By Elizabeth Hilbourn and John Auers
The classic Doors tune, “Riders on the Storm” can be an appropriate description on how refiners and other obligated parties feel in managing their renewable fuel regulatory responsibilities. The renewable fuel standard (RFS) program seems like an old story but, believe it or not, it is still in its infancy and everyone is still wondering what it will look like when it grows up. The RFS2 program began in 2010 following a much simpler RFS1 program. After 7 years, you would think that by now, all of the important questions would be answered. Not so much for the RFS program under this new administration. As we head into the second half of 2017, some (certainly not all) of the questions of the moment include the following. What will be next year’s obligation? Will RIN prices rise or fall? Will cellulosic ethanol ever become economic? If it does, will the corn ethanol producers suffer? Will the obligation be moved downstream? While we certainly ‘can’t answer all of the questions in this blog, we will attempt to give you a few clues on what impacts RIN pricing in this first of a three part series.
“Killer on the road, yeah” – Laying out the Key Issues
RIN prices are subject to the laws of supply and demand, to a point. However, they also depend on government mandates (think politics) which are always less exact than a classic supply/demand curve. The simple factors include prior year RIN inventory available for current year compliance and availability of renewable fuel. Less defined factors include the magnitude of the renewable fuel obligation (set annually by the EPA), the obligated parties’ belief that the obligation set can be met, and government tax relief for domestic biodiesel/renewable diesel and/or imported renewable diesel or biodiesel.
The program appears to be on solid ground for 2017 but 2018 is still a mystery. RIN production in 2016 easily met the RIN obligation in 2016, even if no prior year RINs were used for compliance. In fact, the prior year RIN inventory grew with more 2016 RINs available for 2017 than 2015 RINs available for 2016. However, there are storm clouds on the horizon, with refiners potentially running into a soft biodiesel blend wall, thus potentially resulting in a RIN price spike similar to that experienced in 2013. Stay tuned, things may just be getting interesting.
Figure 1 shows that RIN prices continue to remain strong. Soon after the publication of the final 2017 renewable fuel standard on December 12, 2016, RIN prices declined until the beginning of February 2017. The ethanol or D6 RIN experienced the greatest decrease. D4 & D5 RIN prices currently are almost at the mid December 2016 high of approximately 110 cents per gallon. Over the last few years, D6 RINs have had alternating periods of showing a small differential of 10 cents per gallon or less from the D4/D5 RIN price and showing a larger 40-60 cents per gallons differential.
“Into this world we’re thrown” – Historical Context
The RFS2 program began in 2010 and perked along with very low RIN prices until early 2013 when the industry became concerned that the mandated obligation would crash into the gasoline blendwall in 2014. Ethanol (D6) RIN prices spiked at more than $1.20 per gallon before the EPA publicly recognized the issue and promised to address the problem. The industry breathed a sigh of relief and RIN prices fell. However, the problem was so political, that an EPA proposal to recognize the blendwall and put the program onto a sustainable path was discounted out of hand by the then current administration and the problem remained unaddressed for two years. EPA did not set the 2014 and 2015 RVO standards until December 2015, essentially two years with no mandate. Ultimately, the mandates were set at manageable levels less than the original Congressional mandate avoiding two years of non-compliance. 2016 and 2017 mandates were set at manageable levels and RIN pricing was relatively stable with one exception.
Shortly after the surprise Republican victory in November 2016, a sense of change of direction for the program resulted in a belief that there was a good chance that the RFS program would be modified to make compliance easier or eliminated altogether. During that short period, RIN prices, especially ethanol (D6) RIN prices declined dramatically. The RIN price relief was short lived as it became clear there would be no immediate change in the RFS program.
“Like a dog without a bone” – RIN Price Predictors
There are several factors that impact RIN prices. The absolute volume of the renewable fuel obligation is a primary factor. The expected obligation for 2014 was the driving force for the RIN price spike in 2014. The original mandate was 18.15 billion gallons. Total G+D at the time was around 170 billion gallons. Renewable fuel content in the transportation pool would have been 10.7% more than the 10% ethanol blend wall. The industry experts did not believe that was possible and the RIN prices spiked. The situation was only alleviated when the EPA indicated that they were aware of the problem and would take appropriate action to be sure the RVO was achievable. It took two and a half years for the EPA to come to a politically acceptable solution. The industry has shown that with current conditions, it can comply with a 10.7% renewable fuel mandate. But it is questionable if it can meet anything much higher.
