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.
Much Ado About Something: Why Everyone is Yelling About SRE’s
There are some things that people do, and we just fail to understand why. Putting pineapple on pizza or thinking pickles with peanut butter is a good idea, for instance. Sometimes, granting an entity a Small Refiner Exemption (SRE) can be a lot like that. It’s a little weird and a bit strange. In this month’s article, I am going to talk, somewhat briefly, about the “why” portion of SRE’s and, more importantly, what’s all the yelling about?
As I’ve discussed in a previous article, to receive a small refiner exemption, you had to be a small refiner and you had to show a disproportionate economic hardship. There are a few more details you should know, to get those, read Becoming the Outcast: The “What” Portion of the Small Refiner Exemption. You will also want to have a good grasp on the Renewable Volume Obligations (RVOs) and the Renewable Fuel Standard (RFS) before you continue to read. I figured I’d get the disclaimers out of the way from the start.
So, why all the yelling? We have to start somewhere, so let’s start with what happens to the RIN market when a large number of SRE’s are granted. When an entity is granted an SRE, a portion of the RIN market that would have otherwise been there has been excused. For example, if Small Refiner A applies for and is granted an SRE, it will not need to find RINs to fulfill their obligation. Small Refiner A’s compliance obligation for the applied year has been excused and Small Refiner A will not be held to that obligation. When this is done for a single entity or even a handful of entities, the effect is barely noticeable on the RIN market. It’s basically a single ripple in the large sea of the RIN market. However, when this happens in larger numbers, the effect is more like a tidal wave.
Before we get into talking about how demand affects the RIN market, there’s a couple of things that you need to keep in mind. First, the RIN market is not like the stock market. The RIN market is developed off of a compliance obligation, rather than an investment interest. This means, the thing that drives the market is a regulatory operation rather than an economical consideration. Second, EPA has sole authority in granting or denying an SRE. This means EPA decisions drive the RIN market similarly to the way rumors drive the stock market.
Traditionally, EPA was extremely selective in the number of SREs granted. For example, in 2013, EPA received 29 SRE petitions but only granted 8 of them. EPA granted 8 petitions in 2014 and 7 petitions in 2015. However, in 2016, EPA began granting SREs in much larger numbers. To put this in perspective, in 2016, the EPA granted 19 SREs. These numbers continued to increase with 35 SREs granted in 2017 and 31 granted in 2018. If you would like to take a look at the data for yourself, EPA makes publicly available the number of SREs granted for a given compliance year, as well as other public data.
As you may have noticed by the numbers, EPA seemed to be deliberately less selective in the number of SREs that they granted. Part of this is due to a court case that changed the way EPA evaluated how SREs petitions are analyzed. I’m not going to touch on that case in this article, but I might do so in the future. #suspense. The significance of EPA granting this number of SREs, is the way it affected the RIN market. Again, the RIN market is driven by the compliance obligation, not an investment interest. When EPA exempted tens of thousands of gallons, it essentially took away a portion of the demand, which drove RIN prices down.
Why is RIN prices being driven down a bad thing? This gets really complicated very quickly. Whether RIN prices being driven down is a bad thing is also entirely dependent on the position of the RFS market participant. For blenders of renewable fuel, the entities that allow RINs to flow from the point of generation to retirement, significant decreases in RIN prices make a blending operation less economically feasible. By making blending less economical, blenders will probably not blend as much fuel, which means there will be less RINs available to go to market.
Driving down RIN prices also can be economical harmful to producers of renewable fuel. Producers of renewable fuel look at the RIN market as a indication of demand. For example, if all obligated parties everywhere needed RINs to retire against their obligation, producers would have to ramp up the manufacturing of renewable fuel to meet those needs. If gallons creating an obligation are excused, then the demand for RINs is down, which means the demand for gallons of renewable fuel to blend could also be down.
Now, let’s point out a couple of obvious things. First, in the previous two paragraphs I’m assuming RINs are the only reason blenders blend and producers make renewable fuel, and that’s simply not true. Any well run fuel business probably has multiple revenue streams. The examples of what happens when RIN prices are down are feasible results and have been shown to happen, but are by no means the only reason a blender no longer blends or a producer ratches down production. Second, I’m inherently biased. I work with blenders of all shapes and sizes on a regular basis and I know the trials and tribulations they encounter. From my perspective, RIN prices being driven down is always going to be inherently bad, but you should know there are other sectors of the RIN market, such as refiners, that would not agree with me. The SRE saga is far from over. Just recently, EPA denied all “gap” SRE petitions, which was not an expected move for the renewable fuels industry. Will EPA continue to grant SREs in such large numbers? Your guess is as good as mine
Becoming the Outcast: The “What” Portion of the Small Refiner Exemption
What do car wrecks, hangnails, and Small Refinery Exemptions (SRE) have in common? Nobody likes them. Well, ok, if you’re a participant in the Renewable Fuel Standard (RFS) and not a small refinery, you might not like SREs very much. But why, though? If you’re new to the RFS and you don’t have a good grasp of the industry, you might find all the hulabaloo a bit much. There is a lot that could be said about SREs, but for the moment, let’s discuss what they are first.
There are two pieces to SRE’s. For the first piece, to even be able to apply for the exemption, you have to be a small refinery. A small refinery is defined by the regulations as: “a refinery for which the average aggregate daily crude oil throughput (as determined by dividing the aggregate throughput for the calendar year by the number of days in the calendar year) does not exceed 75,000 barrels.” That’s kind of a mouthful, right? Once you break it down, it’s actually pretty simple. The term throughput means the amount of crude oil that is refined into a consumable product such as gasoline, diesel, or jet fuel. Essentially, if you break down the definition, to be considered “small,” a refinery cannot produce (refine) more than 75,000 barrels worth of gasoline, diesel, or jet fuel for any given year. Makes it a lot easier to understand when you break it down, huh?
