A Primer on RIN's and Futures Prices
Author: Brynne Kelly (w/Lee Taylor technical levels)
With just four days remaining in the Trump administration, the U.S. Environmental Protection Agency Friday (1/15/21) announced four actions related to the Renewable Fuel Standard (RFS) and E15.
In next Tuesday's Federal Register, the EPA will announce it is seeking public comments on requests from refiners and oil state governors to provide a general waiver from 2019 and 2020 RFS renewable volume obligations due to COVID-19.
The EPA has announced in today’s Federal Register a final determination that no additional measures are necessary to mitigate “potential adverse air quality impacts” associated with the Renewable Fuel Standard.
The EPA has proposed to extend compliance deadlines for 2019 and 2020 renewable volume obligations (This document has a comment period that ends on (03/11/2021).
Next Tuesday’s Federal Register will also include a proposal from EPA for removing certain barriers to expanded sales of E15, a gasoline blend containing 15% ethanol (This document has a comment period that ends on (02/18/2021).
The outcome of this legislation is important as it coincides with a rally in renewable fuel prices, specifically those derived from agriculture products. RIN prices don't exist in a vacuum, they represent the market's perspective on how easy RIN obligations will be met.
Rather than requiring refineries to get into the biofuel business, the Environmental Protection Agency (EPA) created an accounting system where every gallon of biofuel produced in or imported into the United States generates a credit, known as a Renewable Identification Number (RIN). To comply with the Renewable Fuel Standards (RFS), refiners must turn in their required amount of RINs to the EPA at the end of each year. How they obtain those RINs is up to them. Petroleum refiners can buy RINS from independent biofuel producers, or get into the biofuel business and produce RINs themselves. Importantly, the price of RINs is set by market forces. The RFS determines the demand for RINs by specifying how much biofuel, and therefore how many RINs, need to be sold in aggregate each year. Biofuel producers determine the supply. As demand for RINs, or the cost of producing biofuel increases, the price of RINs will increase and vice versa.
Renewable Volume Obligations (RVO) and Renewable Identification Numbers (RIN)
RVOs are the percentage shares of gasoline and diesel that must be comprised of renewable fuels
Derived by dividing volumetric requirement for each type of renewable fuel by projected U.S. gasoline and diesel consumption
Ensures all obligated parties (refiners/importers) blend their proportional share
RINs represent gallons of renewable fuel that are produced and blended into U.S. gasoline and diesel fuel
RIN is a numbered credit generated by renewable fuel producer
Obligated parties acquire RINs when they purchase and blend renewable fuel
Obligated parties turn in RINs to EPA to demonstrate compliance with their RVO
RINs are tradeable: obligated parties who blend less than their required share of renewable fuels may purchase RINs from other parties who blended more
RINs have a 2-year life: 20% of an obligated party’s RVO may be met with RINs generated in previous year
The key to all of this is the Renewable Volume Obligations (RVO) calculated by the EPA via a rulemaking. The RVO's establish an annual quantity target of biofuels that the EPA requires the fuel supply industry to purchase and blend. Obligated fuels are those sold for use in the surface transportation sector in the United States; non-obligated fuels are fuels used in Europe and fuels used domestically for purposes other than surface transportation, such as jet fuel.
RVO's are comprised of four categories of renewable fuels under which 7 RIN “D Codes” are dispersed. These categories are defined by the reduction in life-cycle emissions of greenhouse gasses (GHGs), relative to petroleum, by feedstock, and by fuel characteristics.
One "D" code may be used to fulfill one or more renewable fuels category requirements based on the nesting nature of RFS standards.
A more detailed description of each RIN "D" code is listed below. They are specific and confusing, just remember that D6 RIN's make up the majority of RIN obligations in the US currently.
D3: Cellulosic Biofuel (60% GHG reduction)
Cellulosic ethanol, naphtha, diesel, jet fuel and heating oil
Any fuel derived from cellulose, hemicellulose, or lignin—nonfood-based renewable feedstocks.
D4: Biomass Diesel (50% GHG reduction)
FAME biodiesel (produced by transesterification of vegetable oils, animal fats, or recycled restaurant grease)
All of the following can be used in the production of biodiesel:
Vegetable Fats: virgin oil feedstock, rapeseed and soybean oils, mustard, palm oil, hemp, and algae, waste vegetable oil
Animal Fats: tallow, lard, yellow grease, Omega-3 fatty acids from fish oil
D5: Advanced Biofuel (50% GHG reduction)
Sugarcane ethanol, F/B waste ethanol, Advanced biodiesel, Naphtha/LPG
Any fuel derived from cellulosic or advanced feedstocks. This may include sugarcane or sugar beet-based fuels; biodiesel made from vegetable oil or waste grease; renewable diesel co-processed with petroleum; and other biofuels that may exist in the future. Nested within advanced biofuels are two sub-categories: cellulosic biofuel and biomass-based diesel. Both biomass-based diesel and cellulosic biofuel that exceed volumes in their respective categories may be used to meet this category. Fuels in this category must demonstrate a life cycle GHG emissions reduction of 50%.
