An Entertaining 101 on Regulatory Issues Impacting the Renewable Fuel Standard
Introducing Kayley Grant
Thanks for stopping by my blog. My name is Kayley Grant and I am the Compliance Advisor for RINAlliance. The articles posted here are dedicated to explaining the regulatory issues that affect the EPA’s Renewable Fuel Standard, as well as other related fuel industry issues. My wish is that these articles not only entertain you, but also keep you better informed.
How do I know what I’m talking about? Afterall, I am just a millennial and this could very well be another thing that I unceremoniously ruin. I received my Juris Doctorate from Drake University Law School in 2016. After spending some months in litigation, I realized that suing people isn’t what I wanted to do with my life. Before you ask, yes, that would have been a more convenient revelation prior to going to law school, but hey, here we are. So, I’m using my library of sarcastic comments, legal experience, and knowledge of the industry to get the stale, often misunderstood, regulatory issues out to the public at large in a more entertaining fashion.
When I’m not sitting at my computer hopelessly trying to overcome the world’s worst case of writer’s block, I enjoy spending my time outdoors or at the gym. I am an avid reader, Netflix enthusiast, and enjoy cooking (or thinking about how to cook) the things I find on Pinterest. I am a fan of the Chicago Bears, Chicago Bulls and the Chicago Cubs…at least I have a theme? I hope you enjoy what you read here and walk away feeling a little more knowledgeable.
Easy Peezy Lemon Squeezy: The Ins and Outs of the Renewable Volume Obligation
After reading the title to this article, I suppose you’re expecting to see a lot of regulatory and legal hieroglyphics. Plot twist. I’m going to explain the regulatory purpose of the Renewable Volume Obligation (RVO) in a way that makes sense and can include you in the industry conversation like the cool kid you are. #trendworthy.
So what is the RVO and why should you care? Overall, the Renewable Volume Obligation is the volume of renewable fuel, in gallons, that must be blended to produce transportation fuel. On an individual level, the RVO is the regulatory duty (obligation) an importer or refiner of nonrenewable fuel (e.g., gasoline, diesel) incurs as a result of their day-to-day business activities. By mandating this obligation, the federal government is attempting to disincentivize the continued refining and use of fossil fuels (nonrenewable fuels, such as gasoline and diesel), to be made into transportation fuel. Refiners and importers, as a result of their day-to-day business activities, go against the federal government’s wishes and, as a result, have to pay for it. The businesses that incur an obligation are called, predictably, obligated parties. Makes a lot of sense, right? An obligated party incurs…wait for it…an obligation. See? This isn’t that hard.
By now you’re thinking that an obligation needs satisfied right? Right. EPA only requires the very small sacrifice of your first born. Totally joking, EPA is not in the business of taking other people’s children. In order to incentivize the production and blending of renewable fuels, the federal government requires that the obligated party (remember, that’s the company that incurred the obligation) to replace, gallon for gallon, the volume of nonrenewable transportation fuel with renewable transportation fuel. The way this works is an obligated party has to obtain intangible credits called Renewable Identification Numbers (or RINs) and retire (essentially, count against) their incurred obligation. There are, very generally, two different approaches to accomplishing this regulatory requirement: (1) a business can produce and blend renewable fuel, separate the RIN and retire it, keeping the entire operation to themselves or (2) purchase the RINs on an individual basis and retire them, without engaging in any actual blending of renewable fuel.
You’re wondering what a RIN is, aren’t you? A RIN is an intangible credit that is attached to a gallon of renewable fuel. While you can’t touch or see a RIN, think of it like a sticker on the side of the gallon. Once that gallon of renewable fuel is blended with gas or diesel to be used for transportation fuel, the RIN is detached, or separated, from the gallon of renewable fuel (like peeling the sticker off the side of the gallon). As you might expect, the regulations refer to a RIN that is no longer attached to a gallon of renewable fuel as a separated RIN. The separated RIN can then be traded among blenders and obligated parties, until it is used to retire against an obligation. You can do this, I promise! At least that’s what my parents keep telling me about remaining gainfully employed and out of their basement. #millenialproblems.
So to recap, an obligated party incurs an obligation that has to be satisfied. The only way to satisfy that obligation is to retire the things called RINs against that obligation. RINs can be traded among different participants but only once they have been separated from the gallons of renewable fuel. Now you’re cooking with gas! …or biodiesel…
The Biofuels Trilogy: Renewable Volume Obligations, RINs and the Renewable Fuel Standard
All the good things come in threes: the Three Amigos, the Hunger Games trilogy, three-for-one specials. I’m sure there’s more but, you get the picture. When the Renewable Fuel Standard (RFS) mandated the requirement of obligated parties to fulfill their obligation by retiring RINs, it created a market where RINs can be bought and sold among RFS participants. Driving this market are the annually-set Renewable Volume Obligations (RVOs), which can increase an obligated party’s need for RINs.
