Merchant Refiners Face A Return Of 'RINsanity' In 2021

by Tristan R. Brown (Seeking Alpha) -Expectations of U.S. gasoline demand in 2021 are continuing to decline as the country has failed to suppress the spread of COVID-19. -Gasoline demand in 2021 is now expected to be as low as it was in 2013. Mandated biofuel demand will be substantially higher over the same period, however. -This disconnect threatens to cause a repeat of the "RINsanity" that characterized the merchant refining sector in 2013. -This article reviews the factors that would cause a similar surge in merchant refiners' RIN expenditures next year.

Investors who have been following the merchant refining sector for long enough will remember the "RINsanity" that prevailed in the first seven months of 2013. It was a time when refiners saw their reported costs of complying with the U.S. revised Renewable Fuel Standard [RFS2] skyrocket, prompting a strong outcry from the merchant refining sector in particular. While rising U.S. gasoline consumption and the Trump administration's subsequent weakening of the RFS2 have resulted in much-reduced costs in recent years, the impact of the COVID-19 pandemic on transportation fuel demand threatens to cause compliance costs to surge again in 2021.

Many merchant refiners spun off their biofuel blending assets during the logistics MLP creation boom of 2011-2012, and these entities have historically been large purchasers of RINs as a result.

D6 RIN prices ultimately collapsed over the last five months of the 2013 after the EPA proposed to adopt a 10 vol% blend "cap" in its future rulemaking of the mandate's annual blending requirements. This action was later deemed unlawful by a federal appellate court, however. The court's justification was that Congress had established specific absolute annual biofuel blending volumes when its created the RFS2 in 2007, and that the EPA's task is to ensure that those volumes are achieved.

The era of cheap petroleum that began in late 2014 helped to alleviate pressure on the ethanol blend wall because it prompted a reversal of the decline to gasoline consumption that had existed in 2013. Increased gasoline consumption meant that the EPA's denominator in subsequent years was progressively larger than in 2013, causing the resulting blend percentage to be lower than it would have been otherwise. That new trend largely persisted, with a brief exception in 2017, until this March. Even the recent coronavirus-driven collapse to gasoline demand has not affected RIN prices, though, since the EPA had already finalized the blend percentages for 2020 well before the EIA had any inkling of the impact that the pandemic would have on the transportation sector.

The RIN market situation is likely to be very different in 2021, however. Back in March I detailed the conditions that would cause a repeat of "RINsanity" in 2020: specifically, the risk that the pandemic would cause the EIA to reduce its forecast of U.S. gasoline demand in 2021. Such a reduction would not affect the Congressional volumes, though, meaning that the blend percentage would need to increase as the denominator declined.

The latest forecast from the EIA, which it releases via its monthly Short-Term Energy Outlooks [STEO], substantially raises the likelihood that the denominator for 2021 will decline. The EIA now expects U.S. gasoline demand to make only an incomplete recovery in 2021 (see figure). Notably, the forecast 2021 volume of 135.6 billion gallons would represent a decline of 5% from 2019's actual volume of 142.2 billion gallons. Indeed, the EIA's predicted 2021 volume is virtually identical to the volume of actual gasoline demand in 2013.

Two novel factors will partially offset the impact that the 2021 RVO can be expected to have on RIN prices. The first is the EPA's decision last year to allow the 15 vol% ethanol blend to be sold year-round. Even a partial adoption of E15 nationwide would increase the ethanol blend wall and relieve pressure on RIN prices.

The second factor that could inhibit RIN prices is the growing availability of a biofuel that has no blend wall: renewable diesel. This biofuel is a hydrocarbon fuel that meets the same ASTM D975 spec as ULSD does. The U.S. is witnessing an unprecedented expansion of its renewable diesel production capacity as merchant refiners such as Valero Energy (VLO), Marathon Petroleum (MPC), Phillips 66 (PSX), HollyFrontier (HFC), and most recently CVR Energy (CVI) have directly financed or otherwise supported new investment. More than 1.3 billion gallons of new renewable diesel capacity is scheduled to become operational by the end of 2021. Much as the other biomass-based diesel fuel, biodiesel, experienced a large increase to consumption in 2013 as refiners used non-ethanol biofuels to generate D6 RINs, these merchant refiners intend to use renewable diesel for a similar purpose.

The primary question at present is whether enough of this new capacity will be available by early 2021. READ MORE