Thursday, 09/15/2022 Published by: George Hoekstra

What has been the most controversial topic in the U.S. refining industry over the last 10 years? Well, it’s a matter of opinion but, judging from time spent in earnings conference calls, law offices, courtrooms, congressional committees, the White House, and other forums of business and political debate, Renewable Identification Numbers — or RINs — would have to be a top contender for that prize. In today’s RBN blog and the final episode of this series, we consider two differing viewpoints on the effects of the RIN system and specific disagreements — or are they misunderstandings? — about the financial consequences of RINs that have dominated the debates and legal cases.

RINs are tradable environmental credits that serve to subsidize the use of renewable fuel components like ethanol in motor fuels to meet federal mandates on renewable fuel use. (See Part 1 of this series for background on the Renewable Fuel Standard, or RFS, which is the governing regulation.) Figure 1 is a flow diagram for the RIN system that we have used in each blog in this series to help explain how RINs work.

As you can see, the RIN system is complicated and is therefore easily misunderstood. We have subdivided it into color-shaded sections to emphasize how the RIN is a two-part tax-and-subsidize system. Simply put, the RIN is both a tax on refined fuel, paid by refiners (blue-shaded section), and a subsidy granted to blenders of renewable fuel (green-shaded section), whose purpose is to force renewables into fuels. We call this the “tax-and-subsidize interpretation.” The blue- and green-shaded sections illustrate how the tax part and the subsidy part work — these are explained in more detail in Part 1 (tax) and Part 2 (subsidy) of this series. In Part 3, we showed how the RIN system accomplishes its purpose to effectively force ethanol into gasoline, and how that affects the price of the E10 gasoline (90% gasoline, 10% ethanol) that most of us use to fuel our cars, SUVs, and pickups.

Figure 1. The life cycle of a RIN. Source: EPA and RBN

In this blog series we’ve shown how the impact of RINs has been interpreted differently by various constituencies and we’ve broadly simplified the two sides in the debate as Camp A and Camp B. Generally, Camp A holds that the RIN system causes market dislocations and the costs are disproportionately borne by refiners. On the other side, Camp B contends that the RIN system effectively subsidizes ethanol in E10 with the costs balanced among market participants — what we’ve referred to as the tax-and-subsidize interpretation — with few deleterious effects. The dispute centers on three fundamental disagreements about the financial impacts of RINs:

If you look deeper and analyze the specific points of contention behind these contradictory statements, you will find there is little disagreement on the tangible transactions between the parties, namely the payment of cash by refiners to buy RINs (blue arrow labeled "$ Tax") and the receipt of cash for the sale of RINs by blenders (green arrow labeled "$ Subsidy"). Those are hard-cash transactions, made deliberately, with obvious financial impacts, just like the $4-plus you pay for a Venti Caffe Latte at Starbucks. All the controversy and disagreement involves the intangible parts of the "RINs-World," namely how RINs affect the market prices of two yellow-highlighted product streams: the refined blendstock called BOB (blendstock for oxygenate blending; yellow box labeled "BOB") and the blended fuel E10 (yellow box labeled "E10"). These price impacts are intangible (1) because they emerge as a consequence of competitive forces in the market rather than by the deliberate action of any individual or single company, and (2) because they cannot be measured directly.

Check out RBN's ClusterX EMF Channel Live Cells Go to Cluster

Let’s consider six prominent points of contention and how the tax-and-subsidize context reveals different interpretations. The underlined statement at the beginning of each contention takes the viewpoint of Camp A as a jumping-off point for our discussion.

Contention 1. Paying for RINs is an extra cost that reduces a refiner’s profits. The competing view, counters that paying cash for RINs is not the only financial impact for the refiner. Figure 1 indicates the net impact to a refiner also depends on how RINs change the market price of the BOB that refiners sell to blenders. If the RIN tax the refiner pays could be fully passed through to the market price of BOB and picked up by the blender, then the net effect on the refiner’s profit would be zero. However, it's impossible to directly measure whether the tax is fully passed through into the market price of BOB because the price blenders pay for BOB is based upon competitive forces driven by the collective actions of all participants, and because we cannot measure the BOB price that would have occurred in the absence of RINs. In other words, the effect of the RIN is hidden in the noise of other factors affecting the market price. Camp B claims that the pass-through of the RIN tax is complete in most cases and provides evidence for that, but the evidence is indirect, difficult to explain, and less concrete when compared to hard cash going out or coming in the door.

Contention 2. Some refiners don’t have pricing power to be able to pass through their RIN costs. This might happen in markets that aren’t efficient, such as when there is a limited number of regional market participants. The other scenario, the Camp B point-of-view, is that pass-through, in competitive markets, does not occur by deliberate exercise of an individual supplier’s pricing power. Instead, it occurs automatically by a change in the market equilibrium price of the product, which emerges from the collective actions of all participants in that market. So the majority of refiners end up paying the market equilibrium price for RINs and receiving the equilibrium price for their BOB.

