By John Mayes and John Auers
Government programs can often be very confusing and arbitrary and what’s worse, they can sometimes change at the whim of policymakers. For refiners, there is perhaps no rule which has exemplified these qualities more than the Renewable Fuel Standard (RFS). The program, created by the Energy Policy Act of 2005 and expanded by the Energy Independence and Security Act of 2007, was initially intended to bolster U.S. energy security but has since evolved into a tangled web of divergent objectives pushed by numerous special interest groups. It has also become a huge and unpredictable cost burden on refiners, particularly those with limited downstream ethanol blending capabilities. Recently, indecision on potential changes to the rules has come into play. The new Trump Administration is reportedly examining the entire RFS program as part of its broader effort to reduce unneeded governmental regulations and stimulate economic growth, and Congress is proposing its own changes to the program. We are also beginning to see some serious infighting among various interest groups. All this uncertainty is roiling the Renewable Identification Number (RIN) markets, with D6 RIN prices falling by 2/3rds since hitting a post-election peak in December. As we discuss this issue in today’s blog, the words sung by Mick Jones of The Clash come to mind as a variety of groups on both sides of the issue are asking, “Should I(t) Stay or Should I(t) Go Now?”
The original objective of the RFS program (when it was first conceived) was to stimulate the production of renewable fuels (primarily ethanol) to reduce U.S. dependence on foreign oil. This objective had greater clarity in 2006 when U.S. dependence on imported petroleum had reached the staggering level of over 60% of domestic requirements and seemed to be doomed to ever decrease; however, the introduction and expansion of improved drilling and production technologies, especially fracking and horizontal drilling, has significantly changed the situation. U.S. oil production has risen from only five million BPD in 2008 to around nine million BPD today. In December 2016, U.S. dependence on foreign oil declined to about 22%. While growth in alternate fuels and declines in U.S. consumption levels have certainly assisted in this decline, the dominant change has been the dramatic turnaround in domestic oil production.
This change in the fundamental driving forces behind the RFS program is contributing to the current level of discussion as to its future. The mechanics of the program however, have recently become as important as the program objectives.
“One Day is Fine and the Next is Black”
When a gallon of ethanol is shipped from a production facility, a RIN is produced. This RIN has value and is theoretically included in the price of the gallon of ethanol when it is sold by the ethanol producer. When the ethanol is purchased by a marketer for instance, and blended into gasoline, the RIN is separated and can be sold. Gasoline (generally in the form of CBOB and RBOB) refiners and importers buy the RINs in order to meet their Renewable Volume Obligation (RVO) which is set by the EPA in its role of administering the RFS program. By congressional fiat, the refiner/blender/importer funds the program which is often described as the point of obligation. In this manner, transportation fuels producers (refiners, blenders and importers) are providing the capital to expand the nation’s renewable fuels supply.
The financial burden of the RFS program to refiners is significant. Assuming a RIN cost of 80 cents (the 2016 average was 82.4 cents), a typical 200 MBPD refinery that purchased all of its RINs from a third party would incur a RIN obligation of around $190-$200 million per year.
There has also been substantial volatility in the price of RINs in recent years. Both policy and market forces impact the volatility at different times; however, recent volatility is more of a result of rumored policy actions rather than market forces (ethanol supply/demand, etc.).
“It’s Always Tease, Tease, Tease”
After peaking on December 2, 2016, at over 107 cents, D6 RIN prices have plummeted, falling to below 34 cents last week. The dramatic decrease results from numerous indications or predictions that RFS requirements could be relaxed or done away with entirely. For one, President Trump has stated a strong desire to eliminate burdensome regulations and apparently some have concluded this could include the RFS program. Congress has also recently weighed into the issue with a House bill, called the RFS Reform Act. This bill would cap ethanol that can be added to gasoline at 10% and limit targets for cellulosic biofuels at levels actually produced by the industry. Ethanol, however, still carries some political clout with legislators and a competing bill has been introduced in the House which would allow gasoline containing 15% ethanol (E15) to be sold year round by giving it the same summertime Reid Vapor Pressure (RVP) waiver as E10 currently enjoys.
A recent side debate has also risen to prominence in regard to changing the point of obligation (POG). In 2016, the EPA was asked by several refiners to consider changing the POG downstream of the refinery to the location where the actual blending of ethanol into gasoline takes place. This would shift the RVO obligation to marketers instead of refiners. Along with the financial obligation, the substantial accounting and oversight requirements associated with the POG would presumably also move downstream. While the Obama Administration EPA proposed rejection of the request to move the POG, Trumps EPA has not issued an official decision (or even tweeted an unofficial position); however, speculation on a shift in the POG arose again last week. Press reports indicate that White House special adviser and majority owner of CVR Energy, Carl Icahn, negotiated an agreement with the Renewable Fuels Association (RFA) to support changing the POG in exchange for the summertime RVP waiver on E15. Reportedly, this agreement was presented to the White House for short-term executive action. Almost immediately however, the White House firmly denied that any such executive order was in the works and subsequently the EPA stated it was not involved in the White House discussions.
“If I Go There Will be Trouble”
Although we don’t know for sure what is going on behind closed doors in this debate, we do know that an apparently formerly united ethanol and biofuels lobby is suddenly splintering. A number of groups allied to RFA have come out strongly in opposition to the RFA/Icahn deal. Fuels America, a group of corn growers and ethanol producers, has severed its ties to the RFA, and Growth Energy, a competing trade group, reiterated its strong opposition to changing the POG. Two of the largest state organizations, the Iowa and Illinois RFA, have also stated they continue to oppose any efforts to change the law. Many biofuels industry participants believe RFA’s dramatic change in their stance on this issue stems from the November action of the renewable fuels unit of Valero becoming a member of the RFA. Valero, the nation’s largest independent refiner, has been a leading force in the effort to move the POG downstream. It should be noted that the oil industry is not totally united on the POG issue either. The main refiners’ trade group, the American Fuel and Petrochemical Manufacturers (AFPM), is a strong advocate for moving the POG and filed a petition with the EPA last summer requesting this. The trade group which represents the entire oil industry, the American Petroleum Institute (API), has taken the position that the POG debate is a distraction from the larger issue of abolishing the RFS (a position the AFPM also favors), and has stated they favor rejection of the POG movement.
“So If You Want Me Off Your Back”
The POG brouhaha has not been the only rumor circulating in recent months. Another has been that the EPA is expected to revise the already announced 2017 RVO downward. This would likely create the perception that the current production of RINs is in surplus to requirements, and RIN prices would then likely decline. A sharp drop in RIN prices would essentially eliminate the most onerous effects of the RFS program without the political turmoil and economic upheavals associated with canceling the entire RFS program or changing the POG. A sharp decline in RIN prices would likely cause the POG discussion to evaporate.
While the outcome of this debate remains uncertain, volatility in RIN prices is all but guaranteed until a final resolution is achieved. The expectation of decisive, and as of yet, undetermined action has only heightened both inter- and intra-industry tensions as numerous groups await final policy decisions by the Trump Administration with resulting EPA regulatory revisions and/or potential legislative actions by Congress.
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 latest version of which we released last month) 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.