By Elizabeth Hilbourn and John Auers
Developments, regarding the Renewable Fuel Standard (RFS) program, continue to make the news with EPA’s release of the proposed 2018 requirements last week. For the first time in the history of the RFS the proposed Renewable Volume Obligation (RVO) went down (however slightly) and this was greeted with some guarded optimism by the refining industry; however, RFS issues and uncertainties continue to be a challenge for refiners, as we detailed in last week’s blog, “Riders on the Storm.“ The ethanol “blend wall,” which limits the amount of ethanol that can be absorbed by the market in an E10 world, has certainly been among the major concerns. But less noticed, and potentially also troublesome, is the prospect that biodiesel, which is used to generate D4 RINs, has been increasing and might also be approaching a soft limit. In today’s blog, we channel another Doors song, “Roadhouse Blues,” to explore this subject and some others as refiners find that “Yeah, keep your eyes on the road, your hand upon the wheel” to be able to navigate the RFS waters.
“You gotta roll, roll, roll”
Renewable fuel imports have become a significant component of the total amount of D4 RINs generated in recent years. They amounted to 29% of the total D4 RINs generated in 2016 and are at 28% of the 2017 year-to-date volume. The imported volumes have been very seasonal, with the second half of the year (especially December) being particularly high (and January especially low). In fact, biodiesel imported in that July through December period have averaged 73% of the annual total for the last five years. The vast majority of these biodiesel imports come from Argentina where seasons are opposite to those in the Northern Hemisphere. After the soybeans are grown and harvested, they are trucked or railed to a mill where they are processed into soybean oil and then the soybean oil is transported to the biodiesel plant before taking the long ocean-going vessel journey north to the U.S. December 2016 was the record biodiesel importing month at 86 MBPD, while January 2017 only had 8 MBPD biodiesel imports. Considering that the monthly average renewable fuel volume for D4 RIN generation was 174 MBPD and for all RINs generated (D3,D4,D5,D6,D7) was 1,170 MBPD in 2016, the December biodiesel import level of 86 MBPD was a substantial contributor.
Figure 1 shows the renewable fuel imports over the last few years. Biodiesel imports have grown significantly in the last three years and most especially in 2016, becoming very important for both the D4 and D5 categories. In 2016, biodiesel and renewable diesel imports together accounted for 29% of D4 RIN generations and ethanol imports accounted for 35% of D5 RIN generations. 
The biodiesel tax credit allows blenders of biodiesel and renewable diesel to claim a credit of $1 per gallon against their U.S. federal tax liability. The U.S. Congress allowed the biodiesel tax credit to expire at the end of 2009, 2011, 2013 and 2016. In each of the four years where the credit expired it was eventually reinstated retroactively near the end of December each year or in early January of the following year. The biodiesel tax credit has not been reinstated for 2017. There has been a push by the domestic biodiesel producers to not allow the tax credit for biodiesel and renewable diesel imports. If this were to happen, there would be a significant impact on RIN prices since biodiesel and renewable diesel imports make up a significant portion of D4 RIN generation, 29% in 2016. Also, in 2016, D4 RIN generations accounted for 21% of all RIN generations after accounting for retirements other than annual compliance.
“You gotta beep a gunk a chucha”
Obligated parties are allowed to have a RVO deficit in a fuel category for only one year in a row. Since RVO deficits must be satisfied in subsequent years, the levels would have an effect on RIN prices. Figure 2 shows that RVO deficit levels for all years of RFS2 have been insignificant. In fact, the total 2016 RVO deficit amounts to only 0.1% of the 2017 obligation. 
”The future’s uncertain, and the end is always near”
A flexibility in the renewable fuel program is the allowance of prior year RINs. Up to 20% prior year RINs can be used by an obligated party or a renewable fuel exporter to fulfill a current year obligation. Figure 3 shows prior year RIN carryover. Prior year RIN carryover into 2017 is fairly high at just under 2.5 billion RIN-gallons or 12.5% of the anticipated 2017 obligation. Also, at 0.8 billion RIN-gallons, there is a pretty healthy D4 carryover into 2017. The prior year D4 RIN carryover into 2017 is the highest of any year.
“Thrill my soul”
Figure 4 shows EPA estimated and actual neat gasoline and diesel transportation fuel levels. EPA estimated what was projected and published in the final rule publication. Actual is what was actually reported by obligated parties, both importers and refiners. Note that the obligated parties report a total gasoline and diesel production and do not split out the diesel or gasoline components. As mentioned previously, reprojecting 2017 gasoline and diesel transportation fuel volumes is difficult, if not impossible, with EIA data. These volumes along with the renewable fuel category percentages dictate total RIN requirements. One could hypothetically determine RIN shortages or surpluses with this information. 
”Ashen lady, Ashen lady”
Though the actual gasoline and diesel split is not important for reporting, it is important for determining the type and quantity of RINs that can be generated, and therefore, RIN prices. Consider an extreme case where much more gasoline is consumed than diesel; however, the total volume is the same as the estimated obligation at the time when the 2017 renewable fuel standard was set. If more gasoline is consumed, then more ethanol can be blended up to the blend wall; however, the same number of D6 RINs are required to be retired for compliance since 8.147% of the gasoline and diesel production is required to be retired as D6 RINs assuming no cellulosic biofuel waiver credits purchased and therefore, full nesting (10.70%-2.38%-0.173%). Extra 2017 D6 RINs cannot be nested into another renewable fuel category and any excess can only be carried over to 2018. This would directionally increase the D4/D6 RIN spread. Since less diesel would be produced, but the same number of advanced biofuel and biomass-based diesel RINs would be required to be generated, the % of biodiesel in diesel would increase, potentially hitting the soft 5% limit.
Consider the opposite case where much more diesel is consumed than gasoline; however, the total volume is the same as the estimated obligation at the time when the 2017 renewable fuel standard was set. If less gasoline is consumed, then less ethanol can be blended up to the blend wall; however, the same number of D6 RINs are required to be retired for compliance since 8.147% of the gasoline and diesel production is required to be retired as D6 RINs assuming no cellulosic biofuel waiver credits purchased and therefore, full nesting (10.70%-2.38%-0.173%). The D6 shortage would need to be made up with nested D4 RINs if there are not enough prior year D6 RINs to fulfill the shortfall. This would directionally decrease the D4/D6 RIN spread.
The 2017 renewable fuel standards are aggressive in all renewable fuel categories and are based on projected gasoline and diesel production rates. The vast majority of renewable fuels are blended into diesel or gasoline, but there are limits as to how much renewable fuel can be blended into transportation fuel. Changes in the gasoline to diesel ratio will affect the RIN balance and can affect RIN prices. Though this dynamic exists, it is not significant since small changes can be absorbed with the prior year RIN carryover option. The EPA also reviews all the data before setting the following year obligation and their recently proposed 2018 standards seem to recognize and reflect market limits better than in past years.
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 (scheduled to be released in early August) and our various other studies. The OUTLOOK will include a forecast of RIN prices and a discussion of the assumptions which underlie that forecast. 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.