Volatility has returned to America’s RIN market, with court decisions adding some unexpected shorts to a constrained marketplace.
Argus VP of North America Refined Products, John Demopoulos, and Argus Senior Reporter Elliott Blackburn take a deep dive on RFS; looking at what it is, where we are and what’s to come.
Related links:Argus Americas Biofuels
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John: Welcome to a new podcast series called "Driving Discussions." We're gonna be discussing all of the forces that affect road fuels globally. This episode is gonna focus on the U.S. renewable fuel standard. "Driving Discussions" is brought to you by Argus Media, which as many of you know, is a leading independent provider of energy and commodity pricing information. My name is John Demopoulos, and I'm the vice president of North American refined products here at Argus.
Elliott: And I'm Elliott Blackburn. I'm a senior report for downstream and fuels.
John: Elliott, thank you very much for being with us.
Elliott: Yeah, great.
John: Elliott, you and I have talked about the RFS, the renewable fuel standard, plenty. And I think it might be worth us just going through real quick what the RFS is, what RINs are, how this whole program functions. I mean, can you give us a sense for how all of this works?
Elliott: Sure. The renewable fuel standard has been in place for over a decade. And this is a program that requires refiners and importers and certain other companies to ensure each year that a minimum volume of renewables blends into the gasoline and diesel that they add to the U.S. fuel supply. EPA goes through a process every year where they set that number. It's argued about through the summer, and then it gets set usually in the fall. And these companies then shoot for that target the very next year. It's a really important program for biofuels community, particularly ethanol and also biodiesel producers in the U.S. and abroad. Because it basically creates a market for blending that fuel into the U.S.
John: So, now, how do companies demonstrate that they have actually fulfilled their mandate for biofuels blending? This is where RINs come in. Right?
Elliott: Sure. Yeah. The way that you track that is through a number called a renewable identification number. And this is a credit that's associated with every single gallon of ethanol or biodiesel or other fuel that's valid under the program. And this is separated when companies blend this into the U.S. fuel supply, so it becomes a tradeable credit that demonstrates that, oh, we added this gallon of fuel into the supply. Refiners can either sell these. They buy these to show their compliance, and they have to acquire enough of them to meet their mark for the, you know, given compliance year.
John: Right. So, if I'm a refiner, every time I produce a gallon of gasoline or diesel, I incur this RIN debt, I suppose. I incur the obligation to turn in a certain number of RINs to the EPA at the end of the compliance period.
Elliott: Right. If that fuel goes into the U.S. fuel supply — and we'll talk about that later — there is an alternative that has come up and been a bigger deal over the past three years. And that is a waiver program for small refineries. These are refineries that process 75,000 barrels a day of crude or less, and show can show the EPA that the program creates a hardship. These exemptions were fairly rare in the past, but they've been used much, much more in the present Donald Trump's administration. And it's helped drive a lot of volatility in the market for these credits over the past few years.
John: Got you. And of course, we at Argus have market prices that we have set for all of these RINs all the way from the ethanol down to the cellulosic. Now, I think that the matter that we've been dealing with recently, as you said earlier, is this volatility in the RIN market. Prices seeming to go up and down and all directions almost daily. Just give us a sense for what's behind that, what's driving these big price moves in the RIN market.
Elliott: Sure. So, the biggest driver of price changes under the current administration has been how the administration uses special waivers of the program for small refineries. And the controversy here is that because those refineries can receive exemptions, the administration kind of in the interest of some would say fairness, some would say an attack on the biofuels industry, does not make those obligations transfer over to bigger refiners.
What that means is that means that waivers given to these small refiners effectively reduce the whole national standard or minimum volume for a given year. And so, these, as you can imagine, are very controversial to the biofuels industry and very frustrating for them because it effectively reduces the demand for their product.
John: So, if I'm a small refiner, I don't have to turn in any RINs at all to the EPA at the end of a given compliance period.
Elliott: Yeah. I mean, the compliance is a little tricky. If I'm a small refiner, I don't know for sure that I'm going to receive these exemptions even under the Trump administration. So, I probably am still buying or collecting these credits over the course of the year, but what it does mean is that once I get that waiver after the fact, I suddenly have credits that I can sell.