Contention 3. Cashing out the RIN subsidy is a profit for the blender. The counterclaim to this contention is that if the E10 wholesale market is competitive (yellow-shaded box in figure 1), and if the RIN tax paid by the refiner passes through to the blender, then the cash the blender receives for selling the RIN (the RIN subsidy) must be applied by the blender as a credit (the RIN discount) to reduce the effective cost of the ethanol that is blended into the fuel. That’s a dense sentence, but what it means is that Camp B sees RINs as a net wash for the blender. (For the detailed description, see Part 3.)

Contention 4. An integrated refiner gets RINs free while a non-integrated refiner must buy them on the market, which gives an unfair advantage to integrated refiners. Here, integrated refiner refers to a combined refiner-blender unit operating as a single entity. It is true an integrated refiner does not pay cash in a separate transaction to purchase a RIN on the market like a pure refiner does. Instead, the integrated refiner gets a RIN with its purchase of a gallon of ethanol, captures that value by blending the ethanol to E10, keeps the RIN and "retires" it to fulfill its RFS obligation on gallons of the self-produced BOB it blended with the ethanol. The capability of integrated refiners to avoid the open RIN market is what’s seen as an apparent unfair advantage. But because the integrated refiner does not sell those gallons of BOB into the wider BOB market, it also foregoes the opportunity to realize the RIN premium baked into the market price — a premium that is realized by the pure refiner when it sells its BOB into that market (assuming the market is competitive and efficient). So, because the integrated refiner does not receive a premium price for BOB from the blender, according to the tax-and-subsidize interpretation, the integrated refiner, just like a pure refiner, has a net RIN cost of zero. In summary, the integrated refiner gets RINs for free, while the pure refiner pays cash for them and recovers that cost in the premium it receives when selling BOB at a market price that includes the baked-in premium.

Contention 5. Consumers pay more for E10 because of the RIN tax. Building on the contentions above, this argument says that,  if the RIN tax is passed through in a higher price of BOB, then it must also pass through to a higher price of E10. And it does. The response of the tax-and-subsidize crowd is that, for the E10 market as a whole, the cost of the RIN tax passed-through from refiner to blender is offset by a corresponding credit (RIN discount) on the blender’s cost of ethanol, such that the effective blend cost of E10 is almost exactly unchanged. Said another way, the RIN tax cross-subsidizes the cost of ethanol for the blender to the same extent that they have to pay up for BOB from the refiner with the result being almost no net impact on the overall price of E10. Part 3 of this series contains a numerical example showing how this cross-subsidy can be seen in the blender’s cost calculation.

This contention should not, however, be confused with a broader statement that consumers pay more for motor fuel because of the RFS, which is not a point of contention. Among other reasons for this is that E10 does not fully cover refiners’ renewable volume obligation (RVO) and the obligation to blend more than 10% ethanol grows every year. On top of that, blending ethanol also doesn’t cover D3, D4, or D5 RIN obligations — topics for another day — and so additional costs must be factored in when judging the impact of the RFS as a whole.

Contention 6. High and volatile RIN prices indicate the RFS is dysfunctional. Observed RIN price volatility is caused by changes in the level of subsidy needed to force a mandated quantity of ethanol into gasoline. A higher RIN price signals blenders and integrated refiners that more ethanol is needed — and those signals can be sudden and unexpected. From Camp A’s viewpoint, the resultant price volatility is an indication that the market is inefficient, thus introducing disproportionate risk to refiners and blenders. In Camp B’s generalized tax-and-subsidize interpretation, a higher RIN price implies blenders receive more RIN revenue. And competition in the E10 market means that, rather than keep the extra revenue (which would result in a negative gross margin on their E10) they apply this extra revenue to their effective ethanol blend cost, which means they can pay more for the ethanol and thus draw more of it into fuel than would occur if the RIN price hadn’t increased.

So the RIN price acts like a flow control valve, moving up or down as things change to regulate the flow of ethanol into fuel toward the mandated level. This occurs by the design of the system and through the forces acting in competitive fuels markets. The caveat here is that D6 RIN prices tend to be higher than just what is needed to draw in the volume of ethanol that the fuel market requires and the reason is the E10 blend wall. This is because the RFS mandates blending more than 10% ethanol but the design of the current vehicle fleet doesn’t support blends above 10% on a large scale. So demand for D6 RINs exceeds what can be met by blending E10 alone.

Altogether, Camp B’s tax-and-subsidize framework seems to mostly hang together for these contentions because it provides a logical explanation of the mechanism by which the RIN acts as a subsidy to draw renewables into fuels to meet the specified target volumes which is, after all, its fundamental purpose. Further, in competitive E10 fuel markets, there isn’t compelling evidence that RINs produce substantial profits for blenders. However, increasing renewable volume obligations under the RFS threaten to complicate the tax-and-subsidize framework that worked so neatly for our E10 example. Additionally, individual regional E10 markets are not perfectly efficient, meaning that user results will vary. 