In case you have no idea what that means, an obligated party incurs an obligation from the type of business activity they perform. If you’re still lost, read my prior article Easy Peezy Lemon Squeezy: The Ins and Outs of the Renewable Fuel Standard. #shamelessplug. Keep in mind, RINs aren’t magical beings that mysteriously get traded, they’re created (generated) and attached to gallons of renewable fuel. Once the gallon of renewable fuel has been blended, the attached RIN is deattached from the gallon and is free to be traded. Now, the stuff that’s coming up is going to focus on the RFS, RVOs and RINs from a market angle, but it will be an overview, so you don’t need a degree in economics to understand it.
Ok, the first thing you need to understand is a little background. Don’t groan, I promise not to make this like your high school history class. When the RFS was first established by the Energy Policy Act (EPACT) in 2005, it brought with it a new market opportunity – that of the RIN trade. In many ways, the RIN trade appeared to act similarly to the stock market by allowing RFS participants to trade an intangible credit. The biggest obvious difference between the two is that the stock market gives the investor a market share in a company and a RIN is a component of a compliance requirement.
To be clear, this market differs from a commodities market, because the existence of the market itself is based on the production and blending of renewable fuel. RINs are, more or less, a representation of how many gallons are blended to be transportation fuel. I don’t want you to get the impression that RINs are spontaneously formed and then traded. RINs don’t just suddenly appear out of nowhere, and if they do, they’re probably fraudulent.
Speaking of fraudulent, it was pretty easy to manipulate and scam the RIN market in the beginning. My favorite story is of a small blending operation in New England. The owner never blended fuel, but flooded the market with fraudulent RINs, made millions of dollars, and then disappeared with his family to Argentina to live a life of luxury. #lifeplan. While that story is one of my favorites, there are dozens more just like it. After more instances like this popping up, the federal government decided that maybe something should be done and passed the Energy Independence and Security Act (EISA) in 2007. After EISA, RIN market security was greatly improved and there are only rare instances of invalid RINs.
So, what’s the second thing that you need to know? It’s that I’m awesome…and that, as a consequence of how the RFS was created, the RVOs drive RIN prices and RIN demand. While the RVOs dictate how many gallons of renewable fuel need to be blended to make transportation fuel, they also dictate how many RINs an obligated party will need to satisfy their obligation. Predictably, the higher the RVOs are set, the more RINs will be needed by an obligated party. It is this sort of push and pull that drives the RIN market. When RVOs are raised, obligated parties have more of a need for RINs and the RIN market will adjust to that demand.
Now, let‘s be clear about a couple of things. First, production will adjust to meet demand, meaning lower RVOs could mean less RINs on the market. Producers and blenders of renewable fuel will adjust their yearly targets to reflect the fact that the RVOs have decreased which means there is less of a regulatory need or demand for renewable fuel and, as a consequence, RINs. Less demand means the RIN prices will see a decline in value. It is possible that those type of RINs, we’ll call them “excess” RINs, hold value in the next compliance year if an obligated party uses prior year RINs, but that also assumes the RVOs are not re-lowered. It’s like the quarterback tradition for the Chicago Bears. The next one could be better than the last…or not. Second, as long as the RFS continues to exist, the need for RINs will also continue to exist. RINs are a compliance necessity, rather than a business interest. This means a RIN market is more of a “sure thing.” Keep in mind, the RFS is a creation of the federal legislature and as a consequence, the RFS is subject to policy decisions and measures. However, unless the RFS disappears, RINs will still need to be obtained by obligated parties, and compliance measures will still need to be observed.
Will the RIN market react to things like rumors and federal policy changes? Absolutely. Afterall, the RIN market is still a market. There are companies that trade based on those rumors and federal policy changes. The trading habits that typically follow the stock market or a commodities market are certainly mimicked on the RIN market. However, there are also companies that procure RINs solely on the basis of a compliance need. In this way, the RIN market is a beast unto itself inherently existing as a commodities market or a compliance need, depending on the participant.
The RIN market also requires that all regulatory components be present. The RFS cannot exist, from the standpoint of procedure, without the mechanisms of RINs to make it work. The RVOs can’t be satisfied if the RINs don’t exist and RINs wouldn’t exist if the RFS didn’t create the RVOs. Having one without the others would be like eating popcorn without butter and salt: completely pointless. The RFS, RVOs, and RINs have to exist in a threesome to create the RIN market.
Its just like I told you at the beginning: all good things come in threes.