Is the U.S. Renewable Fuel Standard in Danger of Going Over a RIN Cliff?

by Maria Gerveni and Scott Irwin (University of Illinois) and Todd Hubbs (U.S. Department of Agriculture) (farmdocdaily) ... What has received far less attention is what happens when the supply of biofuel exceeds the mandate. Given the scale of the renewable diesel boom in recent years (farmdoc daily, April 12, 2023), this is a potentially important question. The purpose of this article is to analyze the market implications of biofuel supply greater than the RFS mandate, or what we term the “RIN cliff.” This is the 12th in a series of farmdoc daily articles on the renewable diesel boom (see the complete list of articles here).

Analysis

We begin the analysis by reviewing the discussion in our previous farmdoc daily article (May 24, 2023) about the difference between binding and non-binding biofuel mandates.

Technically, D4 RINs are “biomass-based diesel” RINs that potentially represent a variety of biofuels, including FAME (fatty acid methyl ester) biodiesel, renewable diesel, and renewable heating oil. A common industry shorthand is to refer to D4 RINs as biodiesel RINs, and we follow that terminology here. Several observations are noteworthy. First, all three RIN prices generally have exceeded $0.50 per gallon, except for D6 prices before 2013 and a brief period during late 2017 through early 2020. This is clear evidence that the RFS mandate for each category of biofuels has been economically binding almost the entire time since 2013. Second, prices for all three RINs have been at or above $1.50 per gallon for most of 2022 and 2023, historically very high levels. This reinforces the previous point that the RFS mandates have been highly binding in recent years. Third, D5 and D6 RINs have generally tracked D4 RIN prices since 2013. This makes sense because biomass-based diesel has tended to be the “marginal” gallon for filling the biomass-based diesel, undifferentiated advanced, and conventional mandates for most of the history of the RFS (e.g., farmdoc daily, July 19, 2017).

The key is that production of BBD overshoots the mandated quantity for some exogenous reason, with the result that Q^RC > Q^M. The implications for biodiesel and RIN prices are dramatic. Since production exceeds the mandate, the market price of biodiesel is given by the intersection of demand with the tax credit and the RIN cliff quantity, Q^RC, which is the effective supply curve in this scenario. Consequently, the market equilibrium biodiesel price falls to $3.11 per gallon, $2.42 less than the market price when production is at the mandate level. To put this in perspective, the predicted biodiesel price drop is 44 percent. The most dramatic prediction is that the D4 biodiesel RIN price falls to zero, because no additional incentive beyond the market price of $3.11 is needed to incentivize BBD production. The D4 RIN price literally falls off a cliff. Basically, the BBD mandate becomes non-binding due to the exogenous overshooting of production.

First, the decline in RIN prices would not be limited to D4 biodiesel RINs. Because BBD plays the role of the marginal gallon for filling the advanced undifferentiated and conventional mandates, the price of D5 and D6 RINs would also fall off a cliff. It is not out of the question that all three RIN prices (D4, D5, and D6) in Figure 3 would fall all the way back to the pre-2013 level of D6 RINs. Second, the RIN cliff scenario is not a stable equilibrium due to the magnitude of financial losses that BBD producers would likely incur. The implications of significantly lower RIN prices for FAME biodiesel and renewable diesel prices would be profound for BBD producers. The potential for cutbacks in production and/or the shuttering of BBD plants to eliminate excess production and return to the mandated market equilibrium would be high. However, the duration and volatility of this adjustment process is hard to predict.

The question at this point is whether the RIN cliff is just an academic exercise or if there is a real possibility of the scenario happening. The proposed rulemaking for 2023, 2024, and 2025 RVOs by the Environmental Protection Agency (EPA), released last December, provides valuable information to help answer this question. We can use the proposed RVOs to estimate the maximum BBD needed to fulfill the RFS mandates for these three years. In essence, we can estimate Q^M in Figures 4 and 5.

The potential for the RFS going over a RIN cliff in the next few years is real but not a given. A complicated set of factors will determine whether this in fact happens. On the demand side, the level and composition of the RVOs in the final EPA rulemaking for 2023, 2024, and 2025 will have a major impact. On the supply side, several factors will be important, including: i) expansion of renewable diesel production capacity, ii) declines in FAME biodiesel capacity, iii) plant utilization rates for both renewable diesel and FAME biodiesel, and iv) the level of BBD imports.

Implications

The scale of the renewable diesel boom has been so large that it has raised unusual questions about the U.S. Renewable Fuel Standard (RFS). There is a real possibility that the total supply of biomass-based diesel (BBD) will exceed the RFS mandate for BBD by a considerable margin. Since the BBD mandate is binding, the mandate sets the maximum extent of BBD demand. When this condition is violated, our analysis indicates that the consequences for BBD and RIN prices would be dramatic. The D4 biodiesel RIN price is predicted to fall to zero because no additional incentive beyond the competitive market price is needed to incentivize BBD production. Literally, the D4 RIN price falls off a cliff. Because BBD also plays the role of the marginal (“last”) gallon for filling other components of the RFS mandates, the fallout of production overshooting would not be limited to D4 biodiesel RINs. In sum, it appears that something has to give to avoid the RFS going over a RIN cliff, especially in light of current projections for expansion of renewable diesel production capacity. Either RFS mandates going forward have to be increased substantially to accommodate the boom in renewable diesel production, or the supply of BBD will have to be reduced somewhere else. READ MORE