[The U.S. Refinery Billboard provides an unprecedented view into the economics and operations of domestic refineries. This weekly report includes regional price spreads and netbacks as well as a refinery-specific breakdown of indicative margins based on 5-year average feedstock and yield sets in Baker & O’Brien‘s PRISM™ refinery modeling system. Click here for more information and a sample report.]

The RIN drama goes far beyond what we’ve covered so far in this blog series and our E10 example. We have not yet touched on other related issues familiar to some readers, like the ethanol blend wall, higher ethanol blends like E15 and E85, the "nesting" of RIN categories, RIN pricing, and what happens when there are hard limits on supply or demand for a blended fuel or its components – but the framework we’ve described here is fundamental to understanding and analyzing those topics.

Taking a step out of the theoretical and into a quantitative model, how can we apply the concepts above to make sense of RIN prices? There are a couple of indicators we can look at. For starters, a regression of ULSD and soybean oil (SBO) to RIN prices does a pretty good job of correlating. If SBO is traded at a large premium to ULSD the D4 RIN price goes up, whereas if the spread is narrow, the RIN price declines. Why? Because the difference between ULSD and soybean oil prices indicates the amount of subsidy required to incentivize biomass-based diesel production and/or imports. Because the RIN price reflects the amount of subsidy required, other subsidies like the Blender’s Tax Credit (BTC) and LCFS will also affect the relationship. This regression described above only applies as long as the BTC remains in effect. Once it disappears (or, rather becomes a production tax credit in 2025), the RIN price will adjust upward to account for the loss of the BTC. Essentially, the coefficients on the regression equation will change to account for the loss of the BTC.

Alternatively, Hoekstra Trading uses a RIN pricing model that describes the effects of economic variables on RIN prices based on their vintage (vintage refers to the year a RIN was created). Factors influencing RIN prices include the price spread between ULSD and biodiesel as well as the effects of the blender’s tax credit. We refer to that model as the IMS model after its three authors — last names Irwin, McCormack, and Stock — and we have implemented it in a spreadsheet. Figure 2 is a chart from this sample spreadsheet for D4 RINs, which shows theoretical D4 RIN prices (black line) alongside actual prices for 2021-vintage D4s (blue dots) and 2022-vintage D4s (orange dots) so users can understand the fundamental economic variables and parameters that broadly influence price changes for D4 RINs.

Figure 2. Sample Chart from RIN Pricing Spreadsheet. Source: Hoekstra Trading LLC

You can download this sample spreadsheet and adjust the model’s parameters, which will shift the expected RIN value shown by the black line and display how they compare with actual average prices for this time interval. This spreadsheet and related price modeling capability can be used to study and interpret RIN price dynamics, capitalize on RIN price arbitrage opportunities, and forecast and make informed estimates of how changes will affect RIN prices. Understanding how the market as a whole may react, you can then begin to determine the impact to individual regions, markets, refiners, and blenders.   

Regardless of what happens next on the legal front, RIN strategy will continue to be an important aspect of financial management in the refining industry for the foreseeable future. We expect that litigation over the Renewable Fuel Standard will continue, but for now you can make your own informed opinions about the disagreements (or are they misunderstandings?) that underlie that long legal battle.

“Misunderstanding” was written by Phil Collins and appears as the fifth song on side one of Genesis’ 10th studio album, Duke. Released as a single in May 1980, the song went to #14 on the Billboard Hot 100 Singles chart. According to Collins, the song was influenced by The Beach Boys’ “Sail on Sailor,” Sly and the Family Stone’s “Hot Fun in the Summertime,” and Toto’s “Hold the Line.” Personnel on the record were: Phil Collins (lead vocals, drums, drum machine, percussion), Tony Banks (keyboards, twelve-string guitar, backing vocals), and Mike Rutherford (guitars, bass, bass pedals, backing vocals).

Duke was recorded in November and December of 1979 at Polar Studios in Stockholm, with Genesis and David Hentschel producing. Released in March 1980, the album went to #11 on the Billboard 200 Albums chart. It has been certified Platinum by the Recording Industry Association of America. Three singles were released from the LP. 

Genesis is a British rock band formed in Godalming, Surrey, England, in 1967. The band was a pioneer of what was to be labeled progressive rock. Its most successful lineup consisted of Collins, Banks and Rutherford. Original lead singer Peter Gabriel left the band in 1975 to pursue a successful solo career. Genesis has released 15 studio albums, six live albums, four compilation albums, two EPs and 43 singles and have sold over 100 million records worldwide. The band was inducted into the Rock and Roll Hall of Fame in 2010. Eleven people have passed through its ranks since its inception. The band played their last concert together in March 2022, with Collins saying it would be his last Genesis tour due to health issues.

Receive the Free RBN Daily Energy Blog via email every morning to stay on top of energy market trends and the mechanics that drive them.

Learn about new events and offers to keep you at the forefront of industry news and opportunities.