John: Wow. That's a real windfall.
Elliott: Absolutely. I mean it's...it means that I can make up for whatever cost that I had that arguably were a burden under the program. I can go and kind of make myself whole after the fact. Again, the way that it's administered is really confusing and frustrating if you're not a small refiner that knows that you're getting this exemption. So, it causes... For the last few years, it's caused a lot of uncertainty. In the spring, we see a lot of volatility mostly in the downward direction.
What we're seeing this year in 2019 is something different. There's a very key court case that came out in January that said that the way the EPA was administering these was wrong. They said that... And the interpretation from the court would dramatically reduce the number of waivers that are out there. And something to keep in mind is that under the Trump administration, these waivers have really spiked. EPA waived almost as much as 10% of the 2017 regulations through these waivers. And now, we're talking about slashing that, which means that they're not going to be waiving as much which means that the minimum blending level should, in theory, start creeping back higher to where EPA has said they were supposed to be.
John: So, does this mean, Elliott, that we're really going back to the status quo prior to the existing administration? Are we talking about now having...you know, going back to the same number of small refiner exemptions that we had before that administration, or are we going further than that?
Elliott: Well, look. This is a very complicated program that's had a very troubled history under multiple administrations. It's hard to say what a status quo is for the RFS. The safe kind of conservative answer to give you is that it does look like the administration is moving back towards a regime of fewer exemptions being allowed as a matter of this court case. And that's going to mean effectively that they're going to...that refiners and importers are going to have higher numbers to hit, going forward.
John: Yeah. I suppose if we... I mean, I do wanna talk a bit more about the politics of that. But if we take that down to the level of road fuel pricing even sort of pump level pricing, I suppose we're talking about a knock-on impact on gasoline and diesel prices right now.
Elliott: There should be, yeah. I mean, the argument all along has been...one of the arguments all along has been that these are costs that are passed through straight through the consumer. So, if compliance with this program goes up, the refiners, the retailers are going to pass those costs on to the consumer. Sometimes, that works out as a discount. Sometimes that works out as a premium. It's really difficult to say how exactly that lands for a driver at the pump. But what is known is that right now, credit prices associated with this program for refiners, for importers, and for folks trading in the RINs, those prices are definitely going one direction and that's up.
John: Yup. So, let's just think again about policy. So, we've got these small refiner exemptions being canceled. We have small refineries which were previously getting, as you said, a windfall by the end of the compliance period, where suddenly they were potentially able to sell off all of the RINs that they had accumulated over that time. For some of them, that windfall is now going away. Are we going to see more of this, or do we expect to see more court cases, more cancelations, the number of exemptions continuing to drop?
Elliott: Look. The one thing you can absolutely count on with the RFS is for there to be more lawsuits. No matter happens either direction at the end of the day, the EPA is going to get sued. So, you can absolutely count on that.
Some of the other things that we can expect... I mean, this is an issue that I don't think the Trump administration really appreciated how complicated and tricky it was going to be for them when they got into it. I think, early on, they saw this as a quick win to just go ahead and satisfy the small refiners and the refining industry in general by giving them some lower credit prices through the use of this waiver program. They maybe didn't appreciate how furious this was going to make corn farmers, some soybean farmers, and the biofuels industry, you know, rural ag economy at large. This has been an issue that has dogged the Trump administration for two years. Arguably, it brought down the first EPA administrator Scott Pruitt, and has definitely not given any respite to the current EPA administrator Andrew Wheeler.
This is an issue that even after the biofuels industry got a win out of the Trump administration through last summer's introduction of year-round sales, of higher ethanol blends of gasoline, while they were on the stage with Trump, they brought it up again. And so, this dogged the Trump administration again all summer and culminated in a complicated rule setting process for the minimum volumes that we had coming into this year. And then the court case just kind of blew that up again in January.
So, this has been a very tricky issue for the Trump administration, and it's because it pits two camps that would...that the Trump administration at least would like to have be very solid basis for the Trump campaign. One is rural voters and ag voters and farmers, particularly corn and soybean. And the other is the manufacturing base that he wants, which is gonna be refinery workers, you know, unions that are in swing states, and manufacturing bases that, you know, this is relief that was going to them and support that he wants.