Now, the second piece is the exemption portion . As the name might imply, the exemption is an exception to the requirement of Obligated Parties (OPs) to have to fulfil their Renewable Volume Obligations (RVOs) by retiring RINs. If you don’t understand what any of that means, read Easy Peezy Lemon Squeezy: The Regulatory Purpose of the RVOs, written by yours truly. While that is absolutely a shameless plug for you to read my articles, it is also a good way for you to understand the exemption portion this equation. If you don’t understand that portion, the rest of this article might be a little abstract.
To fully understand what an SRE is, you need to understand a bit of regulatory history. It’s not as boring as it sounds, I promise. When the first version of the RFS was put into practice (RFS1), small refiners were exempt from the regulatory requirements of the RFS. As long as you were a small refinery in the calendar year 2004, the small refinery could apply for an exemption from the requirements from the time of application (which had to be submitted by August 31, 2007) until December 31, 2010. In addition to the initial exemption, the small refinery could petition the EPA Administrator for an extension of that exemption for an additional 2 years. To qualify for the extension, the small refinery had to prove that compliance with the requirements of the RFS would result in an “disproportional economic hardship.” I get it, you want to know what that means, but that’s a longer discussion than you might be prepared for, so for the moment, lets get back to history.
When RFS2 began, many small refiners were still struggling from the RVO requirements of the RFS. To ensure that they would be able to maintain their RVOs in the future, RFS 2 reiterated SREs. Essentially, the regulations gave SREs a bit of a remix by changing the dates, but that’s about all that changed. Any small refinery that had applied for an SRE had to prove that they were a small refinery for the calendar year 2006, instead of 2004. Again, the small refinery could apply for an extension of the exemption for an additional 2 years as long as it could show a “disproportionate economic hardship.” The EPA Administrator, whether the petition was for an original exemption under RFS 1 or RFS 2 could take no longer than 90 days to issue a decision on the petition. If the EPA Administrator granted the petition, the small refiner was granted an exemption to the RVO requirement and would not have to fulfill their obligation. If the Administrator denied the petition, the small refiner was on the hook for their compliance obligation.
All good things have to come to an end. For small refiners, that ending was on December 31, 2012. By that date, all original exemptions and initial extensions would have run. However, the small refiner could still get around the RVOs. Beginning in 2013, small refiners had to petition for an extension of the exemption every year. Keep in mind, this means the small refiner had to have been granted an exemption in the first place. Following the December 31, 2012 deadline, if the small refiner had let an extension from previous compliance years lapse or had never applied for an SRE in the first place, the small refiner could not petition for an extension for an SRE. This changed the landscape a bit on SREs for small refiners. Since RVOs are determined on an annual basis, the small refiner had to know much more quickly than in previous years whether or not they could meet their RVOs. The current SRE is more of an extension of the original exemption under RFS 1. Admittedly, this is more a question of schematics, but the application can be important in the current discussion surrounding SREs in the renewable fuel industry. I’ll write more on that at another time. I know, I know, the suspense is killing you!
So, to recap, the SRE is an exemption to the RVO requirements of the RFS. To be eligible for an SRE, the refiner had to be considered a small refiner and had to petition for an exemption by the appropriate compliance deadline. Exactly! See? That wasn’t so bad!
Save Your Receipts! The Inside Scoop on Product Transfer Documents
Do you ever go into a store and completely forget your grocery list? You walk out with a 9-foot receipt and items that you probably didn’t need. Or is that just me? Anyway, that 9-foot receipt is basically what the renewable fuel industry would call a Product Transfer Document (PTD). It works a lot like a receipt for a RIN transaction, and it’s required by the regulations. #bonus.
Unlike my shopping experiences, a PTD can fit on a single page. Convenient, right? Every PTD is required to contain the following information:
- The name and address of the transferor and transferee
- The transferor’s and transferee’s EPA company registration numbers
- The volume of renewable fuel that is being transferred, if any
- The date of the transfer
- The quantity of RINs being traded
- The D code of the RINs
- The RIN status (Assigned or Separated)
- The RIN generation year
- The associated reason for the sell or buy transaction (e.g., standard trade or remedial action).
It looks a lot like the kind of information contained on receipt, doesn’t it? If you keep in mind that a PTD and a receipt have a lot in common, it becomes a lot easier to identify. Why might a PTD be difficult to spot? The regulations do not have a required format for PTDs, so companies can provide that information in a manner that is the most convenient for them. Sometimes it is far more useful to know what information you’re looking for rather than where to look for it.
So, if you were to look for a PTD, where should you look for it? …great question. Many companies include the information found on a PTD within their invoice. The RIN information, such as how many RINs are being transferred, whether the RINs are assigned or separated, and the RIN year, can be found in various spots on the invoice. In other cases, companies abandon the treasure hunt and simply include an additional page with the invoice, clearly labeled Product Transfer Document. It’s really nice when that happens. Want to see a picture of what you’re looking for? Or how about this one? #picsoritdoesntcount.
Great. So I’ve got this document that may or may not be labeled PTD and yeah… Is it actually necessary to keep? Here’s the point where you want to pay really close attention: Do. Not. Discard. PTDs. Why? Well, for two reasons. First, the regulations say that you must keep all PTDs for at least 5 years. Second, because when it comes time to complete an annual attest engagement, your company’s auditors are going to want to see those. What happens if you lost them or can’t find them? The PTD police come to get you. #kidding. A PTD is evidence that a transaction occurred. If you lose a PTD or can’t find one, reach out to your supplier sooner rather than later. They should have a copy of it. Ensuring that you have all your PTDs before attest engagement season will make your compliance work a lot easier.
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.
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…