RINs Gone Wild? (round 2)

by Scott Irwin and Darrel Good (FarmDocDaily) The EPA released the final rulemaking for 2014-2016 RFS standards on Monday, November 30. This release follows preliminary rulemaking released on May 29 of this year. Figures 1 and 2 are based on continuous series of daily 2014 vintage D4 biodiesel and D6 ethanol RINs prices through the close of trading on Wednesday, December 2, and they demonstrate that the final standards were a major shock to the RINs market. In the three trading days since the EPA announcement, the price of D4 biodiesel RINs jumped $0.20 per gallon, or 31 percent, and the price of D6 ethanol RINs increased $0.39 per gallon, or 92 percent. Except for a brief spike in January 2015, the Wednesday price for a 2014 vintage D6 RINs, $0.8075 per gallon, is the highest since August 2013. Equally impressive, the D6/D4 price ratio rose from 0.66 to 0.97 over these three trading days. Since RINs prices represent the marginal cost of complying with RFS mandates, it is important to understand why such large changes occurred. The purpose of this article is to provide an explanation for the recent spike in RINs prices. We begin by delving into the details of the 2014-2016 RFS volume requirements in the November 30 final rulemaking.

Compared to the preliminary proposal, the final rulemaking requires an additional 350 million gallons of total renewable fuels in 2014, 630 million gallons in 2015, and 710 million gallons in 2016. The biomass-based diesel requirement increases from 1.63 billion gallons in 2014 to 1.9 billion gallons in 2016, and 2.0 billion gallons in 2017 (the only standard set for 2017). The most notable changes between the preliminary proposal and the final rulemaking are associated with the implied conventional requirement, which increased from 13.25 to 13.61 billion gallons for 2014, from 13.4 to 14.05 billion gallons in 2015, and from 14.0 to 14.5 billion gallons in 2016.

Since the RFS requirements are actually enforced in a fractional, or percentage, fashion rather than in a volumetric fashion, it is also important to consider how these fractional requirements changed between the preliminary and final rulemaking. In other words, obligated parties under the RFS must demonstrate that their blending of biofuels as a percentage of total firm production of transportation fuel (petroleum gasoline + petroleum diesel) meets or exceeds the percentage standard established by the EPA. The percentage standard for a given year is simply the mandated national biofuels volume (in ethanol equivalent gallons) divided by total national use of transportation fuel. Table 2 presents the fractional standards in the preliminary and final EPA rulemakings. The fractional standards for cellulosic, biodiesel, and advanced changed very little between the preliminary proposal and the final rulemaking. The biggest changes occurred in the fractional standards for the implied conventional mandates in 2015 and 2016, which increased 0.47 and 0.34 percent, respectively. The fact that the fractional mandates were either stable or increased helps to resolve an important question regarding the current policy target of the EPA in setting the RFS standards. More specifically, if gasoline and diesel use projections differ between the preliminary and final rulemaking the EPA can target fixed volume standards, which means fractional standards will change between the preliminary and final rulemaking, or the EPA can target fixed (or non-declining) fractional standards, which means that volume standards will change. Of course, this is a moot point if gasoline and diesel use projections do not change between the preliminary and final rulemaking. Given that gasoline and diesel use projections for 2015 and 2016 increased between the May preliminary proposal and the November final rulemaking and the fractional mandates were stable or increased, one can infer that the EPA is not targeting fixed volumetric standards when issuing preliminary RFS standards. Instead, the EPA is evidently targeting the fractional mandates.

Under the final EPA rulemaking, we estimate the conventional ethanol mandate gap to be 281 million gallons in 2014, 325 million gallons in 2015, and 899 million gallons in 2016. These are estimates of the magnitude of the push in the conventional mandate above the E10 blend wall each year. The conventional gaps for 2014 and 2015 require some explanation in light of EPA's argument that the conventional mandates were set at the actual ethanol production level for 2014 and projected production in 2015. This would seem to imply a zero conventional gap in 2014 and a very small gap in 2015 due to projecting ethanol production without complete information for the year. The key to reconciling our estimates of the conventional gap for 2014 and 2015 and the EPA's estimates is to recognize that the EPA bases their estimates on D6 ethanol RINs generation rather than domestic physical ethanol use as we do. One would think that D6 ethanol RINs generation, after appropriate adjustment for export retirements, and domestic physical ethanol use would generate similar estimates of usage. This is not necessarily the case because D6 RINs can also be generated by "grandfathered" biodiesel and renewable diesel producers who meet the 20 percent greenhouse gas reduction standard for ethanol RINs. As shown in this farmdoc dailyarticle (August 5, 2015), D6 RINs generation from this pathway has grown rapidly in recent years, totaling 243 million gallons in 2014 and over 400 million gallons in 2015 (both stated in ethanol equivalents). These totals can completely account for the differences between our estimates of the conventionalgap in 2014 and 2015 and the estimates from the EPA. Stated differently, the data in the final EPA rulemaking (which our estimates are based upon) implies a positive conventional mandate gap in 2014 and 2015 based on the physical ethanol market, but this gap, or push above the E10 blend wall, was filled by non-ethanol D6 RINs generation. This highlights the important role that non-ethanol RINs generation has played at the margin in recent years for complying with the conventional ethanol mandate.

The review of EPA's final rulemaking for 2014-2016 in the previous section strongly suggests that that the EPA is committed to pushing RFS standards for conventional ethanol past the E10 blend wall and "getting the RFS back on track." The language in the final rulemaking suggests it would not be surprising if the EPA returned the conventional ethanol mandate back to the statutory level of 15.0 billion gallons as soon as 2017.

The release of the EPA's final rulemaking for 2014-16 RFS standards was a major shock to the market. The price of D4 biodiesel RINs went up 30 percent and the price of D6 ethanol RINs increased over 90 percent in the three trading days following the release. The market was apparently surprised by how much the final conventional ethanol mandates, particularly in 2016, breached the E10 blend wall. In addition, the final rulemaking clearly signaled that the EPA is serious about getting "the RFS back on track," and it would not be surprising if the EPA set the conventional ethanol mandate at the statutory level of 15.0 billion gallons as soon as 2017. The prospect of large conventional mandate gaps versus the E10 blend wall evidently shifted the expectation of market participants from one where the existing stock of RINs would not be exhausted for years to one where the stocks could be exhausted in a matter of months. When the stock of RINs is exhausted, the conventional gaps have to be filled by higher ethanol blends, such as E15 and E85, or biodiesel and renewable diesel. Our theoretical model predicts that the price of a D6 ethanol RINs should equal the price of a D4 biodiesel RINs if biodiesel and renewable diesel are the only feasible options for filling conventional mandate gaps. Consequently, the move of D6 RINs prices to nearly the same level as D4 RINs prices in the days following the November 30 release is an unmistakable sign that the market believes higher ethanol blends are not a feasible source of RINs to fill conventional gaps. Instead, biodiesel and renewable diesel are perceived to be the only viable options for filling the expected conventional gaps. It will be interesting to follow whether this expectation is borne out going forward. The cost of complying with the RFS mandates and impacts on feedstock markets may well depend on the answer. READ MORE