John: They can't both win, right? It's almost one against the other, a zero-sum game — more profits for one means, you know, fewer profits for the other. Is that the right way of thinking about it?
Elliott: Right. President Trump over and over again has talked about seeking a win-win on this issue. And it's just not clear what that could possibly be. It really seems like a zero-sum game.
John: More gasoline sales. That's the only win-win.
Elliott: Could be.
John: Now, do we then... You know, we can see that this is impacting...clearly, it's impacting the D6 ethanol RIN, so the RIN that one is able to detach when one blends ethanol into gasoline. Are we seeing the RINs impacted by this kind of period of volatility as well? Is it everything at once?
Elliott: Well, I mean, there's a lot of moving pieces going on. So, yes. Right now, the RIN that's associated with blending ethanol into gasoline is climbing. And that's partly because the U.S. has never actually filled the maximum amount of ethanol that is allowed to be blended into gasoline under this program. We've always kind of fallen short just because the gasoline demand isn't there and there's some other complicated reasons for that. But ethanol RINs are absolutely climbing.
There's another RIN that's associated with biodiesel blending that's often used as kind of a supplement. It's required, but it's also used to kinda pad out demand in other areas under this program. That is being affected by a tax program that was extended belatedly late last year. That's the blender's tax credit. So, it has some other dynamics going on right now that are not making it necessarily as responsive, just purely responsive to this court case.
What we can say very simply, though, is that the Argus-assessed cost per gallon of complying with this program for refiners is absolutely marching up.
John: Where are we now? What's the price that we have?
Elliott: What we're sitting here in late February is it's climbed well above 5 cents per gallon, which is the highest it's been in almost two years.
John: Yeah. That's higher than the tier 3 sulfur costs for the average barrel from last year. So, that's a good number to add into the overall cost.
Elliott: Sure. And a thing to remember is that when refiners have dealt with this before when we very high compliance costs when it was programmed, there were two tracks that they tried to do back in 2013 to deal with it. One was to make way more jet fuel, which does not incur any kind of obligation under the program. The other was to export because fuel that's not consumed in the U.S. doesn't need to jump through these compliance hurdles.
This year with the coronavirus and the deep slash in global travel, jet fuel is not a good play. So, what we could though see is depending on, again, how the global economy is doing and what kinda fuel demand we see in Latin America and other traditional places with the U.S. exports, we could see as that cost per gallon climbs for domestic use, and as you point out, you've got sulfur credits. You've got other costs associated with different regulatory programs for the U.S. market. Certainly, there's gonna be an incentive for at least some refiners who can to place those barrels overseas and get away from those costs.
John: Yeah. Now, just before we close, give us some perspective. You know, this isn't RIN-sanity, is it? We're not back at those very high levels that we had when, you know, I guess five or six years ago, maybe more than that, we felt like we were close to hitting this theoretical blend wall where we simply couldn't blend enough biofuels into the road fuel pool to generate the RINs that were gonna be required by this program. You know, you remember we did see very high prices. We're not really there, are we?
Elliott: No. I mean, right. We're talking about...you're talking about a situation five years ago when everyone realized that the law required way more ethanol than could possibly be blended in at the time. We were talking prices then. I mean, today, we're talking about prices in the 30-cent range, 40-cent range, which is very high for what we've seen in recent history. Back then, prices were peaking above $1.50. So, we're definitely not there and certainly not suggesting we're going to be there. But, you know, prices are on the march. And refiners are savvier since then, and they have more tools in which to deal with. So, the responses may be more subtle.
John: Excellent. And I can certainly draw everyone's attention to the various indexes that Argus has for these RIN prices, renewable volume obligation, LCFS credits which I know we'll talk about another time, and even the tier 3 sulfur credits. So, with that, thank you, Elliott.
If you enjoyed this podcast, please do be sure to tune in for the other episodes in this series, "Driving Discussions." If you want more information about U.S. refined product market, you can look at Argus U.S. Products and Argus Americas Biofuels. And of course, we have two conferences coming up focused on refined products, Argus Global Gasoline in Amsterdam and Argus Clean Product Exports in Miami. So, check out argusmedia.com for more details. Thank you very much for listening.