Last Days of RINsanity
Last week reports emerged suggesting the Trump administration will soon change the U.S. biofuel program in response to the long-standing grievances of the nation’s refiners.
The issue is complex, so a popular reader comment below such stories is some variation of “What does this actually mean?” Today I will try to answer that clearly and concisely, while highlighting the threats and opportunities for investors.
Briefly, the U.S. legislation requires that gasoline sold nationwide contain some 10% ethanol, though the law lets the Environmental Protection Agency (EPA) set the precise annual biofuel quota.
The EPA tracks compliance by assigning each gallon of ethanol used a unique serial number known as the Renewable Identification Number, or RIN. Ultimately, “obligated parties” — as of now predominantly the refiners — must verify ethanol mandate compliance by submitting to the EPA a number of RINs proportional to their gasoline output. (The same system applies to other biofuels, but the RIN values differ according to the type of biofuel).
But many refiners don’t blend in the ethanol themselves; this task is often the preserve of fuel shippers and wholesalers. Those gasoline producers have to buy their RINs in a largely unregulated market from ethanol suppliers, blenders of gasoline or financial speculators.
In the early years of ethanol quotas, the RINs represented a tiny proportion of the price of wholesale fuel. More recently, the cost has soared. Valero (NYSE: VLO), for instance, said RIN compliance cost it $217 million in the fourth quarter of 2016 and $750 million for the entire year, with similar expense forecast for 2017. For reference, Valero reported 2016 adjusted net income attributable to stockholders of $1.7 billion, so RIN compliance consumed just over 30% of the profit by that measure.
Valero and other refiners have lobbied to shift the compliance cost by designating the fuel distributors responsible for the blending as the “obligated party.” The RINs would have to be turned in by the party that holds title to the fuel immediately prior to sale from the bulk transfer/terminal system to a wholesaler, retailer or ultimate consumer. These are the same parties required to report federal excise tax liability for the gasoline or diesel.
Valero’s ultimate objection is that only the fuel blenders can decide how much ethanol gets blended. They are the ones who effectively create the RINs, so they should be the ones to turn them in, which would give them the incentive to use more ethanol. Valero argues that this change would substantially reduce the opportunities for fraud and speculation involving RINs.
Who opposes such a move? Obviously the fuel marketers and retailers who do the blending, many of them now profiting from selling RINs to the refiners. Murphy USA (NYSE: MUSA) was one singled out by Valero in its petition to have the rule changed.
Renewable fuel groups have also fought to preserve the current system. Why would they oppose change? I think their primary fear is that shifting the large compliance obligation to the blenders, which are typically smaller than the multi-billion-dollar refiners, could cause a backlash against renewable fuel mandate as a whole. It could open a can of worms they would rather leave closed.
So what’s going to happen? Last week the Renewable Fuels Association (RFA) claimed it had been told that the White House was going to shift the RIN compliance burden. The White House denied such an order is pending.
But Carl Icahn has long been a vocal critic of the current arrangement. He is majority owner of the refiner CVR Energy (NYSE: CVI). More importantly, he is advising President Trump on the issue.
Expect the change to happen. It’s likely to hurt ethanol producers in the long run, and should improve the fortunes of some refiners at the expense of marketers and retailers. The change could also reopen the debate about the cost of the nation’s biofuel mandates.
This policy shift is going to create winners and losers. Join us at The Energy Strategist to profit.