Figure 2 shows total RIN generation divided by the total mandate spread out over the months. The mandate was 16.93, 18.11 and 19.28 billion gallons respectively in 2015, 2016 and 2017. Take note that this volume mandate is a starting point only. The 19.28 billion gallons is how much renewable fuel which the EPA would like to see consumed in 2017; however, to be able to enforce it, they converted it to a renewable fuel obligation of 10.17 vol% by considering forecasted gasoline and diesel demand. The RIN generation subtracts out the retirements for renewable fuel exports and retirements other than meeting the obligation. Not a lot can be said with only four months of data and with a history that the first four months have a history of being the lowest RIN generation months of the year.
The ethanol blend wall is another real limit. The blendwall could be overcome if significant volumes of E85 or E15 could be sold. Currently, there is limited infrastructure for E85 sales and little demand for E15 partially because E15 in the summertime does not enjoy a 1 psi waiver. This limitation could be removed by government mandate and E15 sales might increase. However, in the near term E15 sales are unlikely to be a major transportation fuel.
A less known soft limit is a labeling limitation on biomass based diesel or renewable diesel in petroleum diesel. The Federal Trade Commission requires retail pumps to note the percentage of biomass based diesel or renewable diesel as up to 5%, 5% to 20%, or more than 20%. There is some belief that there are separate requirements for biomass based diesel and renewable fuel. In other words, a label of up to 5% would allow up to 5% biomass based diesel and 5% renewable diesel or a total of 10% non-petroleum diesel. We are uncertain of this interpretation and suspect that the bulk of the industry will limit total non-petroleum diesel to less than 5%. The non-petroleum diesel is currently less than 5% of the diesel pool but during some months comes very close. Since the gasoline pool has been limited by the 10% blendwall, extra biomass based diesel and renewable diesel above the biomass based diesel mandates has jumped into the breech to meet the mandate. If the non-petroleum diesel meets the 5% labeling limit, we expect RIN prices to increase, possibly quite dramatically.
Figure 3 shows the history of ethanol in gasoline and biodiesel in diesel. The 10% ethanol blendwall has been reached for several years now. Biodiesel in diesel has grown over the years and at a faster rate since 2011. Biodiesel in diesel was at its highest level at the end of 2016 and approached if not reached the 5% soft limit level. The graph does not incorpoarate renewable diesel. It will be interesting to see if the potential 5% soft limit of biodiesel in diesel is felt when biodiesel consumption is anticipated to be at the maximum the end of 2017, particularly in December.
“The world on you depends” – Summary
The 2017 RFS mandate can be met. The percentage of non-hydrocarbon diesel is expected to continue to be greater than the RFS mandate for biomass based diesel/advanced renewable fuel which in turn masks the ethanol blendwall in gasoline. However, the non-hydrocarbon diesel in the diesel pool is approaching its own 5% blendwall. When it reaches that limit, RIN prices could spike as they did in 2013 when the industry anticipated hitting the ethanol blendwall in 2014. In addition, the diesel arena could put pressure on RIN prices if the blending tax credit is not reinstated or is not extended to imported non-hydrocarbon diesels. In Parts 2 and 3 of this series we will continue to explore the RFS program and the challenges refiners and other participants will be faced with as they attempt to “Ride out the Storm.”
TM&C constantly monitors changes and proposed changes in regulations which can impact all segments of the petroleum industry. Many of these are associated with transportation fuels, affecting not only demand, but also production costs, compliance challenges, and other aspects of petroleum refining. We include our independent analyses of these impacts in our semiannual Crude and Refined Products Outlook (scheduled to be released in early August) and our various other studies. TM&C also assists clients involved in all aspects of transportation fuel production, blending activities, planning and compliance-monitoring. More information on these publications and our other work involving oil industry developments and dynamics can be obtained by contacting either one of us, visiting our website at turnermason.com or calling Shanda Thomas at 214-754-0898. We wish all of you a safe and enjoyable Independence Day and look forward to assisting you in whatever we can over the coming months and years.