By Elizabeth Hilbourn and John Auers
Just as the The Rolling Stones sang about a need to get “shelter” from a world where war and everyday violence was closing in back in the late 60’s, U.S. refiners are seeking for ways to be sheltered from the growing and unpredictable costs of Renewal Fuels obligations in today’s world. And just as Mick and guest vocalist Merry Clayton echoed the feelings of helplessness which existed almost 50 years ago, refiners are experiencing those same feelings about an obligation over which they have limited control. While refiners have always contested the need for the Renewable Fuel Standards (RFS) program as a whole; more recently, they have taken a tack toward petitioning the EPA to modify the “point of obligation.” More specifically, they are making a case that the “obligated party” should change from the producers and importers of gasoline to the blenders or other downstream parties, which actually control the addition of ethanol to gasoline. About a month ago (November 9), the EPA provided an initial answer to the refiners by denying the petitions to move the point of obligation. This seemingly handed refiners another defeat in their attempts to get out from under the “yoke” of the RFS; however, the debate is not closed, as the EPA issued a request for comments on their denial, which commenced a 60-day comment period. When it becomes time for the industry comments to be reviewed after that period ends, there will be a new “Sheriff in Town,” who we just learned last week would be Scott Pruitt (assuming he is approved by Congress). While there are no indications which way Mr. Pruitt leans regarding this issue (he likely doesn’t know the answer himself at this point), it can be assumed he will take a fresh look at the petitions, with a decent chance that the EPA’s position could change, perhaps providing refiners the “shelter” they seek.
Background
The Energy Policy Act (2005) required EPA to implement a RFS program. The first program “RFS1” was effective September 1, 2007, and had a yearly renewable fuel volume goal. A yearly obligation was imposed on gasoline refiners and importers based on the amount of gasoline they produced. The currency was renewable identification numbers (RINs) which were generated by renewable fuel producers. Congress enacted a major overhaul under the Energy Independence and Security Act (Dec 2007), which led to “RFS2” in mid-2010. RFS2 was expanded to include diesel and renewable fuel mandates in four categories.
Refiners or importers purchase RINs from blenders if they don’t blend renewable fuel. A simplification of the current system is shown in the Example Lifecycle of a RIN in Figure 1. For the last couple of years, companies have petitioned the EPA to move the point of obligation from the refiner or importer to further downstream, such as the blender. Table 1 shows just some of the companies aligned either with changing the point of obligation or keeping it as is. One of the major proponents of moving the obligation downstream is Carl Icahn who indirectly controls CVR Refining. He posted in the opinion section of the Wall Street Journal on November 21, 2016, explaining how the EPA made the enormous mistake of regulating the wrong party. He cites fraud, incentivizing the wrong party and destruction of merchant refineries.
EPA Proposal to Deny Petitions Moving Point of Obligation
On November 9, 2016, the EPA opened a comment period for their proposed denial of changing the point of obligation. The EPA sites four main reasons as listed below:
- The current program structure appears to be working to achieve the goals of the RFS program;
- Changing the point of obligation in the RFS program is not expected to result in the increased production, distribution and use of renewable fuels;
- Changing the point of obligation would significantly increase the complexity of the RFS program; and
- Changing the point of obligation could cause significant market disruption.
If the obligation was to move to the rack, there is an internal revenue service report which reports the volumes for tax purposes; however, there is not an equivalent EPA report. There would need to be a way for the EPA to track the volumes so that they don’t lose accountability. They would need a system similar to the old diesel designate and track that was used as the low sulfur diesel was phased in to ultra-low sulfur diesel. Currently, any registered party can own a RIN. RIN owners are not limited to the companies which need them for their obligations like sulfur or benzene credit owners are.
Valero Corporation hired E&W Strategies to write a white paper to analyze the regulatory structure and related factors within the RFS that have significantly contributed to fraud within the renewable fuels sector. The paper dated September 4, 2016, uses the fraud argument to support changing the point of the obligation to the blender. They claim that the more direct the relationship is between the party responsible for compliance and the ability to comply, the lesser the chance for fraud and misconduct in the marketplace. The longer and more indirect the chain of custody of the RIN is, the greater the opportunity for criminal and market disruption; however, the blender usually only blends one type of renewable fuel, but will still have four different renewable volume obligations. The relationship between the blender and the renewable fuel producer loses its connection in this case. When the company size gets smaller, as would be the case for many terminal operators, it is possible they would not have compliance employees and that expertise could be difficult to pay.
There are arguments for moving the point of obligation and arguments for keeping it as is. Both sides argue that consumer demand for renewable fuel would increase or be kept at the highest levels possible if the obligation was where they want it to be. The RFA states, “The current point of obligation has worked; and if the RFS is properly enforced, the current program creates the right market tension to incentivize the entire supply chain to make investments in higher-ethanol blends.” The American Petroleum Institute claims that moving the point of obligation doesn’t solve the fundamental problems with the RFS program, namely the E10 blendwall. Several lawmakers expressed interest in repealing or reforming the RFS. With the 2013 through 2015 obligation timing off track and the 2017 set to be the first year since 2012 to be on track, with regard to both the announcement obligation timing, only time will tell if the EPA can set attainable standards that the marketplace can handle.
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 fuel refining. We include our independent analyses of these impacts in our semiannual Crude and Refined Products Outlook (the next version of which will be released in early 2017) and our various other studies. TM&C also assists clients involved in all aspects of transportation fuel production, blending activities, planning and compliance-monitoring. Please contact us for our views on the latest developments and their potential impacts, or if we can assist in any way or answer any questions.