost. In 2015, we estimated total RIN expenses were just shy of $10 billion. In 2016, these RIN costs are expected to increase by more than 50% to the $15 billion value primarily due to increased price of RINs. If the EPA continues to increase the RIN obligation as expected, this expense will likely continue to increase as the system is stressed from breaching the ethanol in gasoline blend wall.
One other important factor in increasing RIN prices is the inventory of prior year RINs available for meeting the current year obligation. This inventory has been steadily decreasing since 2013. When this inventory is depleted, probably in 2017 or 2018, there will likely be another surge in RIN prices.
TM&C models crudes in regions across the world so that Platts can publish daily yield values. This daily yield incorporates product yields and their values, an example would be the average coking refiner in the USGC. Variable operating costs such as catalyst and chemicals, electricity and purchased fuel are subtracted out. Also subtracted are the current RIN costs per barrel of crude oil based upon the amount of gasoline and distillate transportation fuel produced. It incorporates maximum prior year RINs and nesting. Table 1 below shows how the RIN cost per barrel of WTI crude has varied. The RIN cost incorporates September 15 RIN pricing for the last five years. Figure 2 shows how current year RIN pricing has varied through this five-year time frame. Inherent is the fact that the final renewable fuel standards for 2014 and 2015 were issued essentially after the years were over as shown in Table 2.
To demonstrate the impact of rising RIN obligations and RIN pricing, assume a 200,000 barrel per day merchant refinery with 75% gasoline and diesel production. The cost of RINs in 2014 for that refinery would have been on the order of $105 million. The cost would have grown to almost $190 million in 2016. If the EPA continues to push the obligation higher and the prior year RIN inventory is depleted, the RIN cost will almost certainly increase dramatically. This will leave the public with higher and higher costs for transportation fuel. Also, as the additional costs become more significant, there should be more pressure to seriously consider if the current renewable fuel program is in the best interest of the country.
Finally, there has been a recent effort to shift the RIN obligation from the refiner down to the renewable fuel blender. In other words, instead of the refiners purchasing RINs from blenders, the renewable fuel blenders would have the obligation and would retire RINs directly. Even this seemingly simple change has different refiners as proponents and opponents of the change. The actual impact on the refining industry of such a change is unclear but assuming the total obligation remains the same, the consuming public will still feel the pain.
Turner, Mason & Company looks closely at developments in the regulatory arena, especially those associated with the RFS program. In our most recent Crude and Refined Products Outlook, we discussed the most recent changes to the RFS program, as well as provided a price forecast for various types of RINs. In addition, we look at other regulations such as pending changes to gasoline sulfur with Tier 3, benzene regulations, the Low Carbon Fuel Standard, and the impact of lower sulfur bunker fuel on the industry. For more questions on our products or for any specific consulting engagements, please feel free to send us an email or give us a call.