D6: Renewable Fuel (20% GHG reduction)
Corn starch ethanol (basically, "ethanol"), grandfathered FAME biodiesel and everything else
Any fuel derived from starch feedstocks (e.g., corn and grain sorghum). Conventional biofuels produced in plants built after 2007 must demonstrate a 20% reduction in life cycle GHG emissions.
Every equivalent gallon of renewable fuels is assigned a RIN at its point of generation or origination. Conventional ethanol RIN's (D6) have the energy equivalency of 1.0 gallon of ethanol. Renewable fuels with more energy content per volumetric unit than ethanol can generate more than 1.0 RIN per gallon. For example, FAME biodiesel = 1.5, NE RD = 1.7, Butanol = 1.3 RIN per gallon of production.
The predicted RIN price obligation on retail fuels depends on the fractions of gallons of petroleum and renewable fuel blended into a gallon of retail fuel.
Recognizing short-term difficulty in attaining required volumes of cellulosic standards (D3 RINs), the EPA has added even more flexibility to the program beyond that generated by the nesting principle. This is the cellulosic waiver credit (CWC), which is offered by EPA, at a price determined by formula in the statute, so that obligated parties have the option of purchasing CWCs plus an advanced RIN in lieu of blending cellulosic or obtaining a cellulosic RIN. The published price for Renewable Fuel Standard cellulosic waiver credit (CWC) price for 2020 is $1.80. The trading theory is that the value of a D3 RIN should be fairly close to the value of a D5 RIN plus the CWC. Currently, the D3/D5 price spread is closer to $1.20 (more about this later).
The CWC price is calculated via a complex formula in which the EPA indexes the average wholesale (refinery gate) price of gasoline, using the most recent twelve monthly values for U.S. Total Gasoline Bulk Sales (Price) by refiners, as provided by the EIA (these are available as of September 30 of the year preceding the compliance period to inflation).
A major problem in the legitimacy of RIN markets arises from the RVO obligation adjustments made by the EPA, in arrears, to obligation targets. Specifically those products that are in short supply. Advanced biofuels are always in short supply due to capacity. Waivers by various administrations have polluted the market's reliance on their target obligations. However, with a new administration and a focus on ESG investing, could this be about to change?
To understand what has happened with RIN prices, we look at the posted daily RIN prices for 2020 and 2021 obligation years by "D" code below. D6 RINs for 2020 obligations (gold line below) went from $0.15 at the start of 2020 to almost $0.85 as of last Friday. Similarly, over that same time frame D3 RINs (purple line below) went from a low of $0.80 to almost $2.25.
In a final rule released by the U.S. EPA on Dec. 19 2020, there was a slight increase in the 2020 Renewable Fuel Standard cellulosic biofuel and advanced biofuel targets, otherwise there were no other changes to proposed Renewable Volume Obligations (RVOs). The rule also maintains EPA’s much criticized proposed plan to account for future small refinery exemptions (SREs)—a move slammed by members of the biofuels industry.
Translating RIN pricing to Market Prices
The RIN basket refers to the Renewable Volume Obligation (RVO), which is a calculated value that represents the cents/gal cost to an obligated party of complying with the Renewable Fuel Standard (RFS). It is calculated by multiplying a specific year or vintage and category RIN assessment by that renewable fuel’s percentage mandate, as published by the EPA. The RVO percentage mandate is set by the EPA and is based on expected gasoline and diesel consumption over the year and the legislated requirements for the RFS program. Each RIN category is multiplied by the percent value of the current years' RVO mandate and then added together, producing a single per gallon cost of biofuels compliance.
Based on the 2020 RFS standards and RIN prices (both shown above), the cost of 2020 RVO compliance looks as follows (RVO % times RIN price):
The cost of RVO compliance since December, 2020 has risen from just over $0.15/gallon to a high of just over $0.20/gallon as of January 6, 2021.
