Will the EPA Reverse Itself on the Write Down of the Renewable Mandate for 2014? The Message from the RINs Market
by Scott Irwin (FarmDocDaily/University of Illinois) … The purpose of today’s post is to show that the recent behavior of prices in the RINs market suggests the odds of the EPA reversing the proposed write down of the renewable mandate for 2014 in final rulemaking have increased sharply.
In order to understand the message from the RINs markets, we need to review a conceptual model of ethanol RINs pricing that has been used in several previous posts (for example, here and here). The version presented in Figure 1 is a general representation. The demand curve is assumed to be vertical (perfectly inelastic) at 5 billion gallons in order to represent the demand for ethanol as an MTBE oxygenate replacement. It is vertical since non-ethanol alternatives are prohibitively expensive. The demand curve then becomes flat (perfectly elastic) for ethanol prices equal to 110 percent of CBOB gasoline prices between 5 and 13 billion gallons. This breakeven point reflects Department of Energy research on the value of ethanol as an octane enhancer in gasoline blends. The demand curve becomes vertical again to reflect the E10 blend wall, which is assumed here to be 13 billion gallons. The intersection of market supply and demand in this case results in an equilibrium quantity of 13 billion gallons, equal to the E10 blendwall.
An interesting implication of the model presented in Figure 1 is that eliminating the RFS renewable mandate entirely would not impact the amount of ethanol consumed in the U.S. The reason is that it is profitable for gasoline blenders to blend ethanol with gasoline at least up to 10 percent blends. For the same reason, the model predicts that the price of an ethanol RIN is zero up to the E10 blend wall of 13 billion gallons. The situation is quite different if the renewable mandate is set above the E10 blend wall. For example, the statutory mandate for 2014 is 14.4 billion gallons, which results in a “renewable gap” of 1.4 billion gallons (14.4 – 13). If one is willing to assume that higher ethanol blends, such as E85, cannot be deployed in large quantities in the short-run, then the renewable gap effectively becomes additional biodiesel mandate (see the analysis here). In this model the only way to fill the gap and fully comply with the renewable mandate is by blending biodiesel, which is a higher nested biofuel in terms of RFS compliance. Under this circumstance the price of a D6 ethanol RINs equals the price of a D4 biodiesel RINs.
In early July 2013 D4 and D6 prices were fully coupled, reflecting the market expectation discussed above that the 2014 renewable mandate would exceed the E10 blend wall. Then, in late July 2013 D4 and D6 prices uncoupled, reflecting the changed market expectation, subsequently proved correct, that the EPA would write down the 2014 renewable mandate so it would not exceed the E10 blend wall. Since late January 2014 D6 prices have once again risen rapidly relative to D4 prices. The price of a D4 and a D6 with 2014 vintages stood at $0.46 and $0.34, respectively, on January 27, 2014, little changed since early December 2013. Six trading days later on February 5 the price of a D4 and D6 had risen to $0.55 and $0.50, respectively. In other words, the price of D6 RINs increased by about 50 percent over a span of just six days! Obviously, something dramatic must have happened to change the market’s perception of the value of D6 RINs relative to D4 RINs. The conceptual model presented in Figure 1 strongly suggests that RINs market traders were convinced there is a much higher chance that the EPA will reverse the write down of the 2014 renewable mandate in final rulemaking, expected to be released in late spring or early summer. As long as the reversal of policy results in a renewable mandate for 2014 that exceeds the total capacity of the domestic fuel market to physically absorb the mandated quantity of ethanol, then D4 biodiesel and D6 ethanol prices should be effectively re-coupled. So, the reversal does not need to be complete for the switch to be flipped. For example, if the domestic fuel market can absorb 13.4 billion gallons of E10 and E85 in 2014, a renewable mandate of 13.8 billion gallons for 2014 would have a similar price impact in the RINs market as the statutory mandate level of 14.4 billion gallons.
There is one other logical possibility that could explain the re-coupling of D4 and D6 RINs prices in 2014. Traders could have perceived a much higher chance that biofuels groups would be successful in challenging the renewable write down in court. READ MORE and MORE and MORE (Agriculture.com)