How does all of this translate to refined product prices/futures? To unpack this, we compare ethanol and soybean oil futures (black and green lines below) to those of gasoline and distillate (blue and gold lines below). Both ethanol and soybean prices are converted to $/gallon with the price of soybean futures being further adjusted by an energy equivalent factor of 1.50 (see earlier energy equivalent discussion). Generally, ethanol RIN's (D6) have more of an impact on US gasoline futures and biodiesel RIN's (D4) have more of an impact on US ULSD prices.
Ethanol and soybean futures are used for this comparison since they are fairly liquid and the production of both generate a RIN credit (Ethanol = D6, Soybean Oil = D4). According to EIA data, biodiesel production accounts for an increasing share of soybean oil use in the United States, currently representing about 30% of domestic soybean oil disposition (as of May, 2019).
Notable is the fact that for most of 2018 and 2019, soybean oil and ethanol futures were well below refined product prices. This led to RIN obligations being more of a nuisance than a problem. However, as shown earlier, RIN prices have soared since the end of 2019 relative to gasoline and distillate prices, becoming more of a 'nuisance'.
The recent rally in agriculture futures like corn and soybeans have resulted in a steep rally in soybean oil futures which are now trading significantly higher than refined products. Even ethanol futures managed to trade at a premium to gasoline futures in the US last week (black dot vs blue dot above, commonly known as the CURL spread). The cheap pool of renewable fuel sources seems to be evaporating. The EPA has also indicated that the USDA, through a future action, will pursue opportunities through the budget process to consider infrastructure projects that would accommodate higher biofuel blends. Could 'ag' products BE anymore in favor??
In the US, ethanol has been the biofuel of choice, overcrowding other forms of bioenergy. Only recently, other biofuels such as biodiesel and sugar-ethanol started receiving more attention. The production and consumption of biodiesel rose significantly over the past decade. A number of policies were designed to support the biodiesel market and are responsible for driving domestic production. In addition to introducing a specific blending requirement and assigning biodiesel a higher Renewable Identification Number (RIN) value, the Second Renewable Fuel Standard has given biodiesel particular advantage to be eligible to fulfill the volumetric requirements of other biofuels. The biodiesel industry is expected to further expand in the future, and thus its pricing dynamics are commanding increased academic attention. Although biodiesel can be made from a number of feedstocks, soybean oil is the main feedstock for biodiesel in the US. As US biodiesel comes into the spotlight, questions about its price dynamics and its impact on soybean oil prices arise.
Since heating oil is not used as an on-road transportation fuel, there is no renewable volume obligation associated with this fuel. Ultra low sulfur heating oil has the same specifications as ULSD, but without the RVO, so its discount to ULSD tends to move as a proxy of the RVO value. This relationship is particularly true in the Gulf Coast, where ULSD barrels for export have the value of RVO removed, therefore becoming, in essence, an ultra low sulfur heating oil. Looking at the futures spread between USGC and NYH ULSD futures (commonly referred to as the Up/Down spread}, we don't see that much movement over the last 10 days in the futures curve.
RVO obligations do not, at this point, have a majority share in refined product prices. However, they cannot go unnoticed as we move further along the timeline of ESG investing and a new administration. It remains to be seen if the blending requirements will be fully enforced by the EPA in 2020. It is an area to keep in mind when thinking about the new normal going forward and how seriously these mandates might be enforced.
RIN prices represent the marginal cost of producing and consuming required volumes of each renewable fuel. High RIN prices indicate a market perception that annual RVOs will be difficult to meet. Low RIN prices indicate a market perception that annual RVOs will be easy to meet without expanding biofuel production and distribution capabilities. With the market for blending components like ethanol and soybean oil rising, have we perhaps found a floor in RIN prices, absent government waivers?
OF Note Last Week
OPEC released it's Monthly Oil Market Report (MOMR) last week and in it they stated that global oil demand is set to rise by 5.9 million barrels per day (bpd) in 2021 from an estimated average demand of 90 million bpd in 2020, OPEC said on Thursday, leaving its 2021 demand growth forecast unchanged from last month but warning that the pandemic is still skewing risks to the downside. This gave the market the tailwind it needed for the balance of 2020 WTI futures 11-month strip to move decidedly above the $50 level (gold line below).
However, beyond 2020, 12-month strip pricing for WTI remains below the $50 level.
One-month backwardation has almost regained levels seen exactly one year ago in the front of the curve and have surpassed last January levels in the back of the curve.
EIA Inventory Statistics
The EIA reported a total petroleum inventory BUILD of 6.00 million barrels for the week ending January 8, 2021. This was much lower by comparison to previous year builds.
Same as Weekly above since last week's report represented the first full reporting week of 2021.
Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are no longer at their highest levels for this time of year.
Lee Taylor - Technical Levels